Property policies indemnify an insured for damage to covered property. They generally indemnify the insured for damaged property based on an actual cash value basis or replacement cost basis. Most property policies provide for indemnity based on replacement cost value, which indemnify the insured for the cost to repair or replaced the damaged property with new material. Under such policies, however, payment usually involves a two-step process. First, the insurer will pay the insured for the actual cash value of the damaged property. If the insured completes the repairs or replaces the damaged property, then the insurer will reimburse the insured for the additional cost of completing the repair or replacement.
Determining the actual cash value of damaged property can be complicated and is a question of fact. Methods used to calculate actual cash value include the market value of the damaged property at the time of the loss, the replacement cost of the damaged property or the broad evidence rule. When calculating actual cash value, insurers often estimate the cost to replace the damaged property and then deduct a depreciation figure from the replacement cost to arrive at actual cash value. Disputes between policyholders and insurers in property damage claims often center around the depreciation figure used by the insurance company. The cost to replace damaged property includes the cost of the new material and the labor cost associated with replacing the damaged material with new material. The law regarding whether an insurance company may depreciate the cost of labor when estimating the actual cash value of damaged property is not settled and varies among different jurisdictions. On May 12, 2021, the South Carolina Supreme Court ruled in Butler v. The Travelers Home and Marine Insurance Company, that Travelers Insurance could depreciate the labor costs associated with repairing or replacing the insureds’ damaged property in addition to depreciating the cost of materials because the labor costs were embedded in the cost of the materials and were no longer separable from the materials.
The two insureds in Butler each suffered damage to their homes from fire. Each had an insurance policy that provided replacement cost value coverage, under which the insurer agreed to indemnify them for the cost to repair or replace the damaged property. Like many other property policies, the insurance policies only indemnified the insured for the full replacement cost if the insured repaired the damaged property. If the insured chose not to immediately repair or replace the damaged property, each policy only indemnified the insured for the actual cash value of their damaged homes. Each of the insureds in Butler did not immediately repair the damage to their homes and the insurer therefore paid them on an actual cash value basis, which the insurer calculated based on an estimation of the replacement cost of the damaged property less depreciation. When calculating depreciation, the insurer applied a depreciation figure to both the materials and the labor associated with the replacement property. The insureds claimed that the insurer improperly calculated actual cash value and filed separate lawsuits alleging that Travelers breached the terms of the insurance policies by depreciating the cost of labor when calculating actual cash value.
The South Carolina Supreme Court ruled that Travelers did not breach the insurance policy by including the cost of embedded labor components in materials in its depreciation figure. The court explained that embedded labor costs are costs that are no longer separable from the cost of materials, such as the labor costs to make the nails and shingles used in a new roof or the cost of removing an old roof and installing a new one. In the case of a new roof, the court recognized that the typical property owner pays one price for a new roof which includes the materials and labor costs associated with manufacturing the materials and installing the roof. When labor costs for a particular item are embedded in the cost of an item, the court concluded that it may be impractical, if not impossible, to include depreciation for materials and not for labor in order to calculate the actual cash value of property at the time it is damaged. Rather, the actual cash value of damaged property is calculated as a unit. In such situations, the court concluded that an insurer may include depreciation for labor when estimating actual cash value under a property insurance policy.
It is important to note that while the South Carolina Supreme Court ruled that an insurer may include a depreciation figure for labor costs that are embedded in the cost of materials when not specified in a property policy, it does not mean that the insurer’s depreciation figure is necessarily correct. Whether an insurance company correctly, or even reasonably, makes a depreciation calculation remains a question of fact for a jury or an arbitrator. The determination of actual cash value for damaged property in a particular insurance claim depends on a number of variables, including how the insurer chose the amount to estimate for depreciation for materials or labor. If the insured and insurer fail to reach agreement on the amount of loss to be paid in a particular property insurance claim, the issue may need to be resolved by a jury in court or through an appraisal process, if the applicable insurance policy contains an appraisal provision governing the resolution of disputes over the amount of a particular loss.