What is Consequential Loss?
Consequential loss is a kind of collateral damage incurred due to a damage to the equipment, property or any tangible unit. It is an indirect loss that cannot be compensated even when the damaged unit is covered under the insurance.
The consequential loss insurance covers indirect damages and is called business interruption insurance.
- Consequential loss is a kind of collateral damage incurred due to the damage to the equipment, property or any tangible unit.
- It is an indirect loss that cannot be compensated even when the damaged unit is covered under the insurance.
- The consequential loss insurance covers indirect damages and is called a business interruption insurance.
Understanding Consequential Loss with Examples
We will explain this concept with some simple examples.
- A factory is involved in a fire. As a result, much of the plant machinery has become permanently unusable. To the owner’s relief, the insurance policy covers the direct loss to the machinery.
- However, the factory is unable to produce goods as the fire destroyed most machines. Till the owner purchases a new set of machinery, the operations will remain halted.
- This loss due to the halting of daily business operations is an example of consequential loss as it is an indirect loss. It is not covered under the insurance for direct losses.
Insurance Policy for Consequential Loss
- As we have explained above, since a business is out of operations due to a loss to its machinery, it cannot earn a daily income. As a result, the entrepreneur is struggling to keep the business afloat.
- He is unable to pay the salary to his employees. The operations can resume only after replacing the machinery. A business interruption insurance comes as a silver lining as they cover such consequential loss.
- This business interruption insurance will make salary payments. It will also take care of the fixed costsFixed CostsFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity. taking the gross profitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services. into account until the business can resume its operations.
- Another term for business interruption insurance is business income insurance.
- The business takes up an insurance policy to cover direct damages like property loss due to fire, flood, and the like. Likewise, entrepreneurs must think of the possible ways their business can incur such damage.
- Brainstorming is crucial because indirect damages are sneaky. Therefore, entrepreneurs must think of all the possible ways their business could be exposed to such threats.
- Listing down will help entrepreneurs in taking the relevant business interruption insurance. The insurance companies assign consequential loss insurance to cover losses arising from turnover reduction, fire, spoilage, retrenchment and layoffs.
- The insurance company takes into account the gross profit generated by the business. They also set the indemnity period and list down the coverage.
- Even if the business possesses a consequential losses insurance, the insurance company may put in some exclusions under the policy. Such exclusions cause the business to endure the indirect losses even when it is insured against it.
- The consequential loss exclusions may consist of material damage, goodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price., and name loss.
- It is much easier to procure insurance products for direct losses than indirect losses.
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 –