The Arkansas Supreme Court ruled last week that depreciating labor is against public policy when calculating the actual cash value of a loss.1 This was despite insurance policy language permitting the practice. This will undoubtedly generate class action lawsuits against insurers engaged in this practice and cause some claims managers to question if they should continue with this practice.
The policy defined “actual cash value” to mean “total restoration cost less depreciation.” The policy defined “depreciation” as follows:
Depreciation means the amount by which any part of the covered property which must be replaced has decreased in value since it was new. The condition, age, extent of use, and obsolescence of the property will be considered in determining depreciation. When calculating depreciation, we will include the depreciation of the materials, the labor, and the tax attributable to each part which must be replaced to allow for replacement of the damaged part, whether or not that part is damaged.
A number of carriers have added this language to their standard policies. The longstanding standard property insurance language never defined the term "actual cash value." Some carriers are including this language to shortchange policyholders and are selling a cheaper form of insurance than what is available in the market.
The reasoning for finding this language against public policy was:
The shingles are of course logically depreciable. As they age, they certainly lose value due to wear and tear. . . .
Labor, on the other hand, is not logically depreciable. Does labor lose value due to wear and tear? Does labor lose value over time? What is the typical depreciable life of labor? Is there a statistical table that delineates how labor loses value over time? I think the logical answers are no, no, it is not depreciable, and no. The very idea of depreciating the value of labor is illogical. . . .
It is important to keep in mind that “[i]ndemnity is the basis and foundation of all insurance law.” …The objective of indemnity is to put the insured in as good a condition, as far as practicable, as he would have been in if the loss had not occurred, that is, to reimburse the insured for the loss sustained, no more, no less….To properly indemnify Redcorn, State Farm should pay him the actual cash value of the shingles, depreciated for wear and tear, plus the cost of their installation. . . . [A]llowing [the insurer] to depreciate the cost of labor would leave [the insured] with a significant out-of-pocket loss, a result that is inconsistent with the principle of indemnity.
This is a blockbuster opinion. Finding that insurance policy language is not applicable because it is against public policy is rare. Only time will tell if other States will follow with similar reasoning.
Positive Thought of The Day
Don’t tell people how to do things, tell them what to do and let them surprise you with their results.
—George S. Patton