3.2 Types of Property Losses

Direct and Indirect Losses

A direct loss is a loss that occurs as the immediate result of a covered peril. Property insurance policies generally require a direct physical loss or damage to covered property before coverage applies. An indirect loss, also known as a consequential loss, arises as a result of a direct physical loss rather than from the physical damage itself. Indirect losses are typically financial in nature and may include lost income, increased operating expenses, or other economic losses incurred while damaged property is being repaired, replaced, or restored.

Example

A hotel sustains substantial damage as a result of a hailstorm and must temporarily close while repairs are completed. The physical damage to the building caused by the hail is considered a direct loss because it results immediately from the covered peril. As a consequence of the damage, the hotel is unable to accommodate guests and loses revenue during the repair period. The resulting loss of business income and any additional expenses incurred to continue operations are considered indirect (consequential) losses because they stem from the direct physical damage rather than from the peril itself.

Causes of Loss

When a loss occurs, the insurer must determine the cause of the damage to decide whether coverage applies under the policy. Identifying the cause of loss is particularly important when multiple perils contribute to the same loss, especially when some of those perils are covered while others are excluded. In these situations, the insurer must evaluate the relationship between the contributing causes and apply the policy's coverage provisions and exclusions. The outcome may depend on the specific language of the insurance contract, applicable state laws, or legal doctrines governing the treatment of multiple causes of loss.

Proximate Cause

The proximate cause of a loss is the primary cause that sets a chain of events in motion and ultimately results in damage or loss. When a single peril causes the loss, the proximate cause is the initial event in the uninterrupted sequence of events that directly produces the damage. When two or more perils contribute to a loss, the efficient proximate cause is the peril that plays the dominant or most significant role in causing the damage. Insurers often use this concept to determine whether coverage applies when multiple causes are involved. If a policy relies on proximate cause to determine coverage, the proximate cause—or efficient proximate cause—must be a covered peril for the loss to be covered under the policy.

Example

A fire breaks out in a home, causing extensive damage to the structure and its contents. In addition to the damage caused directly by the flames, smoke spreads throughout the home, and water used by firefighters to extinguish the fire causes further damage to the property. In this situation, the fire is considered the proximate cause of the loss because it initiated the chain of events that led to all of the resulting damage. Therefore, a policy that provides coverage for the peril of fire would generally cover not only the fire damage itself but also the related smoke and water damage that resulted from efforts to extinguish the fire.

Concurrent Causation

In some situations, insurers apply the principle of concurrent causation when determining coverage. Concurrent causation occurs when two or more perils act together to cause a loss and each peril is considered a proximate cause of the damage. Under this principle, coverage may apply if at least one of the contributing perils is covered by the policy, even when another contributing peril is specifically excluded. Whether coverage is available in these circumstances depends on the policy language and the laws of the state governing the insurance contract.

Example

A homeowner has a Homeowners policy that provides coverage for fire losses but excludes losses caused by earth movement. An earthquake damages electrical wiring in the home, causing a short circuit that ignites a fire. The resulting fire causes significant damage to the property. If the insurer applies the proximate cause doctrine, the earthquake may be considered the dominant cause of the loss because it initiated the chain of events. Since earth movement is excluded, coverage could be denied. If the insurer applies the concurrent causation doctrine, however, the fire damage may be covered because fire is a covered peril that contributed directly to the loss. In practice, many Homeowners policies provide coverage for fire damage that results from an earthquake or other excluded earth movement, even though the earth movement itself remains excluded.

Inherent Vice

Inherent vice refers to a characteristic or condition within property that causes it to deteriorate, damage, or destroy itself without the influence of an external cause. Examples include the spoilage of food, the rusting or corrosion of metal, natural decay, and ordinary wear and tear. Because these losses result from the property's own inherent nature rather than from a covered peril, property insurance policies generally exclude coverage for damage caused by inherent vice.

Scope of Coverage

Property insurance policies generally classify covered causes of loss, known as perils, into two broad categories.

Named perils coverage provides insurance only for the specific causes of loss that are expressly listed in the policy. If a peril is not identified as a covered peril, any loss or damage resulting from that peril is not covered unless coverage is added through an endorsement or other policy modification. Under a named perils policy, the insured bears the burden of proving that the loss was caused by a peril covered by the policy. Once the insured demonstrates that a covered peril caused the loss, the insurer will evaluate the claim in accordance with the policy's terms, conditions, and exclusions.

Open perils coverage, sometimes referred to as all-risk coverage, provides protection against all causes of loss unless they are specifically excluded by the policy. Rather than listing covered perils, an open perils policy generally covers any direct physical loss that is not subject to an exclusion or limitation. Under an open perils policy, the burden of proof typically rests with the insurer. Once the insured demonstrates that a covered loss has occurred, the insurer must show that the loss resulted from a peril or condition specifically excluded by the policy in order to deny coverage.

Property insurance policies are commonly written using one of three coverage forms: the Basic Form, Broad Form, or Special Form. The Basic Form and Broad Form provide coverage on a named perils basis, meaning they insure only against the specific causes of loss listed in the policy. The Basic Form covers a more limited number of named perils, while the Broad Form expands coverage by including additional named perils. The Special Form provides coverage on an open perils basis. Under this form, all direct physical losses are covered unless they are specifically excluded by the policy. As a result, the Special Form generally provides the broadest level of property insurance protection among the three forms.