(Article from Insurance Law Alert, July/August 2020)
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As discussed in previous Alerts, the highest courts of several states, and appellate courts in many others, have ruled on whether an insurer may depreciate labor costs in calculating actual cash value (“ACV”). See March and April 2020 Alerts; April 2019 Alert; March 2017 Alert; January and February 2016 Alerts. Outcomes have turned largely on policy language, as well as governing jurisdictional law and public policy considerations. Last month, an Illinois appellate court weighed in, ruling that labor costs may not be depreciated in the ACV calculation. Sproull v. State Farm Fire & Cas. Co., 2020 WL 4251702 (Ill. Ct. App. July 24, 2020).
The State Farm policy stated that “we will pay only the actual cash value at the time of the loss of the damaged part of the property, up to the applicable limit of liability.” The policy did not define ACV or explain how it is calculated, nor did it indicate that costs are subject to depreciation. When State Farm depreciated both labor and materials in calculating ACV payment, the policyholder filed a putative class action, alleging breach of contract and deceptive business practices. An Illinois trial court denied State Farm’s motion to dismiss. The trial court noted the lack of Illinois case law and the jurisdictional split on this issue, and ultimately concluded that ACV was ambiguous and should be construed in the policyholder’s favor. In so ruling, the trial court rejected State Farm’s argument that Illinois statutory law, which states that the method for calculating ACV is “replacement cost of property at time of loss less depreciation, if any,” permits depreciation of both labor and materials. 50 Ill. Adm. Code 919.80 (d)(8)(A) (2002). Thereafter, the trial court certified the following question to the appellate court:
Where Illinois’ insurance regulations provide that the “actual cash value” or “ACV” of an insured, damaged structure is determined as “replacement cost of property at time of loss less depreciation, if any,” and the policy does not itself define actual cash value, may the insurer depreciate all components of replacement cost (including labor) in calculating ACV?”
The appellate court answered the question in the negative. The court reasoned the phrase “replacement cost of property” refers to “real property–an asset that can lose value over time due to wear and deterioration, resulting from use or the elements, and does not refer to services, such as labor.” In so ruling, the court noted that an average, reasonable person would expect that depreciation would apply only to physical property and materials, and not to labor services.