Consequential Loss

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. These direct coverage policies do not compensate the owner for income that is lost due to the business' 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.

Example of Consequential Loss Coverage

For example, 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 inventory, while 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 insurance, also 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.

Consequential loss coverage reimburses the insured for business costs due to damaged facilities or equipment.

For example, business interruption insurance can cover situations that result when the loss of revenue occurs 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.

Requirements for Coverage

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

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.

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.