What Is First Loss?

C. Daw
C. Daw
Man climbing a rope
Man climbing a rope

In finance, the term “first loss” refers to a form of partial insurance in which a property is insured for an amount much less than the full value of the property. This is often applied in theft or burglary insurance, where there is very little possibility that all items within the property would be stolen at any one given time. For example, a large retail store would usually get a first loss policy instead of getting full insurance for all that the store is worth. This business decision is based on the logical assumption that, should a burglary occur, not everything in the store would be taken. Only up to a certain amount would be lost, and this is what would be covered in the first loss insurance policy. The amount is calculated based on what is believed would be the biggest loss possible at a single instance of burglary.

Getting a first loss policy would also mean lower payments, so it can be a sound business decision. However, should a major fire, flood, or some other unforeseen catastrophic event occur, destroying the entirety of the store, then it would be to the owner’s disadvantage because they would not get a full insurance payment according to the actual loss; instead, they would get only the amount that they had insured under the first-loss policy. If the policy covers only up to $300,000 US Dollars (USD), this is the insurance amount they would get, even though the actual value lost in the fire or flood is, say, $3 million USD or higher.

Given its nature, it is easy to see that first loss insurance may be reasonable when applied to bigger properties, but it is hardly recommended for other types of insurance, such as for car insurance. In the case of the latter, it is always better to get full replacement insurance and be fully protected in case the car gets stolen or damaged in an accident. Partial insurance may also not be the best option for properties in high-risk areas, such as those that are high-crime or fire-prone.

When voluntarily adopting a first loss policy, the insured person agrees that the average clause cannot be applied in their case. The average clause dictates that a proportionate payment is made in accordance to the actual damage or loss suffered. The insured person also explicitly agrees to not undertake any measures to penalize the insurance company for under-insuring the property, even if they incur a damage that is much bigger than the amount stipulated in the first loss insurance contract.

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