Indemnity principle

Castellain v Preston, English Court of Appeal, 1883: a fire insurance contract is a contract of indemnity, the insured may not profit from the loss, and the insurer recovers what it would otherwise overpay. This is the cardinal rule of property and casualty insurance. The indemnity paid by the insurer can never exceed the loss the policyholder actually suffered, measured at the date of the loss. The rule does two jobs. It protects the moral character of insurance, because a contract that let the insured profit from a loss would eliminate the aleatory nature of the contract and create moral hazard. It also sets the measure of what the insurer owes, which is confined to restoring the policyholder's financial position. In practice it brings in the insurable interest requirement (the policyholder must have an economic interest in preserving the insured subject matter) and the proportionality rule for under-insurance. Subrogation flows from it too: the insurer that has paid can claim against the responsible third party, up to the amount it paid. Parametric insurance puts the rule to the test. It pays a predefined amount whatever the actual loss, so it can over-indemnify or under-indemnify. That tension has led some jurisdictions to treat parametric products as financial derivatives rather than insurance in the classical sense, with significant regulatory consequences.