Indemnity is often used as a synonym for compensation or reparation.

As a legal concept, it has a more specific meaning, namely, to compensate another party to a contract for any loss that such other party may suffer during the performance of the contract. For instance, compensation connotes merely a sum paid to make good the loss of another without regard to the payer's identity or their reasons for doing so. As the following paragraphs should explain, an indemnity is a sub-species of compensation, in the same way that Damages and reparation are.

The obligation to indemnify differs from the obligation to pay compensation, or make reparation, in that an obligation to indemnify is a voluntary obligation. If C crashes into B's car and damages it and the crash is due to C's negligence, most legal systems will impose liability upon C to pay B for the damage caused. C's obligation to B arises by force of law regardless of whether C subjectively wishes to compensate B. This is not, therefore, a situation of indemnity; the relationship between B and C is involuntary. In legal terms, it is a case of tortious (common law) or unlawful act (civil law) liability.

But, if A had a contract with B under which A agreed to pay for any damage to B's car, then A paying B would be obligatory (even if A subjectively regretted the contract at this point). In legal terms, A's liability is contractual and the sum paid is an indemnity. The contract just described between A and B is of course one of automobile comprehensive insurance.

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