Indirect Loss vs Direct Loss: What Are the Differences?

There are several types of insurances available to protect businesses and individuals against loss and damages. Insurances break down and fall into one of two categories—they either protect against direct losses or protect against indirect losses.

This piece explains direct and indirect losses with examples of what each type of insurance covers.

What Types of Losses Are There in Insurance?

A loss in insurance terms is a reduction in asset or property value or damage of said assets or property due to an accident, natural disaster, man-made disaster, or other risks. Losses fall into one of two categories in terms of property insurance: direct loss or indirect loss.

Direct Loss Definition

Direct losses are damages that are immediately caused by or inflicted by an accident, disaster, or other incidents, which are referred to as perils in the insurance world. Direct losses are tangible losses that can be touched and seen.

Examples of Direct Losses and Direct Loss Insurance

If a car runs off the road and into your storefront, direct loss insurance would help to cover the repairs related to rebuilding and making the storefront functional again. Direct losses would not only include damage to the structure, but damage to the furniture, equipment, inventory, and other items within the structure, too.

Theft, smoke, rain, and fire damage generally also count as direct losses. Shock and damage from an earthquake, a tornado touching down and damaging your structure, and your corporate building catching on fire would be considered perils under direct loss coverage. The water sprayed into the building by the fire department to put out a fire would also fall under direct loss.

Casualty insurance is routinely purchased by businesses to cover direct losses, including damages, loss of property, and other liabilities. Some of the most common types of causality insurance include property insurance, theft insurance, liability insurance, and vehicle insurance.

Indirect Loss Definition

Indirect losses are also referred to as consequential losses. Indirect losses are not caused by the risk or peril directly, but are losses that are a consequence of, or caused by, and resulting from, the direct loss. There are two primary types of indirect losses: extra expenses and loss of income.

Examples of Indirect Losses and Indirect Loss Insurance

The most common example of indirect loss insurance is business interruption insurance. Business interruption insurance, also referred to as business income insurance or contingent business interruption coverage, covers losses due to an event that causes your business to shut down temporarily. Business interruption insurance is generally triggered when direct physical damage to insured premises occurs, or a covered peril causes physical damage that causes the need to suspend business operations.

For example, if a car runs off the road and into your storefront, causing you to have to shut down for days or weeks until repairs are finished, a business interruption policy can help cover the loss of profits and other costs associated with having to temporarily close your business. Direct coverage insurance will help to cover the cost of rebuilding due to the car running into your storefront, and indirect loss coverage would help cover the losses due to not being able to operate until the rebuild and repairs are completed. Business interruption insurance can cover:

•            Loan payments that need to be made while your business is not able to operate

•            Employee payroll

•            Revenue you would typically make if open

•            Relocation costs if you need to move your business to a new or temporary location

•            Monthly or quarterly taxes

•            Rent, mortgage and lease payments related to the business space

•            Training costs associated with employees needing to learn how to use new equipment or machinery following the loss

Items typically excluded from business interruption insurance coverage include:

•            Undocumented income

•            Utilities that are typically shut off when businesses are under repair

•            Damaged property otherwise covered under commercial property insurance

•            Communicable disease-related closures

•            Damages due to an earthquake or flood that generally require separate insurance policies

Business interruption insurance might also cover losses due to having to temporarily shut down from a government-mandated road or bridge closure that impacts your business.

Another example of an indirect loss would be the need to rent a car while one’s car is being repaired following a car accident or damage. The damage to the car is the direct loss, and the need to rent a car is the indirect loss.

Many business owners’ policies include both direct and indirect loss insurance coverage by bundling interruption insurance with commercial property insurance and general liability insurance.

Are Physical Losses Always Considered Direct Losses vs. Indirect Losses?

Generally, insurers require that a physical loss occurs for the loss to be covered under a direct loss policy. However, they do not tend to define the word “physical,” leaving a lot of grey areas and uncertainty when attempting to determine what does and does not qualify as a direct loss. In many cases, these types of quandaries end up in front of the courts to make a determination.

Where some losses are clearly physical losses, others are not so clear. Building damage, for example, is most certainly a physical loss, or direct loss. However, if the power to a restaurant is knocked out due to a heavy rainstorm moving through, and all the produce and food in the coolers goes bad, it is unclear if the loss of produce is a physical direct loss or an indirect loss. No rain damage was actually done to the building, making it debatable as to whether a physical loss occurred, yet a loss did indeed occur, which is the loss of the produce that resulted from a peril.

Direct Loss Insurance vs. Indirect Loss Insurance Needs

Indirect losses must be insured separately from direct losses. Direct loss insurance is virtually always included as part of business casualty insurance policies. However, it is indirect losses that can be the most damaging to organizations. A business can often recover from the losses associated with the need to repair damaged buildings or equipment, but many will go under due to a loss of ongoing monthly income and additional expenses because of such direct damages. As a result, it is essential that organizations review their business insurance policies to ensure that business interruption is also covered, and if it is not, they secure such insurance to fill in any insurance gaps.

Key Takeaways

•            Indirect losses are also referred to as consequential losses, which are the indirect result of property damage or loss.

•            Direct losses are caused by the direct impact of perils that cause property loss and damage, including losses associated with damage to buildings, equipment, and more.

•            Direct losses are defined as tangible, or physical losses.

•            Indirect losses must be covered separately from direct losses.

•            Indirect loss coverage policies cover losses due to business interruptions.

•            There are two key types of indirect losses: extra expenses and loss of income.

•            Indirect losses can cause more damage to businesses in terms of costs compared to direct losses, which can be easier to recover from.

•            Business interruption insurance is the most common type of indirect loss insurance coverage.

•            Business owner’s policies often bundle interruption insurance with commercial property insurance and general liability insurance.

•            Common types of direct loss causality insurance include property insurance, theft insurance, liability insurance, and vehicle insurance.

•            Since insurances commonly have exclusions, it is important to read the fine print to highlight any gaps and purchase additional coverage when needed.

•            An insurance broker can help ensure businesses do not have any gaps when it comes to indirect loss and direct loss coverage.

Insurance Brokers for Indirect and Direct Loss Insurance Coverage

If you are researching insurance and want to ensure you have mitigated risk to the fullest extent for your business, consider reaching out to an insurance brokerage firm, like KBI. They can help to take the heavy lifting from your plate, freeing you up to focus on your day-to-day business operations.

A broker knows how to read the fine print to identify any gaps between direct and indirect loss coverage within your current policies, so you know you are covered, regardless of the peril or type of loss. A broker can also help you determine the level of insurance you need by assessing the industry, your business, the number of employees you have, and more.

Additionally, reputable brokers understand local laws and requirements, ensuring you have the right types and levels of insurance to remain in compliance. Finally, insurance brokers have relationships with hundreds of insurance companies and agencies, so they can work to find you the best rate and plans for your needs.

If you’re in the process of evaluating or purchasing direct loss and indirect loss insurance, contact KBI for support. We will point you in the right direction to make sure your needs are met with a customized plan.

Once you have an insurance package you are comfortable with today, it will be easier to make necessary adjustments down the road, as well.