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Updated Jan 22, 2024

Why Your Business Needs Indemnity Insurance

Mark Fairlie
Mark Fairlie, Senior Analyst & Expert on Business Ownership

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From property to general liability, there are many types of insurance businesses should have. While they all serve different purposes, one key attribute they have in common is they protect the insured business from paying the full cost of incurred losses. This is referred to as “indemnity insurance.” Most insurance is a form of indemnity insurance because it serves the purpose of making another party whole for any losses incurred during the policy term.

What is indemnity insurance?

Indemnity insurance is a contractual agreement between the policyholder and the insurance carrier that states that in exchange for a premium from the policyholder, the insurance company will pay for financial losses that happen in a covered claim.

To indemnify someone is to compensate them for any harm or loss that happens. When it comes to insurance, indemnity can also mean to secure from legal liability for operations or actions. As such, an indemnity insurance policy pays for damages that happen in a covered loss. 

Who needs indemnity insurance?

While most insurance policies are considered an indemnity agreement, only certain professions are required to get indemnity insurance, which is often in the form of malpractice or errors and omissions (E&O) insurance. Usually, it applies to professional service providers who might make an error that results in loss or harm for the client who needs indemnity insurance.

These are some common professions that are required to get indemnity insurance:

  • Doctors
  • Accountants
  • Lawyers
  • Architects
  • Contractors

While these professionals must obtain professional liability insurance to maintain their license, every business can benefit from indemnity insurance, whether for professional services or other business liability or commercial property needs.

For example, a shoe store experiences a fire in its storage room. It loses $15,000 worth of inventory and the building it is leasing suffers $50,000 worth of damages. The shoe store owner has a commercial property insurance policy and is indemnified of the losses, meaning the property owner gets the building repaired and the store owner gets reimbursed for his inventory.

Did You Know?Did you know

Builder’s risk insurance is a type of indemnity insurance for property owners, general contractors, subcontractors, building leads and architects. It helps protect against risk of loss and damages caused during the erection of a new building or remodeling and installation in an existing building.

How does indemnity insurance work?

With indemnity insurance, there are different ways to cover the financial losses:

  • Repairing or replacing the damaged property
  • Paying the value of the damaged property
  • Paying for investigation and legal fees for claims

Different types of insurance will indemnify different kinds of losses. For example, commercial property insurance indemnifies against the losses of leased buildings, inventory and business property, including materials and supplies. A professional liability insurance policy indemnifies the policyholder from errors in counsel, advice or workmanship that lead to a third-party loss. General liability insurance indemnifies the policyholder from accidental losses that happen during the course of business operations.

The type of policy you have will determine your coverage as well as the exclusions to the policy. For example, most indemnity policies will not protect against illegal actions or intentional damage.

When a loss arises, the policyholder contacts their insurance carrier to open a claim. From there, the carrier assigns a claims representative to assess damages fully and coordinate the payments based on the contract terms. If a third party is involved, the payment will be made directly to that party rather than the policyholder.

TipBottom line

If you can’t do business because of a fire, wind damage, theft, falling objects, cyberattacks or lightning, business interruption insurance will cover many of your costs until you get back on your feet again, including payroll and taxes.

What does an indemnity policy cover?

An indemnity policy can cover many types of losses depending on the type of policy it is. As long as the policy covers the losses, the insurance carrier will pay them.

Examples of what an indemnity policy will cover

Slip-and-fall accidents

Covered by a general liability insurance policy, slip-and-fall accidents pay the injured party’s medical expenses and potential lost income.

Medical mishaps

A medical malpractice insurance policy will pay for damages a patient incurs when a doctor makes a mistake.

Property theft

Commercial property insurance will pay for the loss of any property stolen from the business, such as computers or inventory (minus the deductible).

How to choose an indemnity policy

It’s important to make sure you have the right insurance. Consider the types of risks your business has and whether you’re required to carry certain types of policies. Remember that certain professionals must carry professional liability insurance to maintain their licenses. You may also be required to obtain commercial property or general liability insurance for a commercial lease contract.

If you aren’t required to carry insurance, you’ll want to consider the risks unique to your company. If your establishment gets a lot of 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 to have the financial resources to pay that if you don’t have an indemnity policy. Generally speaking, if you can’t afford to pay for a potential claim, you should get an insurance policy.

To choose an indemnity policy for your business, follow these tips:

  • Be clear on what exactly you need coverage for: Before searching for a policy, try to identify the specific risks that are associated with your line of business or type of profession. Research the level of liability you might be exposed to if the worst happens. By knowing what the most significant risks are and how much a mistake might cost, you’ll be able to identify the most suitable policy.
  • Compare policy limits: When getting quotes from insurers, look at the maximum coverage they’re offering against potential claims on each policy. If you choose a policy where a potential payout isn’t high enough, it may leave you financially vulnerable.
  • Read the terms carefully: Understand what insurers won’t cover you against and the conditions under which they’ll provide you with protection. Pay close attention to the deductibles — that’s how much you have to pay out of pocket before your insurer starts to pay the rest.
  • Check potential insurers’ reputations: Some insurers pay out a lot quicker than others. You can get a good idea of a particular insurer’s pay-out policies by seeking out reviews from customers online. Try to choose an insurance provider that doesn’t put too many obstacles in your way.
  • If in doubt, speak to a broker: Insurance, like mortgages, are complex legal agreements that are hard for most laypeople to understand. You may wish to work with an insurance broker to help you find the right policy or get an attorney to check out an insurer’s contractual terms before you commit.

How much does indemnity insurance cost?

The cost of indemnity insurance will depend on the type of policy you get and your business’s industry, revenue, location and other factors. A general liability insurance policy could cost as little as $500 per year. Professional liability insurance could be more expensive depending on your profession. Meanwhile, on average, companies spend $500 to $1,000 a year per employee for E&O insurance. Property insurance depends on the value of the property being insured.

It’s best to discuss your insurance needs with your agent to make sure you’re getting the right coverage for your biggest risks. Compare quotes from multiple providers and ask about discounts to save on insurance and get the best possible price.

Pros and cons of indemnity insurance

As with all types of insurance, there are upsides and downsides to indemnity coverage. Here are the four main advantages and disadvantages.

Indemnity insurance advantages

  • Meaningful protection: Doctors, lawyers, architects, marketing teams, information technology consultants — if they get something wrong, they’re exposed to extreme liability risks that could put them out of business. Indemnity insurance means you’re covered financially against any professional errors, omissions and negligence.
  • 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: Having an indemnity insurance policy assures clients and partners they will be fully compensated if they are subject to any potential mistakes or accidents and their complaint is justified. Some larger businesses and public sector agencies will not buy from companies or freelancers with no indemnity insurance.
  • Legal costs covered: Compensation costs can be significant, as can the legal costs associated with a case, even if the court rules in your favor. These costs are covered by your insurance policy.

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 significant.
  • Complex policies: Without professional guidance from an insurance broker or legal expert, you may find it hard to understand the terms, conditions and, most importantly, the exclusions in your indemnity insurance policy. Business owners need to be certain they fully understand the policy they’re offered before committing to it.
  • Coverage limits: Most indemnity insurance policies have generous coverage limits but, depending on what you do and the size of the deals you strike, a policy may not cover you against extremely high claims. This could leave you exposed and responsible for paying the remainder of a large judgment against you. You may wish to speak with a broker about taking out an additional excess liability policy.
  • Complacency: Although unlikely, the existence of an indemnity policy may lead to complacency in how a business manages risks. This is because they believe their insurance will cover them, no matter the circumstances of a case. Even with an indemnity policy, you should always practice other risk management strategies.

Indemnity insurance FAQ

While most insurance is based on the principle of indemnity, not every policy is an indemnity insurance policy. Life insurance is the most common example of a policy that is not an indemnity policy. The reason is that the loss is not definable. Therefore, the payment is a set amount based on ideas of loss that may or may not be accurate.

For a policy to be an indemnity policy, the insurance payment has to be closely tied to a replacement cost, fair-market value or reimbursement. Essentially, the payments must be relevant to the actual loss of the policyholder or a third party.

Commercial indemnity insurance itself is not transferable. However, as the policyholder, you pay the premiums to gain the protection and the protection covers more than just your own losses, so in that sense, the indemnity itself is transferable. With the policy, you transfer indemnity to third parties in the event they experience a loss resulting from your business. The third party doesn’t own the insurance policy and doesn’t need to. Their losses are protected by your contractual agreement with the insurance carrier.

There are times when you, as a business owner, will want to transfer the risk to another party. For example, if you hire a contractor, you may want them to indemnify you from their business risk while working for you. In this case, you would require them to have insurance and name you as an additional insured to protect you while they perform work on your behalf. In this case, the risk is transferred, not the policy.

Indemnity insurance covers business owners, the self-employed and freelancers against claims brought against them by third parties for loss or damages. If the third party argues successfully that you’re responsible for causing them losses or damages, the judge will award compensation to them. With indemnity insurance, your insurer pays that compensation instead of you. The insurance provider will generally also cover legal fees and other related expenses as well, up to a maximum amount.

Professional indemnity insurance policies will not cover intentional wrongdoing, regulatory fines and penalties, physical injuries, property damage, contractual disputes and employee disputes.

Kimberlee Leonard contributed to this article.

Mark Fairlie
Mark Fairlie, Senior Analyst & Expert on Business Ownership
Mark Fairlie has written extensively on business finance, business development, M&A, accounting, tax, cybersecurity, sales and marketing, SEO, investments, and more for clients across the world for the past five years. Prior to that, Mark owned one of the largest independent managed B2B email and telephone outsourcing companies in the UK prior to selling up in 2015.
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