Coverage Issues for Direct and Indirect Loss

Direct Loss Insurance and Indirect Loss Insurance Coverage

Business insurance policies will usually specify that they cover “direct losses” and “physical loses” in the case of damage caused by a disaster. Business owners should be aware of what their policies cover and their meaning.

What Is Loss In Insurance?

In insurance terms, a loss is a reduction of a property’s value, damage or loss of assets resulting from a risk, disaster or accident. There are different types of loss in insurance:

Direct Loss Coverage

In insurance, “direct loss coverage” refers to damage immediately inflicted by a disaster, accident or other event, known in insurance language as “perils.”

Direct Loss Example

If a tornado strikes a town and takes the roof off the building, a direct loss would include damage to the structure, as well as to equipment, furniture, inventory or other items inside. Fire and smoke damage would count as a direct loss. So would theft, or a car crashing through the front window.

Indirect Loss or Consequential Loss Coverage

Indirect loss insurance, often referred to in business insurance policies as “consequential losses,” are not inflicted by the peril itself but describe losses suffered as a result or consequence of the direct loss.

Indirect Loss Insurance Example

Business interruption is the most obvious example. If a tornado destroys the roof of a store, not only are there rebuilding costs, but the business cannot operate until the damage is fixed. Income lost during the rebuilding — and after it, if customers stick with the alternatives they find in the meantime — represents an indirect loss.

Are Physical Losses Covered as Direct Loss or Indirect Loss?

Insurance policies commonly require that a loss be “physical” to be covered as a direct loss. As policies don’t specifically define the word “physical,” it’s been left to courts to sort out what does and doesn’t qualify as a direct physical loss, and surprisingly, there is little consensus on the issue. Building damage is more or less cut-and-dried, but gray areas are everywhere. For example: A windstorm knocks out power to a restaurant, and all the food in the coolers goes bad. Not only is it unclear whether the spoilage is a direct loss, it’s also debatable whether the power outage loss is “physical” because the building itself did not suffer wind damage.

Direct Loss Insurance Coverage vs Indirect Loss Coverage

Business casualty insurance policies almost always include direct loss insurance. But consequential losses can be more damaging to a company. Businesses may be able to recover from the loss of a roof, but losing several months’ worth of income could put a business owner out of business. That’s why it’s critical to review insurance policies to understand if the policy includes indirect loss insurance and, if not, to secure business-interruption insurance. It is also advised to discuss with a broker what constitutes a physical loss, if the policy requires it, and make arrangements to provide the specific coverages needed.