The assault on indemnity

Actual cash value (ACV) clauses have existed in insurance policies for more than a century. ACV is a valuation method that seeks to determine the appropriate amount to indemnify policyholders for their loss and put them back in a position that is neither better nor worse than they were had no loss occurred.

Over the past decade, property insurers have been plagued by costly class action legal battles regarding whether depreciation of the cost of trade labor used to repair damaged property is allowable in determining ACV. Before these class action lawsuits, litigation tended to center around whether an insurance policy contained a definition of ACV that was different than the law governing ACV in an individual jurisdiction, and whether that definition limited an insurer’s ability to effectuate indemnity. Even in states like New York, which adopted the broad evidence rule in 1928, litigation over how to calculate ACV, where an insurer sought to define the meaning of ACV in its policy, has been ongoing for decades, typically to the detriment of insurers.

In California, which historically followed the market value rule, arguably the fairest method to determine ACV, the state legislature has abandoned the concept of indemnity in its adoption of a statute that effectively eliminates the appropriate depreciation of labor in calculating ACV. In California, and other states, which do not allow depreciation of labor, ACV calculations will result in placing a policyholder in a position that is better than the economic position they would have experienced had no loss occurred. This makes no practical sense, particularly since most insurance policies allow for reimbursement on a replacement cost (RCV) basis, and ACV is determined and typically paid prior to the final payment of RCV. In these cases, the insured receives less than RCV only when repairs are not made, or the actual cost of repair is less than the calculated RCV.

ACV, RCV & indemnity

RCV is undeniably a policy of betterment, and insureds have historically purchased this coverage to allow them to make repairs and be fully reimbursed for the installation of new replacement materials. To the extent that ACV valuation methods were always intended to effectuate “indemnity,” any calculation of ACV that results in putting an insured in a position that was better than at the time of loss violates this basic principle of insurance.

Legal attacks on the principle of indemnity have left the insurance industry in a position that undeniably violates their rights to calculate a policyholder’s economic loss in certain jurisdictions, and thus leaves the policyholder in a “better than” pre-loss condition.

For this reason, it is time for insurers to study this dilemma more closely and either eliminate ACV language in policies, and replace it with a clearly articulated indemnity provision, or perhaps carefully craft a definition of ACV that clearly allows the insurer to calculate the ACV in a manner that provides indemnity.

This discussion requires more information than can be reasonably addressed here, but a new whitepaper discusses the issue in detail and offers practical recommendations for an industry currently mired in costly legal battles, the outcomes of which can result in ACV calculations that are fundamentally inconsistent with the basic principle of indemnity.

Jonathon C. Held is president and CEO of J.S. Held, LLC, a consulting company with more than 1,500 professionals on five continents. During his tenure with the company, Held has been responsible for the growth of the firm from two employees to a multi-disciplinary consulting firm with global reach. Contact him at jheld@jsheld.com.

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