Insurer not permitted to depreciate labor for homeowner claim
The Supreme Court of Arizona recently answered two questions certified by the U.S. District Court for the District of Arizona that both concerned how an insurer may or may not use depreciation in calculating the actual cash value (ACV) of damaged property.
The Supreme Court of Arizona recently answered two questions certified by the U.S. District Court for the District of Arizona that both concerned how an insurer may or may not use depreciation in calculating the actual cash value (ACV) of damaged property. The case is Walker v. Auto-Owners Ins. Co., 2022 Ariz. LEXIS 306 (Ariz. 2022).
The Walkers purchased a homeowner’s policy (the Policy) from Auto-Owners to cover their house, located in southeastern Arizona, for a period of one year. During the policy period, the home and several rooms in it suffered damage from an accidental water discharge; Auto-Owners agreed to provide coverage. The Loss Settlement provision of the Walkers’ policy stated that Auto-Owners would “pay the full cost to repair or replace the damaged part of [the] covered property” (quoting the Policy) if the policy was insured at or above 80 percent of the full replacement cost. The Walkers had insured their policy to 80 percent or higher, so the issue became the method Auto-Owner’s used when calculating the payment due. The “actual cash value” provision in the Policy stated that “If you [homeowners] do not repair or replace the damaged covered property, we shall pay the actual cash value of the property at the time of loss. Actual cash value includes a deduction for depreciation” (quoting the Policy, bolding omitted); Auto-Owners depreciated the costs of both labor and materials in determining the amount owed to the Walkers. The Walkers sued, claiming Auto-Owners improperly deducted labor depreciation, resulting in underpayment.
As the issue had not been previously litigated in Arizona, the federal District Court for the District of Arizona certified the questions of depreciating both labor and materials when neither “actual cash value” nor “depreciation” are defined in a policy, and whether the broad evidence rule meant Arizona courts could or could not consider depreciation when calculating the ACV.
In answering the first question, the Supreme Court of Arizona described three separate and distinct ways to define a property’s ACV that had been posited in Arizona: the property’s fair market value; the cost of replacing the property less depreciation (RCLD); and using the “broad evidence rule,” which permits courts to use “every fact and circumstance which would logically tend to the formation of a correct estimate of the building’s value” (quoting Henn v. Am. Fam. Mut. Ins. Co., 894 N.W.2d 179 (Neb. 2017)) in ACV calculations. The court compared the language in the Walkers’ policy to policies from other jurisdictions where a state court had confronted the question of determining the ACV of property in the absence of a specifically-defined method. The second sentence of the ACV provision concerned the inclusion of a depreciation deduction, which changed the first sentence because it gave more context to the meaning of “actual cash value.” This language, according to the court, meant the Policy had “adopt[ed] the RCLD methodology.”
In determining whether Auto-Owners could deduct a depreciation both for labor and for materials, the Supreme Court of Arizona looked at multiple cases from other states where courts had determined actual cash value using the RCLD method did not permit a deduction for labor. Though there was no definitive case law for Arizona, the case Sparks v. Republic Nat’l Life Ins. Co., 647 P.2d 1127 (Ariz. 1982) held that insurers who want to limit their liability under a policy need to spell out such limitations to insureds in a manner they understand. The court flatly stated that “Auto-Owners failed to draft its homeowner’s insurance policy to expressly include depreciation of labor in the calculation of actual cash value” and did not define either “actual cash value” or “depreciation” in the Walkers’ policy. Therefore, Auto-Owners “[was] precluded from depreciating labor” when it calculated the amount owed to the Walkers under their policy.
Having reached this conclusion, the Supreme Court of Arizona determined that the broad evidence rule did not apply to the Walkers’ case. However, as the certified question had asked about the general applicability of the broad evidence rule in Arizona, the court addressed the issue briefly and adopted the three-part approach to the broad evidence rule and ACV from the Henn case cited above: First, if a property’s fair market value may be easily determined, the ACV will be the fair market value; if the first approach is a dead-end, then “replacement or reproduction cost may be used” (quoting Henn); finally, if neither fair market value nor replace or reproduction costs can properly assess the ACV, then the broad evidence rule will apply “where the terms of the policy do not dictate otherwise in the context of other homeowners’ insurance policies in Arizona.”
Editor’s Note: The issue of when and whether labor should be depreciated frequently arises. Depreciating property is straightforward, but the value of labor is an entirely different thing; does the value of the labor to construct a building depreciate over time? Or is labor an intangible and required in order to repair the property?