Walker v. Auto-Owners Ins. Co. – 9/27/2022

December 29, 2022

In an insurance policy using the “replacement cost less depreciation” method for determining “actual cash value,” labor costs may not be depreciated.

A couple purchased a homeowners’ insurance policy from an insurance company. During the time of coverage, several rooms in the couple’s home suffered water damage. The couple filed a claim with the insurer, and the insurer accepted coverage for the loss. The insurer was to pay the couple the “actual cash value” of the property at the time of loss, minus depreciation. In calculating the “actual cash value,” the insurer depreciated materials and labor. The couple then filed a lawsuit in the District Court of Arizona on behalf of themselves and other similarly situated class members alleging underpayment. The insurer filed a motion to dismiss.

The district court certified two questions to the Arizona Supreme Court:

  • (1) When “actual cash value” or “depreciation” are undefined by a homeowner’s insurance policy, may the insurer depreciate materials and labor in determining the “actual cash value?”
  • (2) Whether the broad evidence rule applies to allow an insurer or fact finder to consider labor depreciation in “actual cash value?”

The Arizona Supreme Court found that “actual cash value” in the present policy did not allow for depreciation of labor cost and the broad evidence rule did not apply. The Court, however, noted that the broad evidence rule may apply to other homeowners’ insurance policies in Arizona.

In addressing the first question, the Court reviewed a collection of cases that similarly failed to define “actual cash value” and determined that courts have employed three methods to define the phrase. The Court then turned to the policy language in this case, and it determined that read together, “actual cash value” adopted the replacement cost less depreciation (“RCLD”) method. Within that methodology, courts disagree on whether the depreciation should be applied only as to materials, or as to both materials and labor. Consider a roof replacement which costs $5,000 in materials and $5,000 in labor—a $10,000 roof. The roof has a 20-year expected lifetime and was 10 years old (50% depreciation). Depreciating materials alone would yield actual cash value of $7,500 ($2,500 in depreciated materials + $5,000 in non-depreciated labor). Depreciating both materials and labor would yield actual cash value of only $5,000 ($2,500 in depreciated materials + $2,500 in depreciated labor). After surveying the caselaw on the issue and interpreting the contract against the insurer, the Court held that this methodology allows for depreciation of materials only, not labor.

As for the second question, the Court clarified that although the broad evidence rule does not apply in the current policy, it may apply in other policies. It is dependent on the policy language. A court will first look to the policy terms. But for cases in which a policy fails to define “actual cash value,” the Court set forth a three-step approach.

Justice King authored the unanimous opinion.

Posted by: Annabel Barraza