Which method of loss valuation contradicts the principle of indemnity?

The replacement cost method contradicts the principle of indemnity because it allows the policyholder to recover the full cost of replacing damaged property without deducting for depreciation. The principle of indemnity is designed to restore the insured to their previous financial position without allowing for profit from an insurance claim. Under this principle, an insured should not receive more than what they lost.

While actual cash value incorporates depreciation to determine the payout, replacement cost focuses solely on the cost to repair or replace property with new materials of similar kind and quality, regardless of depreciation. This can result in a payout that exceeds the actual loss incurred, therefore violating the core tenet of indemnity which aims to prevent any profit from the insurance transaction.

Other methods, like actual cash value and agreed value, align more closely with the principle by either factoring in depreciation or setting a predetermined value at which the loss will be settled, ensuring that the payout reflects the genuine economic loss experienced by the insured. Market value represents what the property would sell for in the current market, which also maintains a closer relationship to the actual loss experienced.