The insurer informed them that the claim would be settled on an actual cash value basis.

Using a replacement-cost-less-depreciation method, Auto-Owners calculated that it would cost $12,146.55 to repair and replace the damage with new materials. After subtracting $2,160.19 in depreciation, Auto-Owners informed the Lammerts that the actual cash value of their property was $9,986.36. After the Lammerts inquired about the depreciation, Auto-Owners confirmed that both labor and materials had been depreciated.

Auto-Owners similarly calculated its obligation to Larry and Susan Reasons after their home in Jackson, Tennessee, was damaged.

The four homeowners subsequently filed a putative class action lawsuit against Auto-Owners, asserting breach of contract.

After Auto-Owners moved to dismiss, the district court asked the Tennessee Supreme Court to resolve whether the cost of repair and replacement labor could be depreciated when calculating the actual cash value of a property using the replacement-cost-less-depreciation method of calculation.

The Tennessee Supreme Court's Decision

The court answered the certified question in the negative, holding that a portion of the cost of labor to repair and replace damaged property cannot be deducted from the total replacement cost when calculating the actual cash value of a property.

In its decision, the court explained that the parties agreed on the method for calculating actual cash value – replacement cost less depreciation – but disagreed as to whether depreciation applied only to the materials or to both materials and labor.

The court reasoned that both parties had presented plausible interpretations of the policies, neither of which explicitly stated whether labor expenses were depreciable when calculating the actual cash value.

On the one hand, the court said, the homeowners' position that labor was not depreciable was well-taken because it was “reasonable that a homeowner would understand that depreciation would only be applicable to material goods that can age and experience wear and tear.” The court added that it also was reasonable that a homeowner, knowing that replacement costs included both labor and materials to rebuild a roof, would believe that the insurance company only would apply depreciation to the physical materials – “those things that actually deteriorated.”

For its part, the court continued, Auto-Owners' argument was that the homeowners' interpretation was not reasonable because depreciation was a numerical factor to be applied to the replacement cost to calculate the actual cash value and was “not reflective of literal deterioration.”

The court then said that Auto-Owners was arguing for a “technical definition of depreciation” that was “not evident on the face of either policy.” The court then ruled that, taking the term in its ordinary sense, it applied “to physical deterioration,” which was the meaning attributed to it by the homeowners.

Therefore, the court concluded, finding the language in the policies to be ambiguous and construing them against the insurer, “depreciation can only be applied to the cost of materials, not to labor costs.” 

The case is Lammert v. Auto-Owners (Mutual) Ins. Co., No. M2017-02546-SC-R23-CV (Tenn. April 15, 2019). Attorneys involved include: J. Brandon McWherter, Franklin, Tennessee, T. Joseph Snodgrass, St. Paul, Minnesota, and David McMullan, Jr., Lexington, Mississippi, for the petitioners, Gregory J. Lammert, Jamie Lammert, Larry Reasons, and Susan Reasons. John S. Hicks and Charles Covington McLaurin, Nashville, Tennessee, and Todd A. Noteboom and Jeffrey G. Mason, Minneapolis, Minnesota, for the respondent, Auto-Owners (Mutual) Insurance Company. John E. Quinn, Nashville, Tennessee, for the amici curiae, American Insurance Association, National Association of Mutual Insurance Companies, and Property Casualty Insurers Association of America. William F. Merlin, Jr., Tampa, Florida, for the amicus curiae, United Policyholders.

Insurance Coverage Law Center Comment

Cases across the country have reached different conclusions when considering depreciation of labor costs in these circumstances.

Cases in favor of insureds include: Titan Exteriors, Inc. v. Certain Underwriters at Lloyd's, London, 297 F. Supp. 3d 628 (N.D. Miss. 2018); Arnold v. State Farm Fire and Cas. Co., 268 F. Supp. 3d 1297 (S.D. Ala. 2017); Brown v. Travelers Cas. Ins. Co. of America, No. 15-50-ART (E.D. Ky. Apr. 25, 2016); Lains v. Am. Family Mut. Ins. Co., No. C14-1982-JCC (W.D. Wash. Feb. 9, 2016).

Cases in favor of insurance companies include: Graves v. Am. Family Mut. Ins. Co., 686 F. App'x 536 (10th Cir. 2017); In re: State Farm Fire and Cas. Co., 872 F.3d 567 (8th Cir. 2017); Henn v. Am. Family Mut. Ins. Co., 295 Neb. 859, 894 N.W.2d 179 (Neb. 2017).