Large first-party property damage cases often come down to a battle of accountants. In other words, unlike Olympic beach volleyball, they’re usually not particularly thrilling to watch. (Not that I have anything against accountants.) But the results of the battle can have a major impact on the policyholder’s balance sheet. How is the policyholder’s claim to be measured? Do we use an “actual cash value” or “replacement cost” analysis?
Shockingly, the place to start is the policy itself.
Example: the recent Ninth Circuit case of Sierra Pacific Power Company v. Hartford, which appears here, involved the destruction by flood of a dam over the Truckee River in California. The replacement cost of the dam was $19,800,000. Sierra Pacific argued that it was entitled to the full replacement cost of the dam without any depreciation. The carriers naturally argued that Sierra Pacific was entitled to a lot less, based upon statements by Sierra Pacific’s broker as to the ACV of the dam.
In resolving the dispute, the appeals court turned to the valuation language in the policy, which read: “actual cash value (with proper deduction for depreciation) of the property destroyed.” The Court wrote: “ACV means fair market value. FMV is most commonly determined ‘by way of market data on sales of comparable property’. In cases where there is no relevant market, however, the FMV may be ‘determined by any method valuation that is just and equitable.’ Specifically, ‘recognized alternatives to the market data approach to valuation are reproduction or replacement costs less depreciation or obsolescence.’”
The trial court had held that the policyholder was only entitled to $1,261,200, representing what it determined to be the ACV of the dam. But the court had primarily based its ruling upon a letter in which Sierra Pacific’s insurance broker stated to Sierra Pacific’s claims manager, “We are only agreeing that the [actual cash value] is $1,261,200 and nothing else.” So, there was never an actual agreement between Sierra Pacific and the carrier…only a recommendation from Sierra Pacific’s broker to Sierra Pacific. The appeals court therefore found that the trial court had erred, writing: “Although the district court correctly announced that it would base ACV on replacement cost of the dam less depreciation, it arrived at an amount for the dam’s ACV, $1,261,200, which is not related to the figure it found as the replacement cost ($19,800,000). The district court relied on its view that Sierra and the insurers had agreed on the value of $1,261,200 as the ACV, but the court explicitly found that the parties did not agree on that number, or any other number, as the ACV for the dam.”
So, the proper measure to apply under the policy was $19,800,000 (the replacement cost) less appropriate depreciation.
There were a couple of other matters of interest (to us insurance geeks, anyway) that the appeals court resolved in this case. First was the question of whether increased costs of repair were excluded by the policy’s Building Ordinance or Law Exclusion, which stated in part: “This policy does not insure loss or damage caused by or resulting from…any increase in the loss due to any ordinance, law or regulation, rule or ruling restricting or affecting repair, alteration, use, operation, construction or installation.”
The court held that the exclusion only excluded damage caused by the peril of building ordinances (it appeared in a section entitled “PERILS EXCLUDED”). It did not exclude increased construction costs caused by building ordinances when the loss itself is caused by a covered peril – here, a flood.
Finally, what about $4 million spent by Sierra in preparation for rebuilding the dam (engineering studies, etc.)? The policy contained a provision reading: “In the event of loss or damage to property which is not repaired, rebuilt or replaced within two years from the date of loss or damage, the company shall not be liable for more than the actual cash value (with proper deduction for depreciation) of the property destroyed.” The carriers argued that, because the policy by its terms did not pay for replacement cost if the dam was not rebuilt within two years, they were not obligated to pay anything more than ACV until the dam was actually rebuilt.
Wrong, said the appeals court: “This provision does not state that the Insurers will not pay more than ACV until the property is actually replaced. Rather, it merely limits the Insurers’ ultimate liability if the property is not replaced within the allotted time.” The “preparation expenses” were recoverable if they were properly included in the ACV: “We agree that the money Sierra has already spent in preparation for rebuilding should be included in the estimate of replacement cost which is then used to determine the ACV, and we assume it was included in the estimated replacement cost ($19,800,000) the district court found reasonable. However, if the district court intended that Sierra is entitled to recover expenses in addition to the ACV, there is no support for such a ruling.”
Notably, the trial court found that “Insurers unreasonably denied coverage ultimately available under the policy”…a finding referenced by the appeals court in its own decision.
The takeaway: When dealing with insurance claims, there’s no substitute for reading the policy. Carefully.