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March 13, 2003

I.  Introduction

Assuming that a loss falls with the terms and conditions of the insurance policy and is a covered loss, the next question to be addressed is the quantum of the loss. The quantum of the loss is generally resolved by valuation principles based on “Actual Cash Value” calculations or “Replacement Cost” calculations contained within the particular policy of insurance. The concept of Actual Cash Value arose from the general principle that insurance is traditionally intended to place an insured in the same position that it would be had no loss occurred. “Actual Cash Value” means the cash value of property immediately prior to the loss or damage. Patriotic Order Sons of America Hall Ass’n v. Hartford Fire, Ins. Co., 305 Pa. 107, 157 A. 259 (Pa. 1939).  Replacement cost on the other hand is designed to cover the difference between what property is actually worth immediately prior to the loss, i.e. its Actual Cash Value, and what it would cost to rebuild or repair that property after the loss. It is insurance on a property’s depreciation. Leo L. Jordan, What Price Rebuilding?, 19 ABA Fall Brief 17 (1990), cited with approval in State Farm Fire and Casualty Co. v. Patrick, 647 So. 2d 983 (1994).

The basic premise of property insurance policies is that they are contracts of indemnity which are intended to pay the insured for losses actually sustained as a result of a covered peril. As is stated in 4 Appleman, Insurance Law and Practice § 2107, “All contracts of property insurance, whether of fire, marine, or other types, are considered contracts of indemnity, intended solely to indemnify the insured for his actual monetary loss by the occurrence of the disaster. Unless the insured has sustained an actual loss, the insurer has no liability.”

II.  The Calculation Of “Acv” And “Replacement Cost”

Under most circumstances, there is a difference between the value of the property immediately before the loss and the cost to repair of replace the item after the loss. Some courts interpret this difference to be the depreciation of the property prior to the loss and have held that the measure of actual cash value is replacement cost less depreciation. See Couch on Insurance 3d §175:24; and also, Clemon v. Occidental Fire & Cas. Co. of North Carolina, 200 Neb. 469, 264 N.W.2d 192 (1978); Gilderman v. State Farm Ins. Co., 437 Pa. Super. 217, 649 A.2d 941 (1994); Incardona v. Home Indem. Co., 60 A.D.2d 749, 400 N.Y. S.2d 944 (4th Dep’t 1977); First Preferred Ins. Co. v. Bell, 587 S.W.2d 798 (Tex. Civ. App. Amarillo 1979). However, other courts have adopted the Broad Evidence Rule in calculating the actual cash value of damage to destroyed property. See New York Central Mutual Fire Ins. Co. v. Diaks, 697 2d 786 (Fla. 1954). The Broad Evidence Rule allows for the introduction of any evidence tending to establish a correct estimate of the value of the damage to destroyed property that may be considered by the trier of facts to determine ACV at the time of the loss. J & H Auto Trim Co. v. Bellefonte Ins. Co., 677 F.2d 1365 (11th Cir. 1982). It appears that the Broad Evidence Rule is being accepted by a significant number of courts in recent years and is the evolving trend for determining the Actual Cash Value at the time of a loss. See Couch on Insurance 3d §175:24; and also, Elliano v. Assurance Co. of America, 45 Cal. App. 3d 170, 119 Cal. Rptr. 653 (2d Dist. 1975); Thomas v. American Family Mut. Ins. Co., 233 Kan. 775, 666 P.2d 676 (1983).

III.   “Holdback” For Depreciation And Requirement To Effectuate Repair

The difference between the Actual Cash Value Calculation and the Replacement Cost amount results in a number which is sometimes called the “Holdback.” Most policies contain a provision which requires payment of the Actual Cash Value amount until the Replacement Cost has actually been incurred. After the repairs are completed, the insured is then entitled to the “Holdback.” For example, the Standard Building and Personal Property Coverage Form (CP 00 10 10—00) provides for this Loss Payment calculation as follows:

4. Loss Payment 

a. In the event of loss or damage covered by this Coverage Form, at our option, we will either:

(1) Pay the value of lost or damaged property;

(2) Pay the cost of repairing or replacing the lost or damaged property, subject to b. below;

(3) Take all or any part of the property at an agreed or appraised value; or

(4) Repair, rebuild or replace the property with another property of like kind and quality, subject to b. below.

* * *

7. Valuation

We will determine the value of Covered Property in the event of loss or damage as follows:

a. At actual cash value as of the time of loss or damage, . . . 

                                * * *

                                * * *

3. Replacement Cost 

                                * * *

d. We will not pay on a replacement cost basis for any loss or damage:

  1. Until the lost or damaged property is actually repaired or replaced; and
  2. Unless the repairs or replacement are made as soon as reasonably possible after the loss or damage.

A mere intent to repair or replace the damaged property is not sufficient to invoke the provisions of a replacement cost endorsement. Hilley v. Allstate Ins. Co., 562 So. 2d 184, 190 (Ala. 1990). The Hilley case involved amounts due on a Deluxe Homeowners Policy following a fire loss. Under the terms of that policy, the insurer was not required to pay the actual cash value of the damage until repairs or replacement were complete. Id. at 189. With regard to that issue, the court stated:

[A] mere intention to replace does not trigger the insurer’s replacement cost payment obligations. Consequently, even though the Hilleys allegedly intended to replace their house, but claim that they could not afford to effectuate that rebuilding, they cannot overcome the clear and unambiguous terms of their Allstate policy that precluded any replacement cost payment prior to the completion of rebuilding.

Id. at 190.

Various other courts have held the repair or replacement is a condition precedent to recovery of the endorsement amount. See, e.g., Snellen v. State Farm Fire & Cas. Co., 675 F. Supp. 1064 (W.D. Ky. 1987); Lerer Realty Corp. v. MFB Mut. Ins. Co., 474 F.2d 410 (5th Cir. 1973); Hess v. North Pac. Ins. Co., 859 P.2d 586 (Wash 1993); Higgins v. Insurance Co. of North America, 469 P.2d 766 (Or. 1970).

In Kolls v. Aetna Cas. and Sur. Co., 503 F2d 569 (8th Cir. 1974) (applying Iowa law), the insured owners of a shopping center sustained property damage as a result of a fire loss. They were paid the actual cash value of the property according to the terms of the policy. In repairing the property damaged by the fire, they sought to recover the replacement cost under the terms of the endorsement for such expenditures. In this instance, however, the amount expended for repair was less that the actual cash value. Accordingly, the court held they were not entitled to recover any amount in excess of actual cash value until they expended such an amount since the terms of the policy allowed recovery for the lesser of the replacement cost of the property or the amount actually and necessarily spent to repair or replace the property.

Similarly, the court in Ghoman v. New Hampshire Ins. Co., 159 F.Supp. 2d 928 (N.D. Tex. 2001), held that an insured which seeks replacement cost under a policy which limits recovery for such costs to the amount actually expended to repair or replace the property cannot recover those costs unless and until the repair or replacement occurs.

Based on the foregoing, it is clear that unless and until the Insured actually repairs or replaces the damaged property, the Insured’s actual loss is just the actual cash value. If the Insured never repairs or replaces the damaged property, then it has never sustained an actual loss of those additional amounts it would otherwise take to repair or replace the damage to the property. Under those circumstances, most policies would not require any such payment.

IV.   “Valued Policy Law” Implications On “Holdback”

Generally speaking when a loss occurs by fire or lightning and the state has a valued policy law, the full amount of policy limits must be paid without regard to the policy provisions regarding ACV calculation and replacement cost coverage. However, there are some exceptions to this rule. Ohio Revised Code § 3929.25, sometimes referred to as the “valued policy law”, states: 

                3929.25 EXTENT OF LIABILITY UNDER POLICY

A person, company, or association insuring any building or structure against loss or damage by fire or lightning shall have such building or structure examined by his or its agent, and a full description thereof made, and its insurable value fixed, by such agent. In the absence of any change increasing the risk without the consent of the insurers, and in the absence of intentional fraud on the part of the insured, in the case of total loss the whole amount mentioned in the policy or renewal, upon which the insurer received a premium, shall be paid. However, if the policy of insurance requires actual repair or replacement of the building or structure to be completed in order for the policyholder to be paid the cost of such repair or replacement, without deduction for depreciation or obsolescence, up to the limits of the policy, then the amount to be paid shall be as prescribed by the policy.

The third sentence of this statute was added by amendment in 1980. In the preamble to that amendment, the legislature explained:

An Act to amend section * * * 3929.25 * * * of the Revised Code * * * to condition payment of replacement value of a building under a fire insurance policy upon actual use of the proceeds for its replacement.

138 Ohio Laws, Part I, at 683.

The cases interpreting the second and third sentences of this statute, regarding total loss to the property and repair or replacement provisions, have involved factual situations in which the insured has elected not to repair or replace the property. Under those circumstances, the Ohio Supreme Court has stated:

[P]ursuant to R.C. 3929.25, where an insured party sustains a total loss to property covered under a fire insurance policy and does not replace such property, that party is entitled to payment of the full face value of the policy . . . .

McGlone v. Midwestern Group, 573 N.E. 2d 92, 95 (Ohio 1991).

The facts underlying the McGlone case indicate the McGlones had a policy of fire insurance with Midwestern Group covering a dwelling on their farm property. After the dwelling was totally destroyed by fire, Midwestern sent an adjuster to view the damage who established the amount of loss at $23,585.87, the actual cash value of the building. This amount was paid, and the McGlones were given a six-month extension within which to make an additional claim for costs for repair or replacement. Although the McGlones did not attempt to replace the dwelling, they filed suit to recover the difference between the amount paid to them and the amount for which the dwelling was insured. They based their claim on the valued policy statute and argued the second sentence applied because their loss was total. Midwestern, in opposition, argued that the third sentence of the statute applied, without regard to whether the loss was partial or total. Therefore, Midwestern argued, since the policy contained a repair or replacement clause, the policy supercedes the valued policy law, and the insured was only entitled to the amount allowed under the policy, since the McGlones did not repair or replace the dwelling.

In affirming the appellate court’s decision in favor of the insureds, the McGlone court determined the plain language of the statute indicates a total loss results in payment of the full amount mentioned in the policy. If the statute was interpreted otherwise, the court reasoned, it would render the second sentence of the statute useless since an insurance company could then attempt to avoid paying the full amount by including a repair/replacement clause and deny full payment where the insured elects not to repair or replace. The court also noted that under some situations involving “total loss,” the replacement costs are greater than the amount for which the property is insured, which additional costs would have to be absorbed by the insured. The Ohio Supreme Court concluded:

Our holding in the case sub judice underscores the public policy foundations of R.C. 3929.25 as identified in Leslie, while giving full effect to the statutory language added by the General Assembly in 1980. It assures that consumers of insurance services will be made whole to the extent of their coverage either through receipt of amounts equal to the insurable value of the property for which premiums were paid or through replacement of the destroyed structure.

Id. at 95.

It follows from McGlone, therefore, that where the insured elects to repair or replace the building, the replacement cost provisions of the policy should be given effect. The court in Myers v. Cincinnati Ins. Co., 561 N.E. 2d 1060 (Ohio App. 1989), stated:

The 1980 amendment recognized the validity of a replacement cost provision in a policy if insurance. However, the provision comes into play only if the building is repaired or replaced. The policy then controls the recovery for the loss. The insurer may benefit if the cost of repair or replacement is less than the policy limits. In other words, if the building is repaired or replaced for less than the limits of the policy, the insured is not automatically entitled to collect the difference up to the limits of the policy. The insured would also benefit through reduced premiums.

Id. at 1062 (emphasis in original; citation omitted).

Fifty years ago, the Florida Supreme Court addressed the issue of holdbacks in the context of depreciation for materials used in Glens Falls Ins. Co. v. Gulf Breeze Cottages, Inc., 38 So.2d 828 (1949). The facts underlying that decision involved property damage to beach cottages as a result of both hail and windstorm. The issue before the Glens Falls court was whether the measure of indemnity for a partial loss is the cost of repairing the structure to make it habitable, or the cost of repair less depreciation. Id. at 829. Based on the fact that the purpose of the insurance contract was to indemnify the insured against loss, the court held the property should be placed in as nearly as possible the same condition as before the loss, without any allowance for depreciation for the materials used. Id. at 830.

Subsequent to the Glens Falls decision, the Florida legislature enacted the Valued Policy Law, §627.702 Florida Statutes, which provides, in part:

627.702 Valued policy law.1

(1) In the event of the total loss of any building, structure, mobile home as defined in §320.01(2), or manufactured building as defined in §553.36(11), located in this state and insured by any insurer as to a covered peril, in the absence of any change increasing the risk without the insurer’s consent and in the absence of fraudulent or criminal fault on the part of the insured or one acting in her or his behalf, the insurer’s liability, if any, under the policy for such total loss shall be in the amount of money for which such property was so insured as specified in the policy and for which a premium has been charged and paid.

(2) In the case of a partial loss by fire or lightning of any such property, the insurer’s liability, if any, under the policy shall be for the actual amount of such loss but shall not exceed the amount of insurance specified in the policy as to such property and such peril.

* * *

After the enactment of the Valued Policy Law, the Florida Supreme Court revisited the issue of holdbacks for depreciation of materials in Sperling v. Liberty Mutual Ins. Co., 281 So.2d 297 (1973). The Sperling case involved a partial loss by fire to an insured building. In reversing the lower court’s rulings that depreciation could be withheld in determining the amount of the loss payment, the court declared the amount recoverable was governed by the Valued Policy Law. Accordingly, the measure of the insured’s loss should be determined based on the “actual amount” needed to repair the building to the same condition it was in before the loss, without allowing for depreciation for the materials used. The “actual amount,” according to Glens Falls, was the cost to place the building “in as nearly as possible the same condition that it was before the loss, without allowing depreciation for the materials used.” Id. at 298.

Following Hurricane Andrew, on December 8, 1992, the Department of Insurance issued an Informational Bulletin Number B92—036, which states:

The payment of a partial loss on real property must be handled in a manner consistent with existing statutes and case law. 627.702(2), Florida Statutes, while specifying only fire and lightning losses, is instructive in discerning legislative intent in applying the Valued Policy Law to partial losses on real estate resulting from Hurricane Andrew. This statute provides that the insured is entitled to the “actual amount of such loss,” not to exceed the amount of insurance specified in the policy as to such property.

The Florida Supreme Court, in Sperling v. Liberty Mutual Insurance Company, 281 So.2d 297 (Fla. 1972), held that the “actual amount of such loss” is the cost of placing the building in as nearly as possible the same condition that it was before the loss, without allowing deprecation for the materials used.

This authority is specifically applicable to the practice by insurers of imposing a “holdback” of insurance proceeds greater than actual cash value until replacement has taken place. While this practice is appropriate for personal property, this bulletin serves to place insurers on notice that for partial losses on real property, the “holdback” is inconsistent with established precedent.

The application of a “holdback” to repair of real property can particularly cause hardship to the insured when the actual cash value payment is insufficient to enter into a contract to make repairs. In such an instance, the insured may be forced to seek other funding sources, at his expense, in order to contract for repairs.

Insurers who have been applying “holdbacks” in claims for partial loss on real property should pay the actual amount of the loss. The best indicator of actual loss is the contract for repair entered into by the insured. Once an actual amount of loss is determined by contract, the full loss payment should be made with no holdback applied. This arrangement satisfies the public policy interests both in timely and sufficient claim payments, and in encouraging rebuilding. In instances where a holdback is currently being applied and a repair contract has been executed, the holdback should be released.

This Informational Bulletin, while not binding on the courts, further reinforced the Florida Supreme Court decisions that holdbacks are not permissible.

Subsequent to all of the foregoing, in 1994, the Third District Court of Appeal of Florida issued a ruling in State Farm Fire and Casualty Co. v. Patrick, 647 So. 2d 983 (1994), in which it approved the withholding of depreciation from a loss resulting from Hurricane Andrew. Patrick involved a replacement cost insurance policy, the terms of which required State Farm to pay any amount withheld after work was completed and the insured submitted a claim. State Farm estimated the repairs at $14,207.28, and paid $11,102.87, withholding the deductible and $2,854.41 for depreciation. The insured acted as his own contractor and completed the work for $11,034.86. State Farm refused to pay the additional amount since the insured did not incur any expense in excess of what he had paid. The court, holding the Valued Policy law was not applicable because the case did not involve a partial loss from fire or lightning, ruled in favor of State Farm. It stated:

Replacement cost insurance is designed to cover the difference between what property is actually worth and what it would cost to rebuild or repair that property. It is insurance on a property’s depreciation. Leo L. Jordan, What Price Rebuilding?, 19 ABA Fall Brief 17 (1990). Courts have almost uniformly held that an insurance company’s liability for replacement cost does not arise until the repair or replacement has been completed. Id.; see e.g., Tamco Corp. v. Federal Ins. Co. of New York, 216 F. Supp. 767 (N.D. Ill. 1963). Patrick’s contract provides that State Farm “will not pay for any loss on a replacement cost basis until the lost or damaged property is actually repaired or replaced. . . .”

* * *

[T]he contract plainly provides that State Farm “will not pay more for loss in any one occurrence on a replacement cost basis than . . . the amount you actually spend that is necessary to repair or replace the lost or damaged property.”

Id. at 983—84. Accord, American Reliance Ins. Co. v. Perez, 689 So.2d 296 (Fla. 3d DCA 1997). Unfortunately, there was no mention in either Patrick or Perez of the Glens Falls or Sperling cases or the DOI Bulletin. Also, the Patrick decision specifically notes it does not reach situations involving the perils of fire and lightning and the application, if any, of the Valued Policy Law to a partial loss due to one of those perils.

Clearly, the valued policy law of each state will have its own nuances regarding the ability to take a holdback and pay the ACV amount. As such, each state’s statute should be reviewed before applying the ACV provision in the policy, particularly with regard to losses by fire and lightning.

V.  Must The Acv Calculation Include The Cost Of Overhead And Profit

The principle of paying insureds the cost of a general contractor’s overhead and profit only if the insured contracts for such service and the cost is incurred is required by the Federal Insurance Administration, which oversees the federal flood insurance program. The Director of Claims of the Federal Insurance Administration stated in a memorandum to all insurance companies approved to sell flood insurance under the federal flood program that:

It is important to note that “Overhead and Profit is only warranted if a general contractor has been hired to make repairs. * * * In a cooperative effort, we are recommending that all independent adjusters, as well as adjusting firms, receive immediate notification to only apply overhead and profit when the insured has secured the services of a general contractor.

Memorandum of March 3, 1997, from James P. Shortley, Director of Claims, Claims and Underwriting Division, Federal Insurance Administration, to all Write Your Own Principal Coordinators.

Unless and until the insured actually repairs or replaces the damaged property, the insured’s actual loss is just the actual cash value, which many policies commit to pay as of the time of the loss. If the insured never repairs or replaces the damaged property, or does not engage a general contractor to supervise others who do the repairs, then, it is argued he has never sustained an actual loss of those additional amounts it would take to repair or replace the damage to the property. If, however, the insured never repairs or replaces the damage, he has not sustained any loss beyond the actual cash value, and the policies do not call for any such payment.

In Bankers Security Ins. Co. v. Brady, 765 So.2d 870 (Fla. 5th DCA 2000), the court, in dicta, provided some language for an argument of entitlement to overhead and profit in the ACV calculation. However, a close reading of the case shows that that issue was not reached by the Court. Following a lightning loss and fire, Brady’s public adjuster and the insurer’s independent adjuster reached a verbal compromise agreement that the “dwelling portion of the loss” was $65,000. Before the agreement could be finalized, Bankers removed its independent adjuster and claimed there was no valid agreement as the independent lacked authority to enter into such an agreement and, further, if there was such an agreement, it was entitled to deduct 20% as overhead and profit which had not been incurred.

By the time of trial, the insured had retained a general contractor and Bankers had paid its insured approximately $63,000 which included overhead and profit of $5,846.21. In its ruling, the Court concluded Bankers had apparently determined to pay its insured on the basis of replacement cost rather than ACV and stated:

Having concluded there was a binding settlement reached for $65,000, we need not address the additional issue of whether Bankers could withhold overhead and profit. It apparently has paid the settlement reached by [the independent adjuster], less overhead and profit. But we find nothing in the policy that authorizes Bankers to withhold overhead and profit from the cost to repair or replace a covered loss, since under this policy, Bankers undertook to pay its insured prior to actual repair or replacement.

(Emphasis added.)

The statement “we find nothing in the policy that authorizes Bankers to withhold overhead and profit” must be tempered by the remaining facts of the case. Certainly, if, as the court apparently found, an agreement has been reached to pay a loss on the basis of replacement cost, the insurer cannot later pay only 80% of the agreed amount. However, when paying a loss on the basis of ACV, based on the foregoing and, in particular, the principal of indemnity, courts would support a “holdback” of overhead and profit so long as the insured had not actually procured the services of a general contractor and obligated to pay him that amount. In the event the insured undertakes the repairs himself or does not retain the services of a contractor, payment of such additional sums would provide a windfall to the insured. Additionally, there is an argument that if the replacement cost includes overhead and profit, by depreciating that replacement cost figure, the resulting amount, ACV, already includes an element, albeit reduced, reflective of overhead and profit. Of course, if replacement cost is calculated before overhead and profit are added, this argument does not exist.

The Supreme Court of Oklahoma dealt with this issue in Branch v. Farmers Insurance Company, 55 P. 3d 1023 (Okla. 2002) in answering the question certified by the 10th Circuit Court of Appeals: In determining actual cash value, using the replacement cost less depreciation method, may labor costs be depreciated? Before the court were two cases, Branch v. Farmers Ins. Co., 123 F.Supp.2d 590 (W.D.Okla. 2000) and Davis v. Mid-Century Ins. Co., 1998 WL 1285714 (W.D. Okla. 1998), both involving insurance claims for hail and wind damaged roofs requiring replacement with new roofs. In both instances, the insurers depreciated both materials and labor for tear-off of the old roof and installation of the new roof, and the insureds filed suit arguing, inter alia, that tear-off and installation labor should not have been depreciated. The Branch policy provided, “We will settle covered losses to the roof surfacing … on a replacement cost less depreciation basis.” The Davis policy provided, “Loss to roof surfacing will be settled at Actual Cash Value.” Both policies were silent regarding depreciation of labor costs.

The Oklahoma Supreme Court found that ACV in the Davis policy meant “replacement cost less depreciation,” which was the same manner in which ACV was calculated under the Branch policy. Accordingly, the court held that, “… in both cases, the losses of the two roofs were measured in the same manner. A roof is the product of both materials and labor.” In relying on the Rochester American Insurance Company v. Short, 1953 OK 4, 252 P. 2d 490 (Okla 1953) and McAnarney v. Newark First Ins. Co., 247 N.Y. 176 (N.Y. 1953) cases, the court then answered the certified questions in the affirmative and stated that labor costs associated with installation of the new roofs could be depreciated. However, labor associated with tearing off and removal the old, damaged roof, was not as it was included in the debris removal coverage of the policy which did not allow for depreciation.

  1. The Oklahoma high court issued a nearly identical opinion in Redcorn v. State Farm Fire & Casualty Company, 55 P. 3d 1017 (Okla. 2002), in which the insured’s roof was damaged by either wind or hail. Although, Redcorn involved an actual cash value policy rather than a replacement cost coverage policy, the court held that the ACV calculation method would be the same as in Branch, that is, replacement cost less depreciation. The insured contended depreciation of labor is inconsistent with the principle of indemnity under the theory that the cost to install depreciated shingles (if it were possible to purchase them) would be the same as the cost to install new shingles. The court disagreed, holding that a “roof does not have a separate market value from the building it covers,” and is the product of labor and materials which cannot be separated as they were not insured separately. If the insured’s argument were followed, he would be receiving the benefit of a hybrid policy he did not pay for, to wit: a policy of actual cash value for roofing materials and replacement cost for labor, resulting in unjust enrichment to the insured.  Id. at 4.

    Whereas an “actual cash value policy” is a pure indemnity contract with the purpose of making the insured whole by compensating him/her for the actual value of the property lost or destroyed, “replacement cost coverage” reimburses the insured for the full cost of repairs, even if that results in putting the insured in a better position than prior to the loss. Travelers Indemnity Co. v. Armstrong, 442 N.E.2d 349 (Indiana 1982). For example: If the insured’s 10-year old roof with a “life span” of 20 years is completely destroyed by windstorm, under an ACV policy, the insured would be entitled to payment of only the ACV of the old roof less depreciation, deterioration, and obsolescence, which may or may not be sufficient to replace or repair the roof. Under a replacement cost policy, if the insured actually repairs or replaces the roof, the insured would be entitled to payment for all necessary costs associated with repairing/replacing the roof with one of like kind and quality, and would end up with a brand new roof which could increase the value of the insured’s home. Of course in the latter case, the insured has paid a higher premium for replacement cost entitling him to the added benefit.

    In most insurance policies, the insured is entitled to elect between three options: (1) repair/replace the property and claim full replacement costs, including labor and materials; (2) reserve the right to repair/replace, receive ACV (as defined in the policy), and if repair/replacement occurs within 180 days after payment, claim the difference between the ACV and the final cost of repairs; or (3) affirmatively decide not to repair or replace, and receive only ACV. So if, for example, the insured takes choice (2), and the cost of repairs/replacement does not exceed the ACV payment already tendered, the insured would not be entitled to additional benefits.

    Clearly, under the above policy language and case law interpreting the same or similar policy provisions, the insured must actually incur the expenses for repairing or replacing the property before receiving payment for the full replacement cost as an insurance company’s liability for replacement cost does not arise unless and until the repair or replacement has been completed. See State Farm Fire & Cas. Co. v. Patrick, 647 So. 2d 983 (Fla. 3d DCA 1994). In American Reliance Ins. Co. v. Perez, 689 So. 2d 290 (Fla. 3d DCA 1997), the court construed a similar replacement provision and found that the insured was only entitled to “actual cash value” when the insured had not actually replaced the property. The court equated actual cash value with “fair market value” if the insured did not repair or replace. Even if the insured “intends” to repair or replace the property, only ACV is payable until completion of the repairs as a mere intention to repair or replace does not trigger an insurer’s replacement cost obligations. See Hilley v. Allstate Ins. Co., 562 So. 2d 184, 190 (Ala. 1990). To permit an insured to receive the full repair/replacement cost without actually effecting the repairs would give the insured a greater windfall than the parties contemplated and the insured paid for. Travelers Indemnity, supra at 353.

    In Gilderman v. State Farm, 649 A.2d 941 (Pa. Super. 1994), the insureds’ policy contained a replacement cost coverage provision. When the insureds suffered a covered loss and sought replacement cost benefits prior to undertaking the repairs, State Farm tendered payment of the cost to repair less depreciation and 20% “overhead and profit”, as was State Farm’s routine practice. The Gildermans filed a class action suit on behalf of State Farm insureds stating that the automatic withholding of the overhead and profit was improper as repair or replacement costs necessarily include contractor overhead and profit. State Farm contended the practice was proper as contractors were not always used to repair or replace damaged property, and it would be unfair for an insured to receive advance payment for such “contingent” expenses.

    The court held for the insureds holding: (1) theoretically, all repair costs, including contractor’s overhead and profit, are “contingent” prior to being incurred and (2) the issue is not whether a given cost is contingent but what State Farm contractually agreed to pay its insureds prior to actual repair or replacement. As the Gilderman’s policy did not define ACV, the court held that ACV means “repair or replacement cost less depreciation,” which necessarily included “any cost that an insured is reasonably likely to incur in repairing or replacing a covered loss,” which is some instances, would include the use of a general contractor.

    The Gilderman court also dismissed State Farm’s argument that the insured would get a windfall if they were paid for overhead and profit, and either did their own repairs or did not do them at all by pointing out that the insured pays an extra premium for replacement cost coverage, and only receives the full benefit of that coverage if repairs are completed. Id. at 227.

    A similar result was reached in Salesin v. State Farm, 581 N.W.2d 781 (Mich. App. 1998), another class action protesting State Farm’s practice of withholding overhead and profit from ACV payments to insureds who had replacement cost coverage.  In Salesin, State Farm argued that overhead and profit were “non-damage” factors applicable only in the instance of repair or replacement and should be deducted under the theory that ACV represents the actual cash value of the “damage.” (Other “non-damage” factors would be permits, clean up, security, sales tax.) In finding for the insured, the court relied on the Gilderman rationale that in the absence of explicit policy language stating overhead and profit would be deducted from repair costs in determining ACV, State Farm could not withhold that amount.

    Although it is often assumed that actual cash value will be less than replacement or repair costs, if the insured elects to take ACV with the option to repair, the insured may actually end up with a windfall. This is exactly what happened in Ghoman v. New Hampshire Insurance Company, 2001 WL 1112535 (N.D. Tex. 2001). The insured, owner of a Howard Johnson’s Hotel damaged by wind and hail, elected to receive ACV and reserve the option of seeking additional costs of repair. NHIC paid the insured $299,907, which represented replacement cost less depreciation, overhead and profit, sales tax and deductible. The insured spent only $139,608.78 to fully repair the property by using surplus materials and using on-site personnel, but then filed suit against NHIC for the $70,939 withheld which represented O&P and sales tax. The federal district court, relying on the Gilderman rationale, found for the insured, holding that ACV, not defined under the policy, meant replacement cost less depreciation only, and that NHIC breached its contract by withholding O&P and sales tax. The court pointed out that the insured’s entitlement to ACV was not tied to the repair or replacement of the property.  Id. at 5.

    There appears to be one case in which the Kentucky Supreme Court reached a contrary result regarding withholding so-called “non-damage” factors. In Snellen v. State Farm, 675 F.Supp 1064 (W.D. Ky. 1987), the court resolved a dispute concerning the calculation of ACV in favor of State Farm approving of deductions for overhead, profit, permits or contractor clean-up. In Snellen, the policy offered the insured the three choices: repair/replacement with no deduction for depreciation; ACV until repairs made; or ACV only, reserving the option to submit additional claims within 180 days. The policy did not contain a definition of ACV. Although the insured asserted her claim under the replacement cost coverage option, at the time she filed suit claiming entitlement to payment without deduction for depreciation, O&P, etc., she had not yet begun the repairs. Although the court’s holding that depreciation was properly withheld from the ACV amount offered to the insured was in line with decisions from other jurisdictions, the Kentucky court broke ranks with the other jurisdictions when it held, “… since the goal is to arrive at the actual cash value of the damage, non-damage factors which are applicable only in the instance of repair or replacement … were properly deducted.” Id. at 1068. It should be noted that no other cases were found that approved of the deduction of so-called non-damage factors. In fact, Salesin, supra, specifically declined to follow Snellen in that regard.

    VI.    Conclusion

    The guiding principle in all loss adjustment evaluations should be the basic premise of property insurance policies is that they are contracts of indemnity which are intended to pay the insured for losses actually sustained as a result of a covered peril. The concept of Actual Cash Value arose from the general principle that insurance is traditionally intended to place an insured in the same position that it would be had no loss occurred. “Actual Cash Value” means the cash value of property immediately prior to the loss or damage. Although the key to calculating the correct loss adjustment amount is guided by the particular policy language, these general principles can help make the correct decision.


    1 At the time the statute was enacted, subparagraph (1) applied only to fire and lightning perils.