What is an Indemnification Method?

Indemnification Method is a technique used for computing loss payments caused by the other counterpart for prematurely terminating a swap. The method requires the party at fault to compensate the affected party for all damages resulting from an early termination of a contract. Though the technique was common when swaps we, today, it is used to calculate premature termination payments. The calculation follows the terms and interest rates available for replacement.

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How Does the Indemnification Method Work?

Indemnification is protection or security against financial liability. It exists between two parties in the form of a contractual agreement. One of the parties agrees to meet all the costs emanating from damages or losses that the other one may suffer. Note that indemnity insurance in corporate finance does not hold company executives and Board of Directors liable for personal liability, in case the organization suffers damages or gets sued.

Common Indemnity Agreements/Contracts

Indemnity contract establishes a way of transferring risk related to finance to a third party, usually with a written agreement. The deal includes the parties' names, including the situations covered and the party responsible for compensating. A firm that indemnifies another accepts typically liability associated with certain services or products. Indemnity clauses are standard in the following:

• Legal contracts
• Commercial contracts
• Loan agreements
• Leases
• Supply agreements
• Licensing agreement

When it comes to the principle of indemnity, it asserts that in case of a loss, the insured party will be immediately be put back into the same financial position he was in before suffering the damage. What this means is that the insured person or business will not get more or less than the actual amount lost. Note that the compensation is subject to the limit of the sum insured, including other terms and conditions provided under the policy. So, in other words, the insured can only be put back to the financial position if there are proper insurance arrangements on full value insurance. As far as an agency is concerned, a principal may be tasked to indemnify its agent for any liabilities they incur as they carry out responsibilities under the relationship. Though the events leading to an indemnity may be part of the contract, the actions for compensating the affected party may be unpredictable. Also, the maximum compensation may be limited.

Indemnity Benefits

Indemnity provides financial protection to businesses whereby it covers costs that may result from events such as accidents, mistakes, negligence, or any other unavoidable situations. Indemnity insurance protects the policyholder against claims or lawsuits. It ensures that the policyholder does pay the settlement in full, even if he or she happens to be at fault. Since, then it also covers things such as lawyer's fees, court costs, and even potential settlement, the directors and executive of a business are required to have indemnity.

Methods of Providing Indemnity

Insurance companies may carry out ints indemnity compensation using the following ways:  

• Cash payment
• Replacement
• Reinstatement
• Repair