Property policies commonly refer to losses being settled on anactual-cash-value basis, usually somewhere in the loss-settlementprovisions. Fine, but exactly what is actual cash value?

In a recent breakout session at the National Underwriter's ACEConference in New Orleans, participants were asked to raise theirhands if they could give a definition for actual cash value. Thecommon response was, “Actual cash value is the replacement costminus depreciation.” But is it? And, if it is, what is beingdepreciated? The cost of the materials? Labor? Overhead andprofit?

Furthermore, is actual cash value the same as market value? Whatis the broad-evidence rule and does it apply? Since many policiesdo not define actual cash value, the decision often is left to thecourts.

Looking for Answers

Depreciating the cost of new materials is widely accepted and isnot subject to dispute. But when it comes to labor, it is adifferent matter.

Two similar cases reached the Oklahoma Supreme Court and wereanswered within a day of each other in 2002. Both cases involveddamage to roofs and an actual-cash-value settlement. Both alsoaddressed depreciation of labor.

In the first, Redcorn v. State Farm, the court said, “A roof isthe product of both materials and labor,” and so depreciation oflabor costs was allowable. But in a dissenting opinion, threejustices argued that labor costs should not be depreciated. A roof,they stated, is not a single product consisting of labor andshingles, but rather is a combination of products (shingles andnails) and a service (labor to install). Labor, they argued, cannotlose value over time.

One dissenting justice also pointed out that prior to the loss,the insured had an installed, 16-year old roof. To be indemnifiedmeant the policyholder was entitled to the value of the 16-year-oldshingles plus the cost of installing them.

The second case before the same court, Branch v. FarmersInsurance, also dealt with depreciation of labor. In this instance,the court was asked to determine if the labor costs for tearing offa damaged roof could be depreciated or whether this cost should becovered under debris removal. In its answer to the first question,the court said that labor to install the new roof was a cost theinsured was reasonably likely to incur, which meant it was rightlyincluded within the meaning of replacement cost. It followed, then,that labor could be depreciated along with materials.

But having said that, the court noted that most homeowners'policies contained a separate coverage for debris removal followinga covered loss. If a roof was damaged to the extent that it had tobe replaced, then the damaged portion was debris. Furthermore, ifthe whole roof had to be torn off in order to repair or replace thedamaged portion, the torn-off pieces also must be consideredrubble. Therefore, although the cost of the labor to replace theroof could be depreciated, the cost to remove the debris of the oldroof could not.

Overhead, Profit Depreciation

Another frequently asked question is, “Should contractors'overhead and profit be depreciated?” The Pennsylvania SuperiorCourt addressed this in Gilderman v. State Farm in 1994. Here, theissue was whether the insurer could automatically deduct 20 percentof a contractor's overhead and profit in addition to depreciationin order to reach actual cash value.

The insureds argued that contractor overhead and profit shouldbe included in figuring replacement costs; the insurer argued thatit should not since a contractor was not always used. The insurerheld that the insured would reap a windfall profit if overhead andprofit were included in calculating replacement. The court noted,though, that insureds under a replacement-cost policy had paidadditional premium dollars for the coverage and would lose thebenefit of that coverage if they did not elect to repair orreplace, which meant that they could not be held to have gained.Overhead and profit was a component of replacement cost and couldbe depreciated, but an additional amount should not bewithheld.

The Supreme Appellate Court of New York addressed the same issuein Mazzocki v. State Farm Fire & Casualty. In a 2003 verdict,the court held that the insurer was obligated to include profit andoverhead in replacement cost and, therefore, in actual cash valuewhenever it was reasonably likely that the services of a contractorwould be needed. The court looked to Gilderman and to a Michigancase decided by the appellate court, Salesin v. State Farm Fire& Casualty.

Role of Broad-Evidence Rule

Many states adhere to the broad-evidence rule in reaching actualcash value. Under this rule, as the court explained in the New Yorkcase of Mazzocki, “Every fact and circumstance that would logicallytend to the formation of a correct estimate of the loss” could beconsidered. The Supreme Court of Nebraska held in 2005 that if apolicy contained no definition of actual cash value, then marketvalue — the amount that a willing buyer might pay a willing seller— could be used, as well as any other facts that established value.(See Olson v. Le Mars Mutual Insurance Co. of Iowa.)

Many states, having seen the resulting confusion, are requiringthat a definition be added to policies. Nebraska, doubtless as aresult of Olson, now states in its homeowners' special provisionsthat, “In our determination of the actual cash value of coveredproperty at the time of loss, an adjustment will be made forfactors such as depreciation, deterioration, and/orobsolescence.”

The state of Washington has a comprehensive definition thatencompasses whether a loss is repairable or whether the propertyhas sustained a total loss. Maine, in an attempt to clarify, mightpossibly have opened up another can of worms with its definition: ”'Actual cash value' means the replacement cost of covered propertyat the time of loss, less the value of physical depreciation as tothe damaged property. 'Physical depreciation' means a value asdetermined according to standard business practices.”

Standard? According to which business? Enron? And so itcontinues ….

Diane W. Richardson, CPCU, is an associate editor with Fire,Casualty, & Surety. She is the author of several books on thesubject of homeowners' insurance and has a background in insuranceunderwriting. She may be reached at [email protected]. TheFC&S Claim Queue is prepared and written by the editorial staffof The Fire, Casualty and Surety (FC&S) Bulletins, the mostwidely used encyclopedic reference service devoted to insurancepolicy interpretation and coverage topics. FC&S is published byThe National Underwriter Company. The editors welcome comment [email protected].