What is Maximum Foreseeable Loss?
A maximum foreseeable loss is an insurance term that refers to the worst possible scenario where the claim for damages and loss is the highest. It means that the damages suffered by the insured party are significant, and he/she needs the highest possible payout to restore them to their previous situation before the insured peril occurred.
Such a situation may occur when the insured peril destroys the insured person’s property to a great extent, and it causes disruptions in the regular operations of the business that will take a long time to fully recover.
- Maximum foreseeable loss is the worst-case scenario in terms of damages and financial loss that a company may face should an adverse event occur.
- Maximum foreseeable loss may result from adverse events, such as fires, explosions, tornados, equipment failure, and other unexpected events.
- A claim for maximum unforeseeable loss is extensive, and it includes the physical loss of property and equipment and the interruption of the day-to-day business operations.
Understanding Maximum Foreseeable Loss
In the insurance sector, a maximum foreseeable loss is used to refer to the highest possible loss that may occur to a policyholder. The level of loss may be caused by various adverse events, such as fires, explosions, or equipment failure. When such events occur, they not only cause damage to property but also affect the policyholder’s source of income.
When compensating the policyholder, the insurance claim should include compensation for repair, reconstruction, or purchase of property or an asset, as well as the compensation for the loss of income. However, just as is the norm in the insurance sector, the insurer must conduct investigations into the loss suffered to ascertain that the loss suffered was not due to the negligence of the policyholder. The insurer also conducts an independent assessment and valuation of the value of the loss to determine the extent of damages or loss that the policyholder suffered.
Causes of Maximum Foreseeable Loss
A maximum foreseeable loss occurs when the occurrence of an insured event causes the policyholder to suffer significant damages or losses. The three main events that can result in maximum foreseeable loss include:
Fire is the primary cause of maximum foreseeable loss, and when it is uninhibited, the fire can spread until all combustibles are consumed. For example, if a fire breaks out in a warehouse, and the automatic fire protection fails to work, and firefighters don’t arrive in time, the accumulation of the combustible will fuel the fire for a long duration.
Warehouses generally may contain wooden pallets, packaging materials, plastic containers, and the products themselves, which create a free-burn situation. In such a situation, the only solution to stopping the fire from spreading to other sections of the warehouse is a firewall or space separation between the warehouse sections.
An explosion is a common risk in certain types of facilities that deal with materials prone to explosion. The explosion may be caused by the inherent nature of the facility or when the facility engages in activities with a high risk of explosion.
Examples of such facilities include fuel storage facilities, fertilizer manufacturing plants, breweries, and chemical processing facilities. The facilities are generally required to put measures in place to prevent the occurrence of an explosion or other events that may lead to the highest possible loss. Some of the measures may include improved process safety, separation of explosive materials, and continuous supervision of factory employees.
Failure of essential equipment can also lead to maximum foreseeable loss, especially when the equipment is central to the production process of a company. For example, the failure of highly specialized equipment that a business uses to perform core functions can lead to a significant loss of income to the business.
Also, the failure of the equipment can lead to other events, such as an explosion or fire, which can cause irreparable damage to the business and subsequent financial loss. Businesses can mitigate equipment failure through timely replacement of worn-out or defective parts, routine preventive maintenance, and proper monitoring of the machinery.
How to Claim Maximum Foreseeable Losses
When a policyholder holder suffers a maximum possible loss, it means that the occurrence of an adverse event caused substantial damages and financial loss that they could ever experience. Therefore, filing a claim for maximum foreseeable loss is an extensive process that considers not only the physical losses of the property and equipment but also the negative impact of the loss on the regular operations of the business.
Restoring the policyholder to their initial position before the loss occurred can take weeks or months, depending on the severity of the damages and size of the business. The insurer acknowledges that the business may be unable to progress with their regular day-to-day operations while the repairs or reconstruction are carried out.
Therefore, the business interruption may be partial or full, depending on whether the business can operate an online store or owns other physical locations that were not affected by the event. When a business anticipates maximum foreseeable loss, it should purchase insurance to protect itself from the unexpected events that can cause the highest possible financial loss to the business.
CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: