What Is Indemnity Insurance?

Indemnity insurance is a contractual agreement in which one party guarantees compensation for actual or potential losses or damages sustained by another party. Most commonly, it is an insurance policy designed to protect professionals and business owners when found to be at fault for a specific event such as misjudgment.

Typical examples of indemnity insurance include professional insurance policies like malpractice insurance and errors and omissions insurance. These special insurance policies indemnify or reimburse professionals against claims made as they conduct their business.

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

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Indemnity Insurance

How Indemnity Insurance Works

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 insurance, which is sometimes referred to as professional liability insurance, is a supplemental form of liability insurance specific to certain professionals or service providers. The professionals provide counsel, expertise, or specialized services. Indemnity insurance is unlike general liability or other forms of commercial liability insurance that protect businesses against claims of bodily harm or property damage.

Indemnity insurance protects against claims arising from possible negligence or failure to perform that result in a client’s financial loss or legal entanglement. A client who suffers a loss can file a civil claim, and in response, the professional’s indemnity insurance will pay litigation costs as well as any damages awarded by the court.

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.

Key Takeaways

  • Indemnity insurance is a contractual agreement in which one party guarantees compensation for actual or potential losses or damages sustained by another party. 
  • Most commonly, it is an insurance policy designed to protect professionals and business owners when found to be at fault for a specific event such as misjudgment.
  • Certain professionals must carry indemnity insurance. Examples include those involved in financial and legal services, such as financial advisors, insurance agents, accountants, mortgage brokers, and attorneys.

Special Considerations: Indemnity Insurance in Practice

Certain professionals must carry indemnity insurance. Examples include those involved in financial and legal services, such as financial advisors, insurance agents, accountants, mortgage brokers, and attorneys. When dispensing financial or legal advice, these professionals are potentially liable for negligence or inadequate performance despite the intent of goodwill.

In the financial industry, a professional who provides financial advice that results in the purchase of an insurance or investment product must purchase errors and omissions insurance (E&O). As an example, accountants may be found negligent for advising a client on tax matters that in turn result in a penalty or additional taxes.

In the medical field, malpractice insurance is a form of compulsory professional indemnity insurance. Malpractice insurance protects medical practitioners from civil claims arising from negligence which result in physical or mental harm to patients. A growing number of executives are purchasing indemnity insurance to protect their deferred compensation plans against company claims or bankruptcy. Other professions, such as contractors, consultants, and maintenance professionals, carry indemnity insurance as a practical matter due to their exposure to “failure to perform” claims.

Professional indemnity insurance provides a critical layer of protection for service providers. Often these professionals might also need other forms of liability coverage such as general liability insurance or product liability coverage. Indemnity policies may also carry an endorsement. An endorsement extends coverage to acts that occurred during the life of the policy even if the policy is no longer in effect.