What Is Indemnity?

Indemnity is a comprehensive form of insurance compensation for damages or loss, and in the legal sense, it may also refer to an exemption from liability for damages.

Indemnity is considered to be a contractual agreement between two parties whereby one party agrees to pay for potential losses or damages caused by another party. A typical example is an insurance contract, in which the insurer or the indemnitor agrees to compensate the other (the insured or the indemnitee) for any damages or losses in return for premiums paid by the insured to the insurer. With indemnity, the insurer indemnifies the policyholder—that is, promises to make whole the individual or business for any covered loss.

[Important: Indemnity clauses can be complicated to negotiate and can lead to increased costs of services because of the increased risk of the contract.]

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Insurance

How Indemnity Works

An indemnity clause is standard in most insurance agreements. Exactly what is covered, and to what extent, depends on the specific agreement. Any given indemnity agreement has what is called a period of indemnity, or a specific length of time for which the payment is valid. Similarly, many contracts include a letter of indemnity, which guarantees that both parties will meet the contract stipulations or else an indemnity must be paid.

Indemnity is common in agreements between an individual and a business (for example, an agreement to obtain car insurance), but it also applies on a larger scale to relationships between businesses and government or between governments of two or more countries. 

Sometimes, government, a business, or an entire industry must take on the costs of larger issues on behalf of the public, such as outbreaks of disease. For example, according to Reuters, Congress authorized $1 billion to fight a bird flu epidemic that devastated the U.S. poultry industry in 2014 and 2015. The U.S.Department of Agriculture sent $600 million of money on virus elimination and disinfection and $200 million in indemnity payments.

Special Considerations

How Indemnity Is Paid

Indemnity may be paid in the form of cash or by way of repairs or replacement depending on the terms of the indemnity agreement. For example, in the case of home insurance, the homeowner pays insurance premiums to the insurance company in exchange for assurance that the homeowner will be indemnified if the house sustains damage from fire, natural disasters or other perils specified in the insurance agreement. In the unfortunate event that the home is damaged significantly, the insurance company will be obligated to restore the property to its original state either through repairs by authorized contractors or reimbursement to the homeowner for expenditures incurred for such repairs.

Indemnity Insurance

Indemnity insurance is a way for a company (or individual) to obtain protection from indemnity claims. This insurance protects the holder from having to pay the full sum of an indemnity, even if the holder is responsible for the cause of the indemnity.

Many companies make indemnity insurance a requirement as lawsuits are common. Everyday examples include malpractice insurance, which is common in medical fields, and errors and omissions insurance (E&O), which protects companies and their employees against claims made by clients and applies to any given industry. Some companies also invest in deferred compensation indemnity insurance, which protects the money that companies expect to receive in the future.

As with any other form of insurance, indemnity insurance covers the costs of an indemnity claim including but not limited to court costs, fees, and settlements. The amount covered by insurance depends on the specific agreement, and the cost of the insurance depends on many factors including the history of indemnity claims.

Property leases also include indemnity clauses. In the case of a rental property, for example, a tenant is typically responsible for damages due to negligence, fines, lawyer fees, and more depending on the agreement. 

Acts of Indemnity

An act of indemnity protects those who have acted illegally from being subject to penalties. This exemption typically applies to public officers, such as police officers or government officials, who are compelled to break the law to carry out the responsibilities of their jobs. Often, such protection is granted to a group of people who committed an illegal act for the common good, such as the assassination of a known dictator or terrorist leader.

A Brief History of Indemnity

Although indemnity agreements have not always had a name, they are not a new concept as they are a necessary part of ensuring cooperation between individuals, businesses, and governments. In 1825, Haiti was forced to pay France what was then called an "independence debt." The payments were intended to cover the losses that French plantation owners suffered in terms of land and slaves. While the indemnity described in this article was unjust, it is one example of many historical cases that show the ways indemnity has been applied worldwide.

Another common form of indemnity is the reparations a winning country seeks from a losing country after a war. Depending on the amount and extent of the indemnity due, it can take years and even decades to pay off. One of the most well-known examples is the indemnity Germany paid after its role in World War I. Those reparations were finally paid off in 2010, almost a century after they were put in place.

[Fast Fact: The word indemnity stems from the Latin root indemnis, meaning unhurt, undamaged, or without loss.]