What is compensation?

Compensation is a legal principle that means your insurance company agrees to compensate you for covered losses with amounts equivalent to what was lost. Below, we take a comprehensive look at what compensation means and how it can affect you as a policyholder.

What is Compensation?

Compensation is the act of being compensated by the insurance company for the loss that restores you to your financial position before the loss as much as possible. “Compensation” is a similar term you may also see with the same general meaning.

Your insurance company agrees to bear the losses resulting from covered accidents or property damage when you are a policyholder. Instead of paying out of your pocket for liabilities or replacing property, the insurance company bears the cost of restoring your financial situation to a state similar to what it was before the incident. If there is another party involved in the event, such as a car accident, your insurance company might sue the other party to recover compensations.

How Does Compensation Work?

The insurance company compensates you (reimburses you for your loss) after you file a covered claim. With auto insurance, the insurance company transfers the financial liability from you to itself for costs arising from an accident or another covered event. This may mean paying for vehicle repairs, medical treatment costs, legal fees, or judgments in a lawsuit. Without your policy and its compensation clause, you would be responsible for these bills. The same process and principles apply to other types of insurance, such as homeowners and commercial property insurance.

Note: It is crucial to purchase insurance protection to the extent you can afford in your insurance policy because insurance companies compensate you only up to the limits of your policy. Also, note that the compensation liability of the insurance company is limited by the terms outlined in your policy agreement.

What is the Role of Depreciation in Compensation?

Sometimes policyholders face issues in compensation due to depreciation. Depreciation is the loss of value of an item for various reasons, such as age and condition. It can be a source of concern because if you crash an older car or one that has high mileage, the amount the insurance company pays may not be enough to replace it.

Depreciation plays a lesser role in some parts of homeowners insurance because most policies today include coverage for replacement cost for structural damages. If you need to replace a completely damaged roof or another structure in your home, paying the full cost of a new roof of the same kind is the only practical option for the insurance company.

However, it is essential to check your insurance policy to verify your type of coverage. Older homes may have a modified replacement cost policy that replaces unique features, like hardwood floors, with standard building materials. Furthermore, if you do not have replacement cost coverage for your property, the insurance company may only compensate it at its actual cash value (the actual cash value or depreciated value), not at what it costs to purchase new items.

Compensation vs. Indemnity Insurance

Compensation is not the same as indemnity insurance (also known as professional liability insurance).

As mentioned, compensation is an agreement by the insurance company to return you to an equivalent financial position after a covered loss. Indemnity insurance is additional liability insurance designed to protect service providers or other professionals who provide advice or expertise or offer specialized services. This type of insurance provides coverage that protects professionals from claims made against them for negligence or failure to perform their duties, and the resulting litigation costs or other financial losses.

Typical types of indemnity insurance in business settings may include professional liability, errors and omissions (E&O), and directors and officers (D&O) insurance.

Take

The Lesson

Indemnification involves the insurance company paying for covered losses in your policy to restore your financial status or property to the same state as before the incident. Compensation can be paid for property damage, medical expenses, liabilities, attorney fees, and other costs outlined in your policy agreement. You may be compensated for your home or property at its depreciated value, not its original price, unless you have a replacement cost coverage policy. Indemnity insurance is different from indemnification, as it protects appointed professionals from the costs of claims made against them.

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Sources:

The Hartford. “Indemnification.”

Insurance Information Institute. “Insurance for Your House and Personal Possessions.”

Source: https://www.thebalancemoney.com/what-is-indemnification-5104794