Indirect loss

Indirect loss is a loss resulting from a peril but not caused directly and immediately by that peril ( e.g.,loss of property due to fire) is a direct loss, while the loss of rental income due to the fire would be an indirect loss. Indirect loss tend to be intangible and difficult to quantify. It will often exceed the direct losses by a wide margin, and will continue to be felt for a long time after the disaster is over. For example, a study of the share prices of 15 firms which survived disasters showed that it took an average of around 50 days for the share prices to get back to the level they had been prior to the event. A low share price may seem to be a rather distant problem for a company to have, but it could have a very real effect on the company's efforts to recover, for example, by making it more difficult to secure lines of credit.

Indirect losses are modeled using economical or statistical approaches. Indirect loss levels are often either considered a function of the direct damage level to the structures or are considered a function of the economic sectors. Various models allow calculating the potential indirect losses. These models range from simple linear input-output models examining the interdependencies of sectors, to nonlinear general equilibrium-based systems that attempts to include all relevant changes to the economy after an event.

It is important to understand the timing of economic disruptions that trigger indirect losses in order to plan for efficient emergency responses and to assess the cost-effectiveness of alternate mitigation strategies. The committee recommends that a microsimulation model be developed to create a timeline of regional commercial and industrial closures. Other models that should be devised include a formal restoration model and a comprehensive indirect loss model.

The most important indirect losses

The most important losses to be considered are therefore those which are consequential or indirect. Indirect losses:

• Loss of confidence by customers, employees and shareholders
• Loss of market reputation and market share
• Breaches of regulations or legal requirements
• Penalties payable for late or non-delivery
• Loss of data leading to loss of management control

Categories of losses

All firms and individuals face uncertainties caused by the possibility of loss. A risk management program is an organized method for dealing with risks. The program begins with identification and measurement of exposures to loss. The second step is to choose an approach from among the risk management alternatives and then to implement the decision. The third step is reevaluating and updating previous decisions. The identification process begins with the recognition of four categories of losses:

• direct losses of property, such as the loss of a machine in a fire
• indirect losses of income, such as the loss of income if a useiness cannot operate because its most important machine burned
• liability losses, such as being sued for negligently injuring a customer
• loss of key personnel, such as the loss of a research scientist who has been responsible for several important inventions.

An estimate of the total potential loss that given peril could cause is an important step in the risk management program. The maximum possible loss is the damage that could be caused under the worst possible circumstances. The maximum probable loss is the most likely maximum amount of damage a firm might sustain from a loss given normal circumstances.

Examples of Indirect loss

• Loss of business income due to a disaster such as a flood, fire, or other natural disaster.
• Loss of customers due to a disaster or an event such as a power outage or a disruption of the business.
• Loss of reputation due to negative publicity or bad reviews.
• Inability to access or use essential data or information, such as customer records, due to a cyber-attack.
• Loss of employees due to a disaster or an event such as a criminal incident or a disruption in the workplace.
• Loss of access to resources or products due to a disruption in supply chains.
• Loss of intellectual property due to a cyber-attack or theft.
• Increased costs associated with rebuilding, restoration, or replacement of damaged property.

Limitations of Indirect loss

One of the major limitations of indirect loss is that it can be difficult to identify and quantify. Here are some of the key limitations:

• Indirect losses can be time-related and may be difficult to accurately forecast. They may involve costs that are difficult to measure, such as the cost of lost reputation or the cost of reduced productivity due to the disruption caused by a disaster.
• Indirect losses may be related to changes in consumer behavior, such as a decrease in demand for certain products or services due to the event. This can be difficult to measure, as it often involves subjective factors.
• Indirect losses may not be immediately visible, but may become apparent over time. For example, the long-term effects on the environment may not be immediately visible, but may become apparent in the years after the event.
• Indirect losses can also be difficult to measure in terms of financial impact. It can be difficult to assess the true cost of, for example, a decrease in consumer confidence or a reduction in the availability of resources.
• Finally, indirect losses can be difficult to insure against, as they are often intangible and difficult to quantify. This means that businesses may be left exposed to losses that are difficult to predict and manage.

Other approaches related to Indirect loss

• Risk modelling: This involves modelling the likely effects of a disaster on a particular organization, using techniques like Monte Carlo simulation to evaluate the probability of a particular outcome. This can help to identify potential indirect losses, as well as highlighting areas where further mitigation measures could be taken.
• Business continuity planning: This involves developing plans and strategies to ensure that the organization can continue to operate in the event of a disaster. This can help to reduce the impact of indirect losses, as operations can be resumed quickly and customers can be provided with services as normal.
• Strategic resilience planning: This involves taking a more holistic approach to disaster planning, focusing on the long-term sustainability of the organization and its ability to respond to and recover from disruptions. This includes the development of strategies to mitigate the impact of indirect losses.
• Supply chain risk management: This involves assessing the risk of disruption to the supply chain, and taking steps to minimize the risk. This may involve diversifying the supply chain, or developing alternative sources of supply in the event of a disruption. This can help to reduce the indirect losses resulting from a disruption.

In conclusion, indirect losses can be mitigated through a variety of approaches, such as risk modelling, business continuity planning, strategic resilience planning, and supply chain risk management. These approaches can help to reduce the impact of disasters and ensure the long-term sustainability of the organization.

Footnotes

Indirect loss — recommended articles

Risks and uncertainties — Retention of risk — Total risk — Accident management — Risk management process — Cost risk — Step cost — Hidden cost — Risk evaluation

References

• Dorfman M.S., (1998), Wprowadzenie do zarządzania ryzykiem i ubezpieczeń, Prentice Hall, Little Rock.
• Hawker A., (2010), Security and Control in Information Systems: A Guide for Business and Accounting, Psychology Press, New York.
• Michel G., (2017), Risk Modeling for Hazards and Disasters, Elsevier, Amsterdam.
• Impacts of Natural Disasters: A Framework for Loss Estimation, (1999), National Academies Press, Washington.

Author: Karolina Urbańczyk