The Supreme Court of Tennessee has decided that when calculating the actual cash value (ACV) of property damage, the labor cannot be depreciated. The case is Lammert v. Auto-Owners (Mut.) Ins. Co., No. M2017-02546-SC-R23-CV, 2019 Tenn. LEXIS 169 (Apr. 15, 2019).
Gregory and Jamie Lammert owned a home and other structures that were insured through Auto-Owners (Mutual) Insurance Company (Auto-Owners) with a “Dwelling Insurance Policy.” Some of the insured buildings were damaged in a hail storm in 2016. They filed a claim with Auto-Owners who informed the insureds that the claim would be settled on an actual cash basis. Using a replacement-cost-less-depreciation method, Auto-Owners calculated that it would cost $12,146.55 to repair and replace the damaged parts with new materials. Auto-Owners subtracted $2,160.19 for depreciation and told the Lammerts that the actual cash value of their property was $9,986.36. Auto-Owners confirmed that both labor and the materials had been depreciated.
Similarly, Larry and Susan Reason were insured with Auto-Owners under a “Homeowners Insurance Policy.” Their property was damaged twice, once during a hailstorm and once during a windstorm, in 2016 and 2017 respectively. The claims were accepted. Auto-Owners used the replacement-cost-less-depreciation method and deducted depreciation for labor and materials when calculating actual cash value.
The Reasons and the Lammerts, herein known as “the homeowners”, filed a putative class-action suit for breach of contract against Auto-Owners and argued that Auto-Owners should not have depreciated the cost of labor to repair and replace the damaged property. Auto-Owners moved to dismiss the complaint, and the homeowners opposed that motion to dismiss and asked the district court to certify a question of law to the Supreme Court of Tennessee to answer the question of whether the cost of repair and replacement labor can be depreciated when calculating the actual cash value of a property using the replacement-cost-less-cost of depreciation method of calculation.
The homeowners argued that the language in the Lammerts' policy unambiguously limits depreciation to the cost of the replacement materials because the terms “damaged property” and “prior to the loss” are used in the policy. They argue that “damaged property” does not include labor costs because labor is intangible. They also argue that “prior to the loss” also excludes labor because labor is a post-loss cost. Also, the definition of “depreciation” in the policy is “a decrease in value because of age, wear, obsolescence, or market value”, and since labor does not age, wear out, become obsolete, or decrease in market value, labor does not depreciate. Auto-Owners argues that neither policy was ambiguous and that depreciation of property is taken from the total replacement cost, which includes materials and labor.
The Tennessee Supreme Court noted that depreciation of labor has been discussed in many recent cases, and the outcomes from those cases tend to be divided. The Tennessee Supreme Court declined to adopt any legal theories from other state Supreme Courts and held that the term “depreciation” was ambiguous because there were two reasonable interpretations. As usual, when a term is ambiguous it is to be construed in favor of the insured, so the Supreme Court held that labor could not be depreciated.
Editors Note: The argument of whether or not labor can be depreciated is open, and is being litigated in many jurisdictions. A prudent insurer would check whether the jurisdiction in which they work allows for depreciation of labor.
Insurance contracts are contracts of indemnity. The purpose of an insurance contract is to indemnify the insured by reimbursing the insured or restoring him as near as possible to the position he was in prior to the loss. Indemnification becomes difficult, though, when the replacement item is aged. If an insured has lost a 15-year-old roof, and the insurer replaces that roof with a brand new roof, the insured is making a profit off of that loss. Because it is nearly impossible to replace a 15-year-old roof with another 15-year-old roof, insurers give the insured the actual cash value of the property. Actual cash value can be measured in three ways. First is market value. Market value is generally the price a willing buyer will pay a willing seller. Second is replacement cost less depreciation. This is the method used in the case above and is determined by a formula. The replacement cost less depreciation method lends itself to a higher payout, due to the expense of building materials, despite the value of the finished building being much less. The third method is the broad evidence rule which allows for the trier of fact to call on any relevant evidence to correctly estimate the loss value. It can consider the original cost and cost of reproduction, expert testimony, and any other fact that sheds light on the subject.