Insurers often try to limit damages once they are found liable for breach of the insurance contract by claiming that the insurance policy limits the insured’s recovery to the actual cash value because the insured did not comply with the policy’s condition on recovering replacement cost.1
Insureds generally counter by arguing it would be inequitable for an insurer to withhold payment of actual cash value because of alleged non-coverage under the policy (making it impossible or at least difficult for the insured to replace the damaged property without funds from the insurer), and later deny replacement cost payment when found liable for coverage because the insured did not comply with the policy condition on recovering replacement cost.
In a recent case,2 a federal court addressed this scenario and predicted3 that under Pennsylvania state law an insured could recover replacement cost despite noncompliance with a policy’s replacement requirement condition where the insurer’s denial of liability and failure to pay actual cash value prevents the insured from replacing the property. The court further ruled that the insured must still demonstrate that, but for the insurer’s denial of actual cash value payment, they would have replaced the property. Consequently, an insured may not be able to recover replacement cost if it is shown they had no intention of replacing the damaged property.
In utilizing the “prevention theory” to approach replacement requirement conditions in insurance policies, the inquiry focuses on the insurer’s actions and their consequences for the insured’s ability to perform—whether the insurer paid actual cash value or denied liability altogether and whether denying funds made it impossible, or at least unduly risky, for the insured to comply with the replacement requirement condition. Thus, the replacement requirement condition will be excused (and the insured may recover replacement cost) where the insurer’s denial of liability and failure to pay actual cash value prevents the insured from replacing the damaged property. A replacement requirement condition may not be excused, however, where the insurer has admitted liability and has made payment for the actual cash value, but the insured could not hire a contractor to rebuild because the parties disagreed on the proper value of the damaged property.
1 The following is an example of an insurance policy’s condition on recovering replacement cost:
We will not pay on a replacement cost basis or any “loss”:
(1) Until the lost or damaged property is actually repaired or replaced with other property of generally the same construction and used for the same purpose as the lost or damaged property; and
(2) Unless the repairs or replacement have been completed or at least underway within 2 years following the date of “loss.”
2 Utica Mutual Ins. Co. v. Cincinnati Ins. Co., 2019 WL 290162 (E.D. Pa. January 23, 2019).
3 Under the Erie Doctrine, a federal court hearing a state law claim must apply state substantive law to resolve the claim. When a state’s highest court (in this case, the Pennsylvania Supreme Court) has yet to speak on a particular issue, a federal court deciding the matter and applying the state’s substantive law must predict how the state’s highest court would decide if confronted with the issue. This is commonly referred to as an Erie Guess.