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Why Your Business Needs Indemnity Insurance
While indemnity insurance isn't a specific policy type, it does play a critical role in the types of insurance your business needs.
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From property to general liability, choosing business insurance takes careful thought and consideration. While they all serve different purposes, one key attribute all policies have in common is that they protect the insured business from having to pay the full cost of incurred losses. This is referred to as “indemnity insurance.”
Most business insurance is a form of indemnity insurance because it’s designed to make another party whole for losses incurred during the policy term. We’ll explain what indemnity insurance is, who needs it, what it covers and how much it typically costs.
What is indemnity insurance?
Indemnity insurance is a contractual agreement between a policyholder and an insurance carrier stating that, in exchange for a premium, the insurance company will cover financial losses resulting from a covered claim.
“[It] helps businesses defend their legal claims, losses or damages by providing financial coverage of a business’s liabilities, usually in cases such as professional negligence or breach of contract,” explained Dennis Shirshikov, Adjunct Professor of Economics at City University of New York.
To indemnify someone means to compensate them for any harm or loss they may incur. In insurance, indemnity can also mean protection from legal liability related to operations or actions. An indemnity insurance policy, therefore, covers damages that result from a covered loss.
Who needs indemnity insurance?
While most insurance policies are considered a form of indemnity agreement, only certain professions are required to carry indemnity insurance, often in the form of malpractice insurance or errors and omissions (E&O) insurance.
“Indemnity insurance is commonly needed by businesses in professional services, consultancy, technology, healthcare and construction, particularly those exposed to high financial liabilities arising from errors and omissions in their operations,” Shirshikov explained.
In other words, this type of insurance is designed for professional service providers who may incur financial losses or harm to their clients due to errors or omissions in their work.
Here are some common professions that are required to carry indemnity insurance:
- Doctors
- Accountants
- Lawyers
- Architects
- Contractors
While these professionals are required to carry professional liability insurance to maintain their licenses, most businesses can also benefit from indemnity insurance, whether for professional services, general liability or commercial property protection.
For example, say a shoe store experiences a fire in its storage room. It loses $15,000 worth of inventory, and the leased building suffers $50,000 in damage. The store owner has a commercial property insurance policy and is indemnified for the losses, meaning the building owner receives funds for repairs, and the store owner is reimbursed for the lost inventory.
How does indemnity insurance work?
Indemnity insurance protects against financial losses in several ways. Depending on the policy and the type of claim, it may:
- Repair or replace the damaged property
- Pay the value of the lost or damaged property
- Cover investigation and legal defense costs for claims
“If a client claims your service or advice caused them harm, this policy helps cover legal fees, settlements and judgments,” explained Chris Peterie, the chief executive officer of Tower Street Insurance.
Different types of insurance indemnify different types of losses. For example:
- Commercial property insurance indemnifies the policyholder for losses to leased buildings, inventory and other business property, including materials and supplies.
- A professional liability insurance policy indemnifies the insured against claims stemming from errors in counsel, advice or quality that result in a third-party loss.
- General liability insurance helps indemnify the policyholder for accidental losses that occur during normal business operations.
Your policy type determines what’s covered and what’s excluded. Most indemnity policies do not cover intentional damage or illegal activity.
When a loss occurs, the policyholder contacts their provider to file an insurance claim. The provider assigns a claims representative to assess the damage and coordinate any payouts according to the contract terms. If a third party is involved, payments may be made directly to them rather than to the policyholder.
What does an indemnity policy cover?
An indemnity policy can cover many types of losses, depending on the type of insurance. As long as the loss falls within the policy’s terms, the insurance carrier will pay for it.
Examples of what an indemnity policy will cover
Slip-and-fall accidents | Covered under a general liability insurance policy, these claims typically pay for the injured party’s medical expenses and lost income. |
|---|---|
Medical mishaps | A medical malpractice insurance policy covers damages a patient may incur if a healthcare provider makes a mistake. |
Property theft | Commercial property insurance reimburses the business for stolen property, such as computers or inventory (minus any applicable deductible). |
How to choose an indemnity policy
Finding the right indemnity policy doesn’t have to be overwhelming. Use these tips to narrow your options and choose coverage that makes sense for your business.
- Determine what’s legally required: You may be legally required to carry specific policies. For example, some professionals must carry professional liability insurance to maintain their licenses. You may also be required to obtain commercial property or general liability insurance as part of a commercial lease agreement.
- Evaluate your risks: Even if coverage isn’t mandatory, it’s still wise to consider your business’s unique risks and exposures. By identifying your biggest exposures and how much a mistake might cost, you’ll be better equipped to choose the right policy. For example, if you run a retail establishment with heavy foot traffic, you may be at risk for slip-and-fall accidents or other third-party claims. The average slip-and-fall accident claim is valued at $20,000 — and you’ll need the financial resources to cover that if you don’t have insurance.
- Compare policy limits from insurers: When getting quotes, examine the maximum coverage offered for each policy. If the potential payout isn’t high enough, you could be left financially exposed. The best business insurance providers offer customizable options and flexible coverage limits.
- Read the terms carefully: Understand what’s excluded from coverage and under what conditions protection applies. Pay special attention to deductibles — the amount you must pay out of pocket before your insurer covers the rest.
- Check the insurer’s reputation: Some insurers are more responsive and customer-friendly than others. You can get a sense of their claims handling by reading customer reviews. Try to choose a provider that doesn’t create unnecessary obstacles. “Go with a provider that knows your industry and offers strong risk management support,” Peterie advised.
- Consult a broker: Insurance, like mortgages, involves complex legal language that can be difficult to navigate. Consider working with an insurance broker to help you identify the right policy, or ask a business lawyer to review the terms before you commit.
How much does indemnity insurance cost?
The cost of indemnity insurance will depend on the type of policy you choose and your business’s industry, revenue, location and other factors. A general liability insurance policy could cost as little as $500 per year, while professional liability insurance tends to be more expensive, depending on your profession. On average, companies spend $500 to $1,000 annually per employee on E&O insurance. Property insurance costs vary based on the value of the property being insured.
It’s best to discuss your coverage needs with an insurance agent to ensure you’re getting the right protection for your biggest risks. Be sure to compare quotes from multiple providers and ask about available discounts to save money on business insurance and secure the best possible rate.
Pros and cons of indemnity insurance
As with all types of insurance, there are upsides and downsides to indemnity coverage. Here are some advantages and disadvantages to consider.
Indemnity insurance advantages
- Meaningful protection: Doctors, lawyers, architects, marketing professionals and IT consultants face serious liability risks if they make a mistake. Indemnity insurance helps protect you financially from professional errors, omissions and negligence that could otherwise jeopardize your business.
- Financial certainty: Knowing you have insurance protection in place, you don’t need to charge customers sky-high prices to ensure that, if there is a claim, you have the free cash available to cope with it. This protects you and your clients.
- More credibility: Carrying an indemnity insurance policy reassures clients and partners that they’ll be compensated if a justified claim arises. In fact, some larger companies and government agencies won’t work with vendors or freelancers who don’t carry this type of coverage.
- Legal costs covered: Legal defense costs can add up fast, even if you win the case. Your indemnity insurance policy covers attorney fees, court costs and related expenses, providing critical support during a dispute.
Indemnity insurance disadvantages
- Premium costs: Depending on your business or profession and the size of invoices you deal with, the premium payments on an indemnity insurance policy can be substantial.
- Complex policies: Without guidance from an insurance broker or legal expert, it may be difficult to fully understand the terms, conditions and, most importantly, the exclusions in your policy. Business owners should be confident they know what’s covered before signing on.
- Coverage limits: While most indemnity policies offer generous coverage, they may not be enough to protect against very large claims, especially if your business handles high-value contracts. You could be left responsible for any amount above your policy limit. In these cases, it may be worth speaking to a broker about an excess liability policy for additional protection.
- Complacency: Although rare, having an indemnity policy could lead to a false sense of security. Some businesses may assume they’re covered no matter what, which can lead to lapses in other risk management Even with insurance, you should still take precautions to reduce your exposure to liability.
Indemnity insurance FAQs
- Intentional wrongdoing or fraud
- Regulatory fines and penalties
- Physical injuries and property damage (these are covered by general liability insurance)
- Contractual disputes
- Employee disputes or internal HR issues
Kimberlee Leonard contributed to this article.
