To "indemnify" means to make whole again, or to be put in the position that one was in, to the extent possible, prior to the happening of a specified event or peril. Accordingly, life insurance is generally not considered to be indemnity insurance, but rather "contingent" insurance There are generally two types of insurance contracts that seek to indemnify an insured:
- an "indemnity" policy and
- a "pay on behalf" or "on behalf of" policy.
The difference is significant on paper, but rarely material in practice.
An "indemnity" policy will never pay claims until the insured has paid out of pocket to some third party; for example, a visitor to the home slips on a floor that you left wet and sues you for $10,000 and wins. Under an "indemnity" policy the homeowner would have to come up with the $10,000 to pay for the visitor's fall and then would be "indemnified" by the insurance carrier for the out of pocket costs (the $10,000).
Under the same situation, a "pay on behalf" policy, the insurance carrier would pay the claim and the insured (the homeowner) would not be out of pocket for anything. Most modern liability insurance is written on the basis of "pay on behalf" language.
An entity seeking to transfer risk becomes the 'insured' party once risk is assumed by an 'insurer', the insuring party, by means of a contract, called an insurance 'policy'. Generally, an insurance contract includes, at a minimum, the following elements: the parties, the premium, the period of coverage, the particular loss event covered, the amount of coverage, and exclusions (events not covered). An insured is thus said to be "indemnified" against the loss covered in the policy.
When insured parties experience a loss for a specified peril, the coverage entitles the policyholder to make a 'claim' against the insurer for the covered amount of loss as specified by the policy. The fee paid by the insured to the insurer for assuming the risk is called the 'premium'.
Insurance premiums from many insureds are used to fund accounts reserved for later payment of claims in theory for a relatively few claimants and for overhead costs. So long as an insurer maintains adequate funds set aside for anticipated losses (i.e., reserves), the remaining margin is an insurer's profit.