The “direct physical loss” condition in business insurance policies has caused much confusion and litigation over the years. Unless a covered event causes “direct physical loss” to insured property, insureds cannot recoup under their commercial property, business interruption, or certain other types of insurance policies – no matter how severe the financial loss. But what does “direct physical loss” actually mean?
“Direct Physical Loss” Definition
The term “direct physical loss” refers to a tangible, material alteration or damage to insured property caused by a covered event, such as fire, vandalism, wind, or certain types of water events.
Courts and insurers have consistently emphasized that the loss must be caused “directly” by the covered event, and that there must be a discernible material change to the property itself – that is, damage that can be seen, measured, and potentially repaired. For instance, a fire that damages a restaurant kitchen, a burst pipe that floods office space, or a wind storm that tears off a building’s roof directly causes a physical transformation, triggering coverage.
Types of Insurance That Rely on “Direct Physical Loss”
Commercial property insurance policies cover damage to buildings, equipment, inventory, and other physical assets – but only when a covered peril directly causes physical damage to the property. Without physical damage, there is generally no claim.
Business interruption coverage compensates businesses for lost income and helps them pay ongoing expenses when a covered peril causes a business to temporarily shut down or curtail operations. In most cases, business interruption coverage is bundled with a commercial property insurance policy or a business owner’s policy (BOP) rather than being purchased as a standalone product. For coverage to be triggered, the interruption must have resulted from direct physical loss or damage to insured property.
Some business interruption policies contain a civil authority extension, which covers the insured for an interruption resulting from a government order that prevents access to the business due to damage to a nearby property. With civil authority coverage, the insurer is only obligated to pay if the government-ordered shutdown stems from physical damage to a nearby property that was caused by a covered peril, such as fire.
Similarly, certain types of businesses commonly purchase contingent business interruption insurance, which guards against interruptions stemming from supply chain disruptions. However, these policies typically require that the disruption be caused by physical damage to the supplier’s property.
Gray Areas: Contamination from Toxic Fumes and Viruses
While some events clearly involve direct physical damage, legal debate has been sparked by whether contamination from toxic gases or fumes or invisible threats like viruses and bacteria could constitute direct physical loss, and by whether loss of use alone could be considered “physical loss.” When the COVID-19 pandemic forced thousands of businesses – from restaurants and gyms to retailers and hotels – to temporarily shut down operations, many filed business interruption claims with their insurance companies. However, in the vast majority of cases, insurers denied the claims, and courts largely sided with the insurers. The courts overwhelmingly held that there was no coverage because the virus did not cause tangible physical damage to property and that loss of use alone was not enough to trigger the insurer’s obligation. Further, some insurance policies at the time explicitly excluded coverage for viruses. Since the pandemic, many other insurers have added virus and bacteria exclusions to their policies to remove any ambiguity.
In insurance policy fine print, few terms are as consequential as “direct physical loss.” It is critical for businesses to understand the language in their insurance policies so they can accurately assess their protections and limitations.
If your business insurance company has denied or is challenging your claim, contact Schwartz, Conroy and Hack PC, for assistance. We have the expertise and tenacity to make insurance companies keep the promises they make to you and your business.
