Period Of Indemnity: Definition and Examples

Period Of Indemnity

Investopedia / Ellen Lindner

What Is a Period Of Indemnity?

The period of indemnity is the length of time for which benefits are payable under an insurance policy. It is also used to denote the time period for which indemnity or compensation is payable under a business interruption policy. The period of indemnity is usually the most critical component of quantifying the business interruption loss.

Key Takeaways

  • The period of indemnity is the length of time for which benefits are payable under an insurance policy.
  • The period of indemnity is also used to denote the time period for which compensation is payable under a business interruption policy.
  • Typically, an indemnity period will have a time limit stated within the policy, such as 12, 24, or 36 months.

Understanding Period Of Indemnity

Indemnity is a legal contract in which a company agrees to pay for financial losses and damages caused by another party or event. Insurance contracts typically contain indemnity agreements in which the insurer agrees to compensate the policyholder or the insured for any financial losses and damages to the assets covered under the policy. In return, the insurance company receives monthly premiums paid by the policyholder. If needed, the policyholder can file an insurance claim, which is a request to the insurer for financial compensation for a covered loss. If an insurance claim is filed as a result of a loss, the policyholder is made whole financially by the insured, which covers any of the costs associated with the claim. 

For example, a homeowner with a homeowner's insurance policy would pay monthly premiums to the insurer in exchange for financial protection in the event of a natural disaster. If the home is damaged by a fire, the insurance company will cover the costs to repair the home and restore it to its previous state. The period of indemnity would be the length of time that the insurer would make payments to the contractors or homeowner for the repairs and restoration.

An indemnity can also be used in the corporate world to protect a party from financial loss covered under the terms of the policy. For example, a indemnity is common with members of an company's board of directors, who oversee the direction of the company and appoint the chief executive officer (CEO). The board members would have financial protection, meaning they wouldn't be personally financially liable if there was a lawsuit or financial losses during their tenure. The insurance policy would kick in and pay out any of the costs in the event of a lawsuit.

The period of indemnity is the length of time the insurance company is obligated to make payments to cover the losses insured under the policy. Typically, an indemnity period will have a time limit stated within the policy, such as 12, 24, or 36 months. The payment of the indemnity insurance would be in the form of cash or payments to the parties who are owed money as a result of a claim.

Extended Period of Indemnity

An indemnity period can be extended so that the policy covers losses that occur beyond the event and the restoration period following the event. An extended period of indemnity is commonly found within business interruption insurance policies. Business interruption insurance covers the revenue or income that a company has lost as a result of damage to their establishment.

For example, if a company endures a natural disaster, such as a fire, the property insurance policy would cover the cost of the repairs. The business interruption insurance would cover the lost revenue from the lack of sales as of result of being shut down while the repairs are completed.

An extended period of indemnity coverage extends the covered loss period beyond the time required to restore the property. In many cases, businesses don't immediately bounce back following being shut down due to a disaster. Even with full restoration, many businesses often experience fewer customers and lower sales following the restoration period and reopening.

The period after restoration is critical because, without insurance coverage, the full costs of business operations are being absorbed without corresponding income. The effect of the revenue shortfall, therefore, directly hits the bottom line or profit. However, with extended period of indemnity coverage, the insured can be indemnified for the shortfall that occurs during this extended period.

An extended period of indemnity endorsement also enables a policyholder to recoup significant pre-opening expenses, incurred during the extended period, to restore revenues to their pre-loss levels. They might include extraordinary advertising and public relations activities or hiring new personnel. These expenses are not normally covered under basic business interruption insurance because they're not normal operating expenses, nor would they be considered “expediting” expenses because they do not reduce the loss within the traditional loss period. However, these expenses do reduce the carrier’s liability when the post-restoration period is covered by an extended period of indemnity endorsement.

Business interruption insurance is not a separate, standalone policy and may need to be added to an existing insurance policy as a rider. A rider is an add-on feature that extends coverage to an existing policy but comes with an added cost to the policyholder. Business interruption insurance can also be included in a comprehensive insurance policy.

Example of an Extended Period of Indemnity

Consider ABC corporation, which manufactures oil drilling equipment to order. After a fire causes extensive damage to its factory, a six-month shutdown ensues. When ABC reopens, company executives discover their business is only 50% of what it would have been before the loss. In the second month after reopening, the firm is only at 75% of anticipated volume. Ultimately, it takes four months after reopening to return to pre-loss levels.

One month before reopening, and for a considerable period thereafter, the company incurs significant additional expense advertising that it will be back in business shortly. These ads are placed in trade journals, and representatives are sent around the world to assure customers that the company will be able to fill their orders. Under the right extended period of indemnity endorsement, these extra costs would be covered.