What is Consequential Loss?
The consequential loss is defined as the loss of indirect nature caused due to direct damage to the equipment or a property or a tangible unit. This type of loss arises when the individual or business loses earnings or rent on account of damages to property or tangible unit even if the tangible unit had insurance in place as protection.
To prevent this, the individual or the business purchases typically an insurance policy that protects the business property from accidents, fires, and natural disasters. Such a policy would, therefore, compensate the individual with the lost business income. The insurance policy that covers consequential loss is regarded as the business interruption insurance. Such a policy is also termed as business income insurance.
Examples of Consequential Loss
- Let us take the example of a high-octane and technologically equipped car. Here we note that the engine of the car, when ignited or turned on, utilizes the principle of combustion. The process of combustion in the motor vehicle happens in such a way that when the air valve or the pipe of the car tends to take in the air present around it and compress it to ignite the fuel of the motor vehicle to drive the car.
- However, when a car drives through the waterlogged area, the water tends to channel itself to the engine and hampers the process of combustion. When the driver unknowingly turns on the car, the engine may go into the seizure and hence get damaged.
- Such loss on account of water seeping into the engine through air valve is regarded as a hydrostatic loss. The hydrostatic loss is a case of consequential loss. Such a damages don’t cover under the terms and conditions of a conventional motor vehicle policy. The hydrostatic loss or damage to the engine due to waterlogging is regarded as a certain event and not an uncertain event.
- The conventional motor vehicle policy covers all kinds of uncertain events, which can cause damage to the car. Similarly, there could be several examples of consequential losses.
- Suppose the business faces an operational shut down for 5 months due to political instability in the region where it operates. However, the business has taken up business interruption insurance. This insurance product makes salary payments and takes care of the fixed costs taking the gross profit into account till the time business can regroup itself.
- The severity of consequential loss becomes vital for both business and insurance companies to determine the level of premiums the business can pay to the insurance company from where it is taking up insurance. Basis the level of severity, when the business faces business loss on account of damage to properties, the business approaches the insurance companies wherein they generally understand the level of damage before settling claim to the business.
- The insurance companies assign consequential loss insurance to cover losses arising due to turnover reduction, fire, spoilage, towards retrenchment and layoffs. Therefore, to take up this insurance, the business should determine the severity well in advance and approach the insurance companies to buy such a policy.
- Therefore, it becomes critical to define and determine the consequential loss. The insurance company should take into the gross profit generated by the business. They then set the indemnity period and selections. They also define the basis of the exclusions of the severity of such a loss.
- Even if the business is secured against consequential loss, the insurance policy may put in some exclusions in the policy itself, which causes the business to suffer the losses even when insured against it.
- The exclusions may consist of material damages, goodwill, and name loss.
- Typically insurance companies do not issue policies for consequential losses.
- In simpler words, it is easier to procure insurance products for direct losses but not for indirect losses.
Consequential Loss is classified as a variant of indirect loss. Such losses are not covered under conventional insurance policy products. Instead, these are covered under business interruption insurance plans. As per conventional insurance guidelines, such damages happen as losses due to certain events rather than uncertain events.
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This has been a guide to What is Consequential Loss & its Definition. Here we discuss the examples of consequential loss and importance along with benefits and disadvantages. You can learn more about from the following articles –