Insurance companies, working without legislative or judicial guidance, created a working definition of the term “actual cash value.”
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Insurers recognized that ACV in a fire policy was designed to determine a dollar value for items of damaged property that were not new at the time of loss. Because insurers had no easy means of determining the utility value of property, they chose the following as a working definition of “actual cash value”: “Actual cash value is the cost of replacement with similar kind and quality less physical impairments.” [Jefferson Insurance Company of N.Y. v. Superior Court, 3 Cal. 3d 398 (1970).]
The working definition, while not always providing the full compensation contemplated by the insured and the various legislatures, was eminently practical.
A burned-out shell of a house leaves only clues as to what its actual cash value was before the fire. With minimal research, the cost of remodeling can be easily determined. If the insurer paid the full cost of compensation to its insured (since the number was easy to calculate) it would violate the traditional concept of compensation.
Payment of compensation costs puts the insured in a better position than he was in before the fire. Deducting from the replacement cost a reasonable percentage corresponding to the physical diminution in value will come as close as possible to providing the insured with actual compensation for the damage.
Over time, courts have developed three primary tests for measuring the actual cash value of property. They are:
- Fair market value, usually described as the price a willing buyer would pay to purchase property from a willing seller in an open market.
- Replacement cost less depreciation, generally accepted to mean the cost of replacing property at the time of loss, less its physical depreciation.
- The broad rule of evidence. A reasonable application of either 1 or 2 to the unique circumstances of the claim, whichever is most beneficial to the insured.
Some insurance companies have taken the hint first expressed in 1970 i Jefferson Insurance Company v. The Superior Court of Alameda County3 Cal. 3d 398, and now defines the term in most policies issued in California and nationwide. Depending on the insurer, one of the three options chosen by courts across the country has now been incorporated into the policy.
Some insurance companies chose to calculate ACV by deducting 20% from the full cost of repair or replacement. Since the underlying charge had no connection to obtaining true ACV, this practice was widely condemned. For example, the Michigan Court of Appeals went even further in rejecting the practice of withholding 20% for a contractor’s overhead and profit. IN Salesin v. State Farm 581 NW2d 781, (1998), the court stated this regarding the calculation of the actual cash value: “State Farm’s policy in this case does not contain a definition of “actual cash value,” nor does it state the basis upon which State Farm determines the actual cash value. The process by which to determine the actual cash value was contained in State Farm’s Operation Guide.In accordance with the provisions of that document, State Farm routinely deducts the contractor’s overhead and profit as well as depreciation when making an “actual cash value of the damage” under section Ic(l) of their insurance. There was deposition testimony that this procedure is contrary to industry norms and practices.”
IN Bradley v. Allstate Ins. Co., USCA, Fifth Circuit, 620 F.3d 509 (2010), the court found Under Louisiana law, the actual cash value owed by the property insurer is determined by calculating the cost of duplicating the damaged property with new material of a similar kind and quality, less consideration for physical deterioration and value reductions. ACV is not, in the Fifth Circuit, necessarily synonymous with market value at the time of the loss.
The touchstone for determining ACV is the basic principle that an adequately insured person should incur neither financial gain nor loss when his property is destroyed.
The term obsolescence appears within the contract definition of “actual cash value,” which is one of several methods that insurers use to value a property in the event of a loss. Other methods are market value, reproduction value and replacement value.
Many courts, including those in Michigan, adopted what is known as the “broad evidence” rule to determine actual cash value when the term is undefined in a contract. [Davis v. Nat’l Am. Ins. Co., 78 Mich.App. 225, 259 N.W.2d 433, 438 (1977)]. Under the rule, fact finders or appraisers may consider “any evidence that logically tends to form a correct estimate” of the value of the property, including “market or reproduction or replacement values.”
The standard fire insurance policy has stated, in essentially the same language since 1909: “Subject to the provisions and regulations herein … this company insures the above named insured … to the extent of the actual cash value of the property at the time of loss.”
The intent of the legislature in the various states that have enacted a statutory fire policy, by enacting a mandatory form of fire insurance, was to codify and implement the traditional concept of fire insurance. Insurance is to replace or compensate the insured for the actual damage he suffered, without necessarily putting him in a better position than he was at the time of the fire. [Breshears v. Indiana Lumbermans Mutual Ins. Co., 256 Cal. App. 2d 245, 63 Cal. Rptr. 879 (1967).]
Courts of appeals have rarely been called upon to explain this fundamental purpose of fire insurance, as codified. Upon request, the courts have limited their decisions to the factual situations presented to them. They have always confirmed that the purpose of the insurance is to provide compensation. Only the methods by which such redress was to be achieved were subject to interpretation.
Perhaps to ease the burden on the courts, state legislatures provided a means by which the traditional concept of redress could be measured. For example, the California legislature stated: “The measure of compensation in fire insurance is the expense to the insured of replacing that which was lost or damaged in its condition at the time of the damage, which cost is calculated from the time of the beginning of the fire”. [California Insurance Code § 2051.]
However, the legislature failed to explain how to calculate the cost of replacing a 30-year-old building. There is almost no supply of 30-year plumbing or lumber for the insured to purchase. A carpenter cannot build a 30-year home, he can only build a new home. It is physically impossible to put an insured exactly as he was before the fire.
It took 30 years of severe weather to empty the siding; many windstorms to carry and unload shingles, an earthquake or two to tilt the foundation, and four growing children to beat it up mercilessly. The problem of making old with new was left by the legislature to courts, tribunals, and the nimble minds of adjusters and lawyers.
Courts have approached the issue cautiously. They have paid lip service to the statutory mandate that the insured is only entitled to compensation under the policy for the damage he has actually suffered. [Whitney Estate Co. v. Northern Insurance Co. of London, 155 Cal 521, 101 P. 911 (1909).] Sometimes the courts simply reduced a judgment to an amount less than the full cost of compensation without any explanation as to why the deduction was made. [Koyer v. Detroit F & M Ins. Co., 9 Cal. 2d 340 (1937).]
The question of how the actual cash value of Covered Property is to be determined when calculating the value of any applicable premium is essential. There are three different tests to determine the actual cash value of property when the policy is silent on the definition. These tests are:
1. the fair market value test.
2. the replacement costs minus the depreciation test; and
3. the broad rule of evidence.
This article came from my latest book, “How to Acquire, Understand and Successfully Claim Commercial Property Insurance: Information Needed by Individuals and Insurance Professionals to Manage Commercial Property Insurance” Now Available as a Kindle Book Here Paperback here and as hardcover here
(c) 2022 Barry Zalma & ClaimSchool, Inc.
Barry Zalma, Esq., CFE, now limits his practice to serving as an insurance consultant specializing in insurance coverage, insurance claims management, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He practiced law in California for more than 44 years as an insurance coverage and claims attorney and more than 54 years in the insurance industry. He can be reached at http://www.zalma.com and email@example.com.
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