Definition, Insurance, Vs. Direct Loss

What Is Consequential Loss?

A consequential loss is an indirect adverse impact caused by damage to business property or equipment. A business owner may purchase insurance to cover any damage to property and equipment, and may also obtain coverage for secondary losses. A consequential loss policy or clause will compensate the owner for this lost business income.

This type of insurance is also called business interruption or business income insurance.

Key Takeaways

  • Consequential losses are the indirect results of property damage.
  • These must be insured separately from the policy that covers physical damage to facilities or equipment.
  • Such policies cover losses due to business interruptions.

Understanding Consequential Loss

Business owners routinely obtain casualty insurance to cover any damage to their facilities or equipment caused by theft, fire, flood, or other natural disasters. However, these direct coverage policies do not compensate the owner for income that is lost due to the business’s inability to use that property or equipment.

Indirect losses that are the result of physical damage and adversely affect normal business operations may be considered consequential losses. Coverage of consequential losses may include compensation for ongoing obligations such as salaries and fixed operational expenses.

Thus, insurers distinguish between two types of damage: primary or direct damage, such as destruction by fire, and indirect or consequential loss, such as a cessation of business due to the fire.

Losses relating to income are consequential and require separate coverage, with consequential loss coverage reimbursing the insured for business costs due to damaged facilities or equipment.

Example of Consequential Loss Coverage

Let’s say a tornado destroyed a Portland, Michigan, Goodwill store several years ago. The organization’s property insurance covered the damage to the physical structure and the loss of the store’s inventorywhile separate coverage reimbursed it for the loss of business revenue that stemmed from the temporary closure of the store.

Losses relating to income are consequential and require separate coverage.

Insurance Policies for Consequential Losses

Business interruption insurancealso known as business income insurance, covers consequential losses. These policies compensate a business for loss of revenue after a catastrophic event, regardless of physical damage to the property or equipment.

Interruption insurance coverage will typically begin from the time of the adverse event and continue until the business is able to return to its normal operation.

Business interruption insurance, also known as business income insurance, covers consequential losses.

Business interruption insurance can cover a loss of revenue due to events such as an extended power outage, a flood, or a mudslide. Business interruption insurance can also protect against loss of income during a breach of contract dispute that leads to a temporary cessation of business, such as a dispute with a supplier or other third party.

Business interruption insurance is peril-specific and often must be purchased separately.

Special Considerations

Insurance companies are on the lookout for claims that indicate inflated expectations. For example, a bakery closed temporarily for repairs after a fire might put in a claim for reimbursement of a reasonable level of lost sales, but not for losses that wildly exceed its usual numbers.

Moreover, even though insurance may be available for a variety of situations, only certain types are required. Many businesses may hold general liability insurance policies to protect themselves from costs relating to accidents, injuries, or negligence.

What Is an Example of a Consequential Loss?

One example would be a shop that is forced to shut down after being flooded. The company’s property insurance will provide funds to fix the damaged building and equipment but is unlikely to cover consequential losses—the money lost because the shop had to remain closed until everything was fixed and back up and running again. For these particular damages, the shop owner needs to acquire a separate, specific type of insurance.

What Is the Difference Between Direct Loss and Consequential Loss?

Direct loss is the damage inflicted, such as destruction by fire, whereas consequential loss is the indirect consequence of those damages. In other words, the direct loss would be damage to the building and equipment, whereas the consequential loss could be the losses created by the business having to remain closed.

What Insurance Covers Consequential Losses?

Usually, casualty and property insurance and so forth don’t cover consequential losses. For this type of coverage, it is often necessary to buy a specific type of insurance known as business interruption insurance or business income insurance.

How Big a Payout Can You Get from Business Interruption Insurance?

That depends on the policy you have. Most policies will have a coverage limit, meaning the insurer will only cover x amount of losses.

The Bottom Line

Standard insurance policies often contain clauses limiting liability for “indirect or consequential” loss or damage, primarily because such losses can be extremely large and costly to cover. Business owners should be aware of this and consider adding additional coverage against consequential loss to make sure they are fully protected.

The impact of having to close for what could be weeks or even months shouldn’t be underestimated. Such a loss of business income, coupled with ongoing expenses such as employee salaries, could cripple companies, making business interruption insurance a must, regardless of how rarely floods, fires, or other freak events occur.

Related Posts