Values of loss often have components which seem small but add up to millions of dollars to insurers over the long run. In Holden v. Farmers Ins. Co. of Washington, 2010 WL 3504821 (Wash. Sept. 9, 2010), the Washington Supreme Court affirmed that sales tax should be considered when determining Actual Cash Value. Noting that terms of Actual Cash Value and Fair Market Value would be referred to as ACV and FMC, the significant facts of the case are as follows:

On June 9, 2004, a fire broke out in the kitchen of the rented house at which Holden and her three children lived. The fire damaged or destroyed some of the family’s personal property, including furniture and various kitchen items. At the time of the fire, Farmers insured Holden under a “Broad Form Renters Package Policy” (Policy), which included coverage for fire damage…The Policy contains the following provision on loss settlement:

Covered loss to property will be settled at actual cash value. Payments will not exceed the amount necessary to repair or replace the damaged property, or the limit of insurance applying to the property, whichever is less.

…The Policy defines ACV as “the fair market value of the property at the time of loss.” …The Policy does not define FMV or specify what method Farmers will use to calculate ACV or FMV. Nor does the Policy expressly state whether sales tax is accounted for in calculating ACV or FMV.

For an extra premium, Holden also purchased a “Contents Replacement Cost Coverage” endorsement (RCE) with her Policy…. The RCE provides for “the full cost of repair or replacement without deduction for depreciation.” Id. “Replacement cost” is defined as “the cost, at the time of loss, of a new article identical to the one damaged, destroyed or stolen.” …The RCE provision requires the insured to actually replace or repair the damaged property within 180 days of the loss. The insured pays the cost of repair or replacement out-of-pocket and submits receipts to Farmers for reimbursement under the RCE. Farmers often pays sales tax under the RCE, upon proof that it has been incurred.

After the fire, Holden submitted a claim to Farmers under the ACV provision of the Policy. Farmers sent Holden a check for $1,174.41, an amount Farmers determined to be the FMV of Holden’s property. This amount was calculated with no regard to Washington state sales tax. When Holden requested that sales tax be included in calculating her reimbursement, Farmers informed Holden that if she submitted receipts for coverage under the RCE, only then would her reimbursement include sales tax. Holden explained in her deposition that she opted not to submit her claims under the RCE because she could not afford to pay the out-of-pocket repair or replacement cost and wait for reimbursement from Farmers.

The legal discussion is worthy of study:

The ACV coverage at issue provides for the settlement of losses according to the FMV of the damaged property. Farmers advances a technical definition of FMV, but it is the ordinary understanding of the contract that controls. A technical approach fails to account for the way Farmers actually implements the ACV coverage provision. One method Farmers uses to calculate FMV looks at current replacement cost less depreciation. Farmers admits that it sometimes calculates replacement cost to include sales tax, representing the amount of money a buyer would actually have to spend to replace the damaged property. The language of the ACV provision plainly allows for looking at replacement cost in calculating the insured’s loss:

Covered loss to property will be settled at actual cash value. Payments will not exceed the amount necessary to repair or replace the damaged property, or the limit of insurance applying to the property, whichever is less.

…This policy provision suggests to the average insurance consumer that his or her loss will be determined according to what it would cost to replace the property, less depreciation to reflect the age or wear and tear of the damaged property.

Yet, Farmers argues and the dissent concludes that sales tax must be excluded from any replacement cost calculation on the ground that FMV, as used in other contexts, excludes consideration of taxes. See Farmers’ Suppl. Br. at 8-12; Dissent at 2-4. The dissent notes that inheritance tax and property tax are assessed on the FMV of taxable items before tax. If tax were included, the argument goes, an endless cycle would be created because one would need to know the tax in order to determine the FMV, in order to determine the tax, etc. The problem with this “chicken and egg” argument is that the meaning of FMV in other contexts is irrelevant. Its meaning in the context of this insurance contract is what matters, which is why Farmers’ own practice of including sales tax is critical. Indemnifying a policyholder for his or her actual loss is quite different from valuing property for the purpose of assessing an inheritance, property, or capital gains tax.

Nor does it advance the argument to say that the traditional notion of FMV necessarily excludes transaction costs, such as sales tax, because these extra costs do not add to the value of an object. Farmers’ policy does not define FMV in this manner. Indeed, it does not define the term at all. We have recognized in other contexts that the common understanding of “ ‘ “[f]air market value” is the amount of money which a well informed buyer, willing but not obliged to buy the property, would pay, and which a well informed seller, willing but not obligated to sell it, would accept.’ “…Sales tax represents a portion of the actual out-of-pocket expense to the buyer and bears on the decision to buy. Accordingly, there is nothing intrinsic in the notion of FMV that necessarily includes or excludes sales tax.

Faced with the fact that Farmers only sometimes interprets FMV to include sales tax-namely, when a policyholder replaces damaged property under the ACV provision-the Court of Appeals asserted that such practice reflects “a consistent application of the principles of indemnification.”… But, whether an ACV claimant actually replaces damaged property has no logical bearing on the property’s FMV. Consider an example in which two different policyholders own identical sofas that are destroyed in fires. Each seeks coverage under the ACV provision, so Farmers must determine the sofas’ ACVs. If one of the policyholders buys a new sofa, does this fact affect the value of the old sofa that was destroyed? Does it mean that this policyholder’s sofa was worth more than the identical sofa of the policyholder who did not buy a new one? Of course not; the value of the old sofas was the same without regard to these circumstances. The sole purpose in using a replacement-cost-minus-depreciation method of valuation is to estimate the policyholder’s loss. This loss is the same regardless of whether the sofa is actually replaced.

The vast majority of insurers include sales tax in valuation of property. Apparently, Farmers wants its policyholders to get less than what other insurers pay their customers. Nevertheless, the conclusion is what matters and requires Farmers to get in line with everybody else:

The value of coverage under the ACV provision of Farmers’ policy does not clearly exclude sales tax on damaged or destroyed property. While the policy defines ACV as FMV, it gives no definition of FMV. Neither does the traditional notion of FMV exclude sales tax from its definition. Farmers sometimes accounts for sales tax when calculating FMV. Moreover, the ACV provision indicates that the measure of recovery is related to “the amount necessary to repair or replace the damaged property.”…This language, combined with Farmers’ practices and the absence of a definition for FMV, creates an ambiguity as to whether sales tax is included under the ACV provision of the Policy. Because we construe this ambiguity against Farmers, the Policy must be read to include consideration of Washington State sales tax. (emphasis added)