Have you ever received gift cards only to forget about them or not use them for years? Have you ever wondered what happens to the money that was spent on the card, since no goods or services were received in exchange? In retail, this is known as “breakage,” where customers pay up front for items like gift cards, and the company then benefits financially when those gift cards are not used. Effectively, if your gift card expires before you can use it, it’s free money for the company. This practice raises some obvious questions about consumer rights and corporate responsibilities.

A parallel situation is unfolding in the insurance industry, giving rise to what I call “insurance breakage.” Take, for instance, a recent case in Virginia involving State Farm.1 The company is insisting that its customer must “complete” repairs on a fire-damaged building within a two-year timeframe in order for those repairs to be covered under the customer’s replacement cost coverage policy. This demand brings to light a critical question: Why do insurance regulators sanction clauses that impose such arbitrary time limits?

Replacement Cost Coverage Versus Actual Cash Value Insurance

Total replacement coverage, also known as replacement cost coverage, pays out the full, current-day cost to replace an item. It is often differentiated from actual cash value (ACV) coverage, which provides reimbursement for the cost of the item as it exists today, including depreciation and wear and tear. Replacement cost insurance policies typically offer more robust coverage since they’re meant to cover the full current day cost of replacing the damaged property, not just its depreciated value.

My research hasn’t uncovered any legal reason for placing time limits on customers’ replacement cost coverage policies, suggesting that the reason is simply that insurance companies are profiting off of the breakage introduced by selling policies and then imposing time limits on policyholders that would prevent payment of any claims. In other words, time limits on claims introduces breakage where there was none before.

I suggest that arbitrary time deadlines for replacement are just another form of the insurance breakage problem I noted in Insurance Breakage—Insurance Companies Profit When Policyholders Give Up. Further, in my opinion, insurance breakage is an issue that should be addressed in order to benefit consumers, not just line the pockets of insurance companies.

Insurance Breakage: A Case Study

These are the facts from the recent Virginia case that drew my attention:

Bowman’s house was severely damaged by fire on March 24, 2020, and he made a timely claim to State Farm under his policy. State Farm began to investigate, and in October 2020, provided Bowman a first estimate of the cost to repair his house, as well as an initial actual cash value payment. In addition to enclosing a 60-page breakdown of estimated repair costs by room and item, the letter attached an ‘Explanation of Building Replacement Cost Benefits’ form, which stated that ‘[t]o receive replacement cost benefits you must … [c]omplete the actual repair or replacement of the damaged part of the property within two years of the date of loss.’

At issue here is the gap between the initial ACV payment and the additional replacement cost coverage outlined in the policy. It took State Farm six months after the fire to provide the policyholder an estimate of the fire loss, delaying any possible repairs while Bowman waited for the insurance company to conduct their investigation. Bowman was paid the ACV, and told that the replacement value coverage was dependent upon repairs being completed within 2 years of the loss.

Further, State Farm argued that the two-year timeframe was the point before which Bowman could not file suit; the company claimed that not only must Bowman complete repairs within two years, the two years also stood as a time limit on any potential suits against them for nonpayment of the policy. As you might guess, this is an untenable situation for the policyholder: they are being required to meet a two-year timeline for repairs that also prevents them from filing suit unless they do so within two years. This seems to me a clear example of insurance breakage, where companies are selling policies and simultaneously making it impossible to collect on those policies.

As the two-year time limitation to both make repairs and to file suit approached, Bowman did indeed file suit for declaratory relief, “asking the circuit court to interpret the insurance policy [to clarify whether the two-year timeline was for repairs or for filing suit] and hold that State Farm could not refuse to make payments for repair or replacement costs incurred after two years from the date of loss.” State Farm demurred, and that was upheld by the Virginia trial court on the grounds that the policyholder could not bring suit against State Farm for relief without complying with the two-year repair or replacement timeline as specified in the policy.

Once this was brought to an appellate court, the decision was reversed, however, finding that any two-year time frame was ambiguous.

State Farm has argued that the policy does not require it to reimburse Bowman for costs incurred after two years from the date of loss. As discussed above, the policy is ambiguous on this point. Should the factfinder conclude that the policy does not require Bowman to complete repairs within two years, and State Farm relies on the ‘Suit Against Us’ provision and refuses to reimburse him, there is at least some possibility that Bowman might be entitled to relief.

This case shows how some courts have found timelines introduced into policies to be ambiguous and needing clarification.

Do Insurance Companies Have a Time Limit?

While my research has found no explanation for why many insurance companies place a time limit requirement in replacement cost policies, I have several practical guesses, including a major underwriting risk — insuring a risk that is in disrepair. This remains an educated guess, however: If any reader has an actual source explaining the rationale for these arbitrary time frames, I would greatly appreciate you forwarding it to me.

In my view, the obligation of an insurance company to pay for replacement costs should hinge primarily on whether the company has suffered financial prejudice. The breach of a time frame for repairs or replacements is immaterial unless it demonstrably results in financial detriment to the insurer. Given that most courts are averse to the forfeiture of contracts, it stands to reason that an insurance company should only be able to withhold payment for delayed replacements to the extent that it can prove financial prejudice caused by the delay.

Absent such prejudice, it appears to me that the insurer is essentially profiting from holding onto ‘the float’ — the funds that are due to policyholders for repairs or replacements. This practice raises significant ethical questions. It suggests that the insurer benefits financially from the time value of money that rightfully belongs to the policyholder, especially when the delay in replacement does not materially affect the insurer’s financial position.

Therefore, the focus should be on the actual impact of the delay. If the delay does not financially harm the insurer, withholding payment seems more like a strategic financial gain than a response to a legitimate contractual or financial issue. This perspective aligns with the principle that insurance should serve the interests of policyholders, providing them with the security and financial support they are entitled to under their policies.

Further Resources on Insurance Coverage Law

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1 Bowman v. State Farm Fire & Cas. Co., No. 1256-22-3, 2023 WL 8040862 (Vir. App. Nov. 21, 2023).