This principle sets the rule according to which insurance companies undertake to compensate the insured upon fulfillment of all the stipulations that are agreed upon in the insurance contract. The insurer charges a small amount as premium for undertaking the liability to cover the risk and in return promises to pay the value of the insurance policy or the amount of loss whichever is lower. The principle of Indemnity ensures that the insurer is liable to pay up to the amount of loss and not more than that. In other words it implies that the insured should not derive any unwarranted benefit from a loss. Normally the principle of indemnity applies to property and liability insurance contracts and it promises that the insured be restored to the same financial position that existed prior to the occurrence of loss.

Whenever the insurance company indemnifies the insurer for the full value of the insurance policy (when the asset is completely damaged) the insurer takes possession of the damaged asset to realize the salvage value.