What are the Differences Between Indemnity and Insurance?
While both indemnity and insurance are ways to manage risk and avoid financial losses, what makes them different is the way they undertake risk. This article is going to focus on how indemnity and insurance work, and why they take different approaches to managing risk.
What is Indemnity?
According to Investopedia “Indemnity is a comprehensive form of insurance compensation for damages or loss. When the term indemnity is used in the legal sense, it may also refer to an exemption from liability for damages.”
In that legal sense, Indemnity refers to a clause in a contract. In said clause, party number One (the indemnifier) promises, voluntarily, to protect party number 2 (the indemnified) in case of a loss cause by an event or occurrence. This Indemnity clause, therefore, transfers risk of loss from the indemnified to the indemnifier.
Indemnity clauses can be found in many distinct types of contracts. These clauses are quite common in the construction industry. In the case of construction, an indemnity clause works to protect the owner of the property (The indemnifier) from claims of injury from indemnitees on the construction site. Without an indemnity clause there would be no way for an insurance policy to establish accountability.
There are six common types of indemnity clauses:
- Bare indemnities: Indemnifies for all liabilities or losses incurred in a specific event with no limitations on the number of losses it covers.
- Limited indemnities: Indemnifies against losses except when the occurrence involves the indemnified own actions.
- Reverse indemnities: Indemnifies against losses associated with occurrences originated on the indemnifier’s own actions.
- Party indemnities: Indemnifies both parties for losses caused by the indemnifier’s breach of contract.
- Third party indemnities: Indemnifies against claims by a third party.
- Financing indemnities: Indemnifies against losses incurred if a third party fails to deliver on their financial obligations.
How Does Indemnity Relate to Insurance?
While Indemnity transfers risks from one party to another, in an insurance policy, the insurer receives a premium for the acceptance of risk. With insurance, Instead of only transferring risk, the insurer absorbs that risk in exchange for an amount of money that is determined by measuring the amount of risk.
There is a point to be made in that insurance and indemnity are complementary. Furthermore, they are usually required legally. So, for example, any retail store that does not own, but rents their physical location will have an indemnity clause with their property owner. At the same time, as is required by law they will have and a General Commercial Liability insurance policy to respond to whatever claim may arise, be it bodily injure or property harm.
Complementary and Non-Mutually Exclusive
An indemnification clause not only establishes who is accountable for risks on a particular project, but it can dictate how the insurance policy must respond to the indemnitee or how the risk is addressed in a particular situation.
It is important to highlight that liability covered under an indemnity clause can exceed the indemnitor’s insurance limit. That is why it is important to have the two concepts well differentiated and to keep adequate track of insurance policies and contracts.
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