• Membership
• NIBA Toolbox
• NIBA Community
• NIBA College
• CAPIBA
• IRP - NIBA's Publication

User Login

‘Indemnity’ versus ‘Reinstatement’ – what’s the difference?

The term indemnity is often incorrectly used to describe a category of compensation that is distinct from reinstatement.

By Dr Allan Manning and Peter O’Brien from LMI Group

To indemnify means to compensate, whether by way of reinstatement or depreciated market value. The ordinary grammatical meaning of indemnify includes compensate, recompense, repair and make whole again.

It has become common practice to differentiate between indemnity and reinstatement (or where repairs are not embarked upon, replacement) as two distinct categories of compensation.

This fallacy owes its origin, in part, to a convenient means of differentiation between a market related value and the cost of reinstatement (or replacement). This potentially artificial distinction between the two scenarios has, to an extent, been perpetuated by the courts.

Reinstatement, as a method of compensation, is a form of indemnity. Certain policies define indemnity as constituting reinstatement and the courts have held that, in appropriate circumstances, the appropriate measure of indemnity is reinstatement.

Despite the underlying principle of insurance to place the insured in a pre-loss position, the stark reality of contemporary policies (which may provide for reinstatement value and a variety of additional benefits) is that insureds can and do profit from losses. An insured whose ageing printing machinery is replaced pursuant to a loss is undoubtedly in a better position than he was prior to the event. However, where an insured is given ‘new for old’ compensation, he is nonetheless being indemnified.

At common law (i.e. in terms of the principles enunciated by the courts over the years) there are several ways that a loss can be quantified. The most common method of determining the indemnity value of a building, or piece of plant or equipment, is to start with its full replacement value and then make adjustments for the age, wear and tear, and the general condition of the item.

A second method is to determine the value of the property prior to the loss compared to its value after the damage. In the case of land, this value is usually determined by a registered valuer and in the case of other property, by specialist valuers. Where equipment is involved, the post-loss value is often only a small percentage of the replacement cost, or may be confined to the salvage value or, in the instance of obsolete but functioning equipment, there may be no value left at all.

With buildings, the method may only be appropriate where the property was for sale at the time of the loss. It is unlikely to be a fair measure of indemnity if the insured had no intention of selling the property and was holding it as an ongoing income-earning asset, or if it was the insured’s family home.

The difference between the pre- and post-loss values approach represents an objective value to others, but ignores the intrinsic loss that the insured has suffered. If this approach were to be universally applied, in many cases it would be rather meaningless for an insured to arrange cover for an old building where the value of the land exceeded, or was the same as, the combined value of the land and buildings.

With items of plant and equipment or contents, the second hand value may be the most appropriate, especially if the risk has been assessed, and the premium calculated, on the second hand value. Many policies avoid any confusion by defining exactly how the damages are to be measured, such as is frequently found under a ‘Basis of Settlement’ clause.

Although there are other methods of valuing property, these are beyond the scope of this article. A more comprehensive treatise of the topic can be found in Dr Allan Manning’s soon to be published 6 Principles of Insurance.

Although many of us are guilty, to varying extents, of using the terminology of indemnity and reinstatement/replacement as mutually distinct categories, they are often one and the same. In practice, the overlap between the terms seldom poses a problem as the various methods of calculating a loss do not hinge on the terminology in isolation but rather are interpreted according to the facts and specific policy wordings.