Overview: Insurance policies fall into two categories based on how the payout after a loss is calculated — and which category applies has significant consequences for how much the insured receives.

The Principle of Indemnity

The cornerstone of property and casualty insurance is the principle of indemnity: insurance is designed to restore the insured to the same financial position they were in immediately before the loss — no better, no worse. The goal is to make the insured whole, not to make them wealthy.

This principle exists because the moment insurance can produce a profit from a loss, it creates a financial incentive to cause that loss — the definition of moral hazard. If you could collect $500,000 for a house worth $200,000, you would have a powerful incentive to ensure the house burns down. The principle of indemnity forecloses that incentive.

In practice, indemnity contracts calculate the payout based on the actual financial loss suffered, subject to the policy limit. The insurer typically uses either:

Actual Cash Value (ACV): replacement cost minus depreciation. A five-year-old laptop worth $1,000 new but $250 now gets paid at $250.
Replacement Cost Value (RCV): the cost to replace the item new, without a depreciation deduction. This is a contractual enhancement to the strict indemnity rule.

The principle of indemnity is enforced through three supporting mechanisms: subrogation (after paying a claim, the insurer steps into the insured's shoes to recover from the responsible third party — preventing the insured from collecting twice), contribution (when multiple policies cover the same risk, they share the loss proportionally so the insured never collects more than 100% of the loss), and the insurable interest requirement discussed above.

Indemnity Contracts vs. Valued Contracts

An indemnity contract pays based on the actual loss — always measured after the fact. This is the standard for property and casualty insurance.

A valued contract (sometimes called an agreed value contract) bypasses post-loss measurement entirely. The insurer and policyholder agree in advance on the amount to be paid if the covered event occurs, and that amount is paid regardless of what the actual loss turns out to be.

Feature	Indemnity Contract	Valued Contract
Payout calculation	Actual loss, measured after the event	Pre-agreed fixed amount
Depreciation	May be applied	Irrelevant
Overpayment risk	Prevented by actual-loss measure	Possible if item appreciates
Common in	Property/casualty insurance	Life insurance; fine art; antiques

Life insurance is almost always a valued contract. This is not an exception to the principle of indemnity — it is a recognition that human life cannot be assigned a precise monetary value, so indemnification in the traditional sense is impossible. The policyholder and insurer agree that upon the insured's death, the insurer will pay a specific face amount — $250,000, $1,000,000, or whatever was contracted — without any attempt to measure the "actual financial loss" the death caused. The insurer simply confirms the death occurred and pays the agreed sum to the beneficiary.

Fine art, rare collectibles, and other unique items may also be insured under agreed value or valued policies when objective market pricing is unreliable.