Whether labor can be depreciated in arriving at an actual cash value property loss settlement has been a hot topic of debate over these past five years. A federal district court in Ohio recently weighed in on the issue in ruling on motions to dismiss two putative class action lawsuits, one against State Farm Fire & Casualty Company1 and one against Allstate Indemnity Company.2

The insureds in both cases challenged whether labor could be depreciated in arriving at an actual cash value settlement. In concluding that it was proper to do so, resulting in the dismissal of the lawsuits, the district court reasoned that the term “actual cash value,” which was undefined in the State Farm and Allstate policies, meant replacement cost less depreciation and that the plain and ordinary meaning of the term “depreciation” was inclusive of labor. The district court also found persuasive those decisions from other courts that had likewise found that labor should be included in depreciation.3

The results reached in Perry and Cranfield are contrary to the results reached in Hicks v. State Farm Fire & Casualty Company,4 and Titan Exteriors, Inc. v. Certain Underwriters at Lloyd’s, London,5 two recent decisions in which the Sixth Circuit Court of Appeals and a federal district court sitting in Mississippi concluded that labor costs should not be depreciated in arriving at an actual cash value settlement using a replacement cost less depreciation formula. Unlike the district court in Perry and Cranfield, the courts in Hicks and Titan Exteriors found no reason to decide which of the competing legal decisions were correct. Instead, they concluded that all of the interpretations offered by courts considering the labor depreciation issue were reasonable, rendering the term actual cash value ambiguous when defined as replacement cost less depreciation.

While the labor depreciation issue is an interesting legal debate, insurers can put this debate to rest simply by drafting its policy like State Farm has done in its “Actual Cash Value Endorsement” to clearly and unambiguously state that labor is subject to depreciation.6 Until they draft their policies to reflect their intent for labor to be subject to depreciation, insurers will be left to deal with decisions like Hicks and Titan Exteriors.
1 Cranfield v. State Farm Fire & Cas. Co., No. 1:16-cv-1273, 2018 WL 6162900 (N.D. Ohio Nov. 26, 2018).
2 Perry v. Allstate Indem. Co., No. 1:16-cv-01522, 2018 WL 6169311 (N.D. Ohio Nov. 26, 2018).
3 The district court referred to these cases as the current majority view among state and federal courts. But, as the Hicks court observed, these cases are not similarly situated. Many of them were not decided using the replacement cost less depreciation formula; instead, they employed the broad evidence rule, or some form of fair market valuation. See, e.g., Wilcox v. State Farm Fire & Cas. Co., 874 N.W.2d 780 (Minn., 2016) . Under both the market value test or the broad evidence rule, all relevant evidence is considered in in calculating actual cash value.
4 Hicks v. State Farm Fire & Cas. Co., No. 18-5104, 2018 WL 4961391 (6th Cir. Oct. 15, 2018).
5 Titan Exteriors, Inc. v. Certain Underwriters at Lloyd’s, London, 297 F. Supp. 3d 628 (N.D. Miss. 2018).
6 Under this endorsement, all components of the estimated actual cash value, defined as the estimated cost to repair or to replace damaged property, are subject to depreciation, including labor, materials, taxes, and overhead and profit.

  • Stephen Sarasohn

    After reading one of the cases, I still don’t understand the argument for not depreciating labor. Labor depreciates at least as quickly as the materials and, in many cases, more quickly. Let’s suppose you have to paint a building every 10 years. When the building is 10 years and one day old, you have to hire painters to repaint the building. The old paint has no value but neither does the labor expended to put the old paint on the building 10 years ago. You must add new labor as well as new paint. The previous paint and the previous labor both have no value. The labor is, effectively, used up at the same speed as the paint. The labor and materials have the same life expectancy.
    Let’s suppose you put a new barrel tile roof on a building. The next day you sell the property to someone who wants to tear the building down and build something else. The buyer tells the seller he’s welcome to salvage whatever he wants from the building prior to closing. The seller sends a crew over to remove the 1 day old roof tiles. The roof tiles have value. They can be sold. They can be reused. The labor expended to install them has no value. It can’t be sold or reused. If the seller or anyone else wanted to use the salvaged roof tiles, they’d have to supply 100% of the labor again. The original labor, though expended only a day ago, has no value.

    • Ben Steiniger

      I think you just made your point, except to the complete opposite argument. You are correct that labor is not tangible and has no actual value, which is why you can’t depreciate it. You pay for a service, once that is used up, it is gone. If I take the bus today to work for $10 and then do it again tomorrow, it will cost me another $10–two separate services. By the insurance company saying that they will replace my current roof with another one, that is two separate services and the full labor cost is associated with each service. They should not have the option to say, well, you took the bus yesterday but since we are paying for it today, we are only allowing you $8.

  • Mark Jacoby

    Based on my High School and College level economics courses, only durable goods or “assets” depreciate in value over time. State Farm is replacing the FP 7955 policy with the HW 2135 Policy. Under Section 1 loss settlement they changed the language to specifically state that they can depreciate labor. State Farm knew they had no legitimate grounds to depreciate labor with the FP 7955.

    The danger with this ruling is that it directly effects the people who can only afford older housing in distressed neighborhoods, who don’t have the resources to augment claim awards to secure professional contracting. High deductibles and scheduled roofing depreciation hinder recovery and insurability. The net result is further degradation of challenged neighborhoods.

    The court failed the people on this one. Kudos to the firm(s) that attempted to address this injustice.

    • Stephen Sarasohn

      I wouldn’t say they had no grounds. I’d say they amended the policy to avoid the argument. My college major was economics and finance. The labor has a finite life expectancy, just like the materials.

      • Mark Jacoby

        Depreciation applies to building materials, an “end product” of manufacturing, which has a labor and material components as Stephen has pointed out. The labor to install building materials, to make repairs, is only a minor portion of labor for manufacturing the “end product” aka “the dwelling”. Labor alone is not “depreciable” by definition.

        One of the tenets for insurance policy writing is that policies are supposed to be easily understood. When the industry redefines concepts for their purposes, this hinders comprehension. The court ruling effectively redefines depreciation, a concept for which many have a tenuous grasp in my personal experience. This alteration must be explained and fully understood by the Insured. Most feel their Insurance Company will take good care of the them until they get the ACV check.

        But that’s not why the court blew it. They failed to consider both the purpose of insurance; to assure recovery from a catastrophic loss by transferring risk, and the practical implementation of coverage.

        In Ohio, depreciation can be assessed at 100%. You can now be awarded 0% coverage up front for restoration. Depreciating labor will only serves to make recovery less attainable and more complicated. Large deductibles coupled with ACV awards for both materials and labor translate into being marginalized if you have neither the cash or credit to front deposits to legitimate contractors. Allowing this is simply disingenuous to the concept of Insurance. The only purpose it serves is to discourage claims, thwart recovery and enable underwriters to pocket policy premiums.

        When homes fall into disrepair and become uninsurable, forced policies are instituted and/or mortgages get called in. Abandon and unoccupied property is vandalized, or burned and leveled even when purchased by investors /investor groups. This was already happening at an alarming rate. The absentee owner/landlord issue in our distressed cities is not improving conditions rather it fuels urban decay and homelessness. The underwriters are trading roof claims for VMM and Fire claims.

        The Underwriters, the Banks, the Investors and the Property Owners all lose.

    • Stephen Sarasohn

      I wouldn’t go so far as to say that, prior to changing the policy language, State Farm had no legitimate grounds to depreciate labor. I’d say they changed the policy to avoid the argument.

  • Jonathan Sadick

    I happen to agree with Mr. Sarasohn, namely that labor should be depreciable. When someone argues to the contrary, I ask if an old, worn out, cat clawed couch should be depreciated when calculating its ACV. Generally, the response is “of course”. I’ll then ask if you should only depreciate the material components of the couch (i.e. the cost of the raw fabric, steel frame, padding, etc.) or the final manufactured cost (sales price of couch) that includes processing the cotton into thread, the thread into fabric, and that fabric attached to the frame of the couch. These cost have both labor and material components. I believe that this analogous to construction depreciation, the can of paint used to paint a house is no different than the raw cotton used to cover a couch.

  • Brian Molineaux SPPA

    I agree with Stephen Sarashon labor is part of the trade costs none of us care to depreciate and when it apply’s it needs to be correct for items being replaced not repaired

  • No offense intended, but I find the Sarasohn response to be contradictory. It suggests the labor has no value the day after the work is complete, but also suggests labor depreciates at least as quickly as materials, then at the same speed as the materials (paint). I’m not sure by this which he feels is correct, and it shows this topic can be argued in many different ways. I hope we can agree more purely labor-intensive items (cleaning, scaffolding, demo, …) should not be depreciated, and as indicated in the blog, the policies should unambiguously define these terms.

    • Stephen Sarasohn

      Immediately and at least as fast as the materials are not contradictory. You install a central air conditioning system in a building and the next day the state says they’re taking the building under eminent domain. They tell you they’re going to demolish the building to put a road through and you can salvage whatever you’d like. You remove the central air and you sell it. Do you think the buyer will pay you for the labor you used when you installed it? That labor has no value to him since he has to spend an equal amount to install it in his building. If you can’t reuse the labor or sell it, how can you think it has any value and, if so, what would the value be? The value of the labor is gone. If the building burned down the day after the installation, the ACV would be one day’s depreciation on the labor and materials. If the labor and materials were of equal cost, would the ACV of a building component never depreciate below 50%, even on the day you had to replace them both?

    • Stephen Sarasohn

      Cleaning and demo weren’t in the building before the loss. That’s why they don’t depreciate. It’s not because it’s labor. When a contractor charges for boxes and bubble wrap to pack out a house, those materials aren’t depreciated either for the same reason.

  • rogerpoe

    Insurers fairly know that “tangible” material properties can naturally “depreciate” over time. However – Parallel “intangible” labor costs are accounted for in ongoing real time, and do Not “depreciate” per true underwriting forecasts. Thus also comes a/the reason for “market surge” labor costs being built into premiums assumptions.