Which principle generally underlies insurance policies?

The principle of indemnity is fundamental to insurance policies, as it dictates that insurance should restore the insured to the same financial position they were in before a loss occurred, without allowing for profit from the insurance claim. This principle ensures that policyholders are compensated for their covered losses but are not financially enriched beyond their original loss.

Indemnity requires that the amount paid out in insurance claims be proportional to the actual loss suffered. This approach prevents individuals from intentionally inflating losses or taking excessive risks since they cannot profit from a claim. By adhering to this principle, insurers maintain financial stability and fairness within the insurance market, promoting ethical behavior among policyholders.

In contrast, adverse selection refers to the tendency of those at higher risk to seek insurance coverage more frequently than those at lower risk, which can lead to an imbalance in the insurance pool. Retail competition and the doctrine of investor protection are not foundational principles of insurance; rather, they pertain to different aspects of economic and regulatory environments. Thus, the principle of indemnity stands out as the correct answer, as it is integral to how insurance functions and provides coverage.