In Lammert v. Auto-Owners (Mut.) Ins. Co., 572 S.W.3d 170 (Tenn. 2019), the main concern came down to the ambiguity of the policy language at issue. On three occasions between two different policies, the insurer had used, after disclosing to the insureds, the "replacement-cost-less-depreciation" method to determine the actual cash value of the payments due. Other courts that had considered the issue used the "broad evidence rule," (for an explanation see: A Brief Overview of Broad Evidence) which in effect states that fact-finders may consider "every fact and circumstance which would logically tend to the formation of a correct estimate of the loss." (Id.). When the insurer argued that labor depreciation could and should be considered in calculating payments, the court stated that, while the broad evidence rule had been acknowledged by the Tennessee Supreme Court, it had not been explicitly adopted; moreover, the broad evidence rule was not at issue in Lammert, period. The insurer argued for "a technical definition of depreciation that [was] not evident on the face of either policy[,]" which led to the justices' holding that "[b]ecause the language regarding depreciation in the policies was ambiguous, the insureds' interpretation of the policies was controlling." (Id.)

In Hicks v. State Farm Fire & Cas. Co., 751 Fed. Appx. 703 (6th Cir. 2018), the plaintiffs' houses had both been destroyed by fires. The adjusters who assessed the damages gave the homeowners a written estimate for repairs that included labor and materials; when State Farm was making its ACV calculations, the amounts reflected depreciation for both labor and materials. When the plaintiffs filed suit, State Farm defended their method based on its acceptability under both company policy and state law. In neither policy, however, had State Farm defined "actual cash value"; instead, they had incorporated a state-law ACV provision. While the incorporation was undisputed, the parties each took issue with the other side's definition of "depreciation." The court declared that, since each side's definition of "depreciation" was reasonable, the overall definition of "actual cash value" was ambiguous. Since prevailing case law required that any ambiguities be construed in favor of the insureds, State Farm could not depreciate labor costs for the plaintiff's claims.

In Mitchell v. State Farm Fire & Cas. Co., 954 F.3d 700 (5th Cir. 2020), the insured and the insurer agreed on how to calculate the actual cash value after a loss but contested which costs should be depreciated. Again, the State Farm policy at issue did not explicitly define "actual cash value," leaving open to interpretation whether or not labor could be included in the costs of depreciation. State insurance law required that any ambiguous terms be construed in favor of the insured's reasonable interpretation of the ambiguity. The court ruled that the insured's interpretation of the term was reasonable because, in line with state insurance law, it would put the insured in the identical position as before the occurrence.

In Perry v. Allstate Indem. Co., 953 F.3d 417 (6th Cir. 2020), the parties disagreed on whether the insurer could include labor in its depreciation costs. The insured argued that "depreciation" was ambiguous and should therefore be interpreted in her favor. The trial court, on the other hand, agreed with the insurer that, though the term "depreciation" was not expressly defined in the policy, the term included labor costs, and thus the insured's suit was dismissed. The Sixth Circuit disagreed, pointing to multiple cases, at both the federal and state level, where a definition of "depreciation" that excluded labor costs had been found reasonable, thus rendering the term ambiguous in this case. Since state law had already established that any ambiguity in insurance contracts be construed against the insurer, the Sixth Circuit reversed the trial court and entered judgment in favor of the insured.

While these cases all find for the insured that labor should not be depreciated, the position of many carriers and some courts is that labor is indeed depreciable. Many carriers will contend that when a policy is paying on an actual cash value basis, that labor should be depreciated and that the premium is based on settlement taking into account depreciation of both materials and labor. A common thread in cases where a court has allowed an insurer to depreciate labor costs, or allow depreciated labor as a factor, is the adoption of the broad evidence rule.

Cases for Depreciation of Labor

In Henn v. Am. Family Mut. Ins. Co., 894 N.W.2d 179 (Neb. 2017), a homeowner submitted a claim after a hail storm caused extensive damage to the dwelling. The insurer accounted for labor depreciation in the initial payment to the insured; the insured took issue with labor depreciation; and the parties ended up in court. Here, however, unlike some previous cases, state law concerning actual cash value was well-established, therefore taking the definition outside what could be considered "ambiguous." Also, unlike other courts, Nebraska had actually adopted the "broad evidence rule," allowing "all relevant facts and circumstances to be considered when determining the actual cash value." (Id.). The court decided, in light of the well-established law, the insurer's inclusion of labor depreciation was reasonable.

In Wilcox v. State Farm Fire & Cas. Co., 874 N.W.2d 780 (Minn. 2016), the insureds' home suffered hail damage. In providing an estimated ACV to the homeowners, State Farm did not separate the costs of labor and materials when calculating depreciation. Here, the question for the court centered not on the meaning of "actual cash value," but how ACV may be calculated. The Minnesota Supreme Court had formally adopted the "broad evidence rule" in an earlier litigated insurance dispute. This rule, according to the court, allowed the consideration of labor depreciation as a factor in determining "actual cash value."

In Butler v. Travelers Home & Marine Ins. Co., 858 S.E.2d 407 (S.C. 2021), the South Carolina Supreme Court had to answer a certified question from the District Court for the District of South Carolina as to whether "embedded labor costs" could be depreciated in calculating an ACV payment for a claim. An insurer had depreciated labor from ACV payments under two separate policies. The insureds who brought suit disputed whether labor should have been included in the insurer's depreciation calculations. The Court pointed out that the "embedded labor costs" referred to "the labor costs that are no longer separable from the cost of materials." (Id.). It would not make sense, the Court reasoned, to depreciate embedded labor costs because the ACV is determined on the whole of the damage, not its parts. The Court did not say whether the offers to the separate insureds were reasonable, only that the insurer could depreciate labor costs when calculating the ACV of damaged property.

Washington State Insurance Department View

This year the Office of the Insurance Commissioner of Washington State took a close look at this issue. Under review was the insurer practice of issuing initial payment on replacement cost policies on an actual cash balance as per policy language, but also depreciating labor as well. This depreciation of labor places a burden on insureds of the costs of repair before they have received their full settlement payment. The Commissioner has seen a rise in policy forms that include this practice in the definition of actual cash value. A rule was proposed as follows: "(4) Except for the intrinsic labor costs that are included in the cost of manufactured materials or goods, the expense of labor necessary to repair, rebuild, or replace covered property is not a component of physical depreciation and may not be subject to depreciation or betterment."

From June through September of this year, a proposal from the Commissioner was open for comment, and a public hearing was held in October. While publicly supported, industry representatives stated that the rule would discourage insureds from making repairs, that forms allowing for depreciation of labor had already been approved, and that it would cause rates to increase, among other things. A synopsis of comments received and response from the Commissioner can be found here.

The rule is being implemented effective January 1, 2022. A copy of the order can be found here.

For further reading:

A Brief Overview of Broad Evidence Rule

Actual Cash Value – A Changing Concept

Replacement Cost Insurance