Prof. Bill Long 2/16/05
Theories of Recovery under the Homeowners Policy
One of the difficulties courts have had to struggle with over the years is the nature of recovery allowed a homeowner when the insurance policy only specifies that "actual cash value" will be granted them upon loss. Newer policies have paragraphs that award "replacement" value, but even that isn't always clear, and the paragraphs where that is awarded are specified rather than universal or general. Thus, it might be helpful to know a little about what these terms mean in insurance law and how courts have construed them.
The most insurer-friendly policy is to have one that is a "replacement cost" policy. Of course, you still have to get over the hurdles of the policy exclusions, and you have to make sure that "replacement cost" applies to your particular loss, but then you can get the loss "replaced." But what does that mean? In insurance law, replacement cost is determined "by reference to what it would cost at the time of loss or a reasonable period after the loss to replace the destroyed goods with goods of like kind and quality" (Jerry, p. 691)." At first the replacement cost policies ran into the problem of possibly violating the principle of indemnity (how so?), but once they overcame that hurdle, they have become popular. However, you do have to pay more for one, and there is the problem of moral hazard that might arise with such a provision, but they are here to stay.
One issue that has arisen with replacement cost policies is that there is standard exclusion in the policies for "Ordinance or Law" (Section I-Exclusions, 1.a, p. 175). This exclusion means there is no coverage for "enforcement of any ordinance or law regulating the construction, repair, or demolition of a building or other structure..." What is the implication of such a statement as it relates to new zoning codes that a community might put into place after a natural disaster? For example, insurance companies didn't want to pay costs of bringing new homes "up to code" after Hurricane Andrew hit Florida in August 1992.
Actual Cash Value
The traditional language in most homeowner (and business) policies is that there would be recovery only to the "actual cash value" of the loss. This seemingly reflects the principle of indemnity and wouldn't give the insured a possible "windfall" in the wake of a loss. But the phrase "actual cash value" is not really clear in what it means. Courts have developed four approaches to limn what it might mean.
a) Replacement Cost less Depreciation
This is the most common measure and is easier stated than put into practice. Depreciation takes into account the age of the property at the time of loss, the extent of its use and, possibly, the degree of its obsolescence. No insurance policy will define depreciation for you, however. In tax law depreciation is calculated by reference to schedules that have little relationship with a property's useful life. In insurance, the calculation of depreciation does not occur by reference to rigid schedules. Hence, depreciation is a "squishy" term in insurance law, possibly alllowing it to adjust itself to the realities of the loss. A big issue in this kind of calculation is whether obsolencence will be considered. You might have suffered a huge clothing loss in your fire, but if your clothes were mostly in moth-balls and from the 1980s, and you wouldn't be caught dead wearing them today, your recovery hinges almost completely on how an insurer or court will read "obsolescence" into the idea of depreciation.
b) Market Value
Some courts, faced with catastrophic loss of property, have applied a "market value" test to define what "actual cash value" means. This may be much easier to determine than to figure out exactly how much you have lost. If the property is destroyed and it is the kind of property that is bought and sold in a recognizable market, the market value may be the best estimate of what the insured needs in order to be put in the same position as s/he was before the loss. Some courts which have applied the "market value" test have also called it the "market value or value to the owner" test, in order to try to include some measure of recovery for things that might not have a huge market value but may have sentimental or other value to the owner.
c) Replacement Cost
Surprising as it might seem, some courts have identified replacement cost with actual cash value. For example, the Kansas Supreme Court, when considering a case about a roof that was damaged in a storm, awarded the full cost to repair without deducting depreciation (under an "actual cash value" policy) because it thought that the insured had the reasonable expectation of a new roof over its head without having to expend possibly thousands of dollars to get one, which it would have to do if depreciation was taken into consideration. This approach, however, makes the "acv" approach highly beneficial to the insured. It gets a "free" roof for the period of time that it had the roof before loss.
d) Broad Evidence Rule
This is the option towards which more and more states seem to be moving. This approach, as Jerry explains, "allows the trier of facts to consider any evidence logically tending to establish the correct estimate of the value of the property at the time of the loss" (p.694). This method arose out of a Prohibition-era case in which a building used for the manufacture of malt before Prohibition was destroyed during the Prohibition era. The jury returned a verdict saying that the value of the building, less depreciation, was very high (because it was intact before the loss, the machinery worked, etc.) but the insurer argued that no one would pay nearly anything for it because of the historical situation. The appellate court decided that all factors should be taken into consideration in determining the value of the loss. McAnarney v. Newark Fire Ins. Co, 159 NE 902 (NY 1928).
This background information should help you understand the Zochert case (p. 236) assigned for today. In addition, it should give you a window into the reality that loss settlement is often a highly subjective undertaking. Whenever this is the case in law, law rewards effective advocacy. Go to it!
Copyright © 2004-2007 William R. Long