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Understanding Consequential Loss

In a world that seems to constantly produce new forms of risk, it is wise for the public to rely on insurance intermediaries to benefit from their knowledge, experience and expertise, coupled with a good working relationship with one or more insurers, to prevent unpleasant surprises at the time a claim arises.

Even the most experienced advisers at times run into new scenarios which often lead to a dispute on how the claim should be handled. One of these grey areas concerns what is termed ‘consequential loss’ in the short-term insurance industry.

BusinessDirectory defines consequential loss as: “Indirect loss which accompanies an insured loss, such as loss of earnings resulting from a burnt down business that was insured against fire. Consequential losses are not covered by ordinary insurance policies, unless specifically included on payment of additional premium.”

In commercial insurance, it could happen when a fire takes place at a warehouse (the direct loss or damage) and the business, being unable to operate as a result, loses its revenue (the consequential loss). In a scenario like this, the business usually should have business interruption insurance in place to provide for the consequential loss.

But questions often do arise about the consequential loss – particularly when it comes to the car insurance sections of personal lines policies. For example, a local insurance broker recently dealt with a claim that was repudiated by an insurer on the grounds that the damage sustained to the insured’s vehicle was as a result of consequential loss. In this instance the vehicle’s engine seized because of loss of water from the radiator while the vehicle was driven following an accident. The short-term insurance ombudsman ruled against the insurer on the basis that it would not be fair and reasonable to expect the insured to have the same knowledge and experience as that of a vehicle engineer.

Another tricky scenario played itself out earlier this year when Ford Kuga vehicles caught fire as a result of mechanical failure. Mechanically, the issue appeared to be insufficient cooling to prevent material warping of the engine’s aluminium cylinder head, which cracked, leaking oil into a hot engine compartment, resulting in fire. A number of insurers rejected these claims on the basis of the exclusion of damage caused by mechanical failure. This means that any consequence of the initial damage (in this case, fire) was not covered in terms of the insurance policy.

But some insurers argued that the fire that resulted from the mechanical failure itself should not be excluded because the fire was a consequential loss thereof. In other words, the client is covered if the consequential loss (or damage) to any other mechanical component of the vehicle is directly linked to the functionality and working of the first breakdown (an insufficient cooling system).

In scenarios like these, some short-term insurers may also refer to the insured’s responsibility of ‘duty of care’. This means that a client (insured) is obligated to take all reasonable steps to prevent loss or damage to their vehicle. If the insured had furthermore applied the principles of ‘duty of care’ – in this case including taking the vehicle to the dealership to have the defective parts inspected and replaced, the insurer may likely honour any claims arising.

Issues around consequential loss are not necessarily easy to wrap one’s head around. And the approach to it varies from insurer to insurer. However, insurance intermediaries would really do well to understand the different approaches thereof to ensure that their clients are adequately protected.

Perhaps this is a timely wake-up call to discuss your insurer’s approach to consequential loss to ensure that you make provision for the possibility of such an event occurring.

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