Opinion ID: 2056376
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Heading: actual cash value and replacement cost distinguished

Text: The difference between actual cash value coverage and coverage for the full cost of repair or replacement without deduction for depreciation is not only a linguistic one but also each provides a different practical result. The actual cash value policy is a pure indemnity contract. Its purpose is to make the insured whole but never to benefit him because a fire occurred. Appleman on Insurance 2d § 3823 at pp. 218-219; Brand Distributors Inc. v. Insurance Co. of North America, (1976) 532 F.2d 352 (4th Cir.). Replacement cost coverage, on the other hand, reimburses the insured for the full cost of repairs, if he repairs or rebuilds the building, even if that results in putting the insured in a better position than he was before the loss. If a fire occurs in a new building, the actual cash value generally is equivalent to the cost of repairs since the full cost of repair merely restores what was there. It indemnifies but does no more. If an old building burns to the ground, the actual value is commonly established by reference to its fair market value less the value of the land on which the building sits. If an old building has only very minor fire damage, repairs probably do not result in a substantial betterment, and depreciation is usually ignored in adjusting the loss. However when the building is old or obsolescent and is seriously damaged but not destroyed, the actual cash value is more likely to be disputed. The courts uniformly hold, as did the Court of Appeals, that actual cash value insurance is strictly a contract of indemnity. The insured should be made whole but not be put in a better position than he was in before the fire. Braddock v. Memphis Fire Ins. Corp., (1973) Tenn., 493 S.W.2d 453. A problem common to all the foregoing tests is the extent to which physical deterioration and obsolescence should be taken into account in computing loss. If the principal of indemnity be adhered to, depreciation must be considered in loss adjustment so that the insured will not receive the equivalent of a new building for a loss of the old one. Insurance law is not concerned with the estimated depreciation charged off on the books of business establishment but rather with the actual deterioration of a structure by reason of age and physical wear and tear, computed at the time of the loss. 49 Colum.L.R., 818, 823. The same principle is discussed at 44 Am.Jur.2d 549, Appleman on Insurance 2d, § 2823 at p. 226. A building constructed thirty years ago will have many interior features and structural components that are not only old and used, but of a style, material and color no longer available or in fashion. If damaged by a fire, they will be replaceable only with new components and the fire will be the occasion of renovation and remodeling which, if done without reference to a fire, would be an improvement paid for by the owner. 44 Am.Jur.2d p. 549. In such event, the property is worth more and the fire loss provided the insured with an enhancement for the value of his assets. Replacement cost insurance on the other hand is not a pure indemnity agreement. It is an optional coverage that may be purchased and added to a basic fire policy by endorsement. It is more expensive because the rate of premiums is higher and the amount of insurance to which that rate applies is usually higher. Replacement cost coverage is available on the insurance market to meet the need which troubled the plaintiff. That need may be expressed this way: Since fire is an unwanted and unplanned for occurrence, why can't the owner of an older home buy insurance to cover the full cost of repair even if those repairs make it a better or more valuable building? Since at the time of fire the homeowner may be least able to pay for improvements, why can't that hazard be insured too? Instead of apportioning the cost of repair after a fire between the actual cash value, to be paid by the insurer, and the betterment to be paid by the insured, why can't the policyholder simply pay a higher premium each year but not have to pay anything more to have his home fully repaired in the event of fire? When the insurance industry adopted a standard extension of coverage endorsement to provide replacement cost, it took into account the one great hazard in providing this kind of coverage: the possibility for the insured to reap a substantial profit, if fire occurs. See Higgins v. Insurance Co. of North America, (1970) 256 Or. 151, 469 P.2d 766, 66 A.L.R.3d 871 and the annotation beginning at 66 A.L.R.3d 886. The cost of repair may exceed the fair market value of the building, and in the case of very old or obsolescent buildings, the difference may be very substantial. To permit recovery of the cost of repair, without also requiring the repairs to be made usually provides an even greater windfall than is provided when repairs are made. In effect the insured sells his building not at its market value but at a much higher figure and for cash. The basic insurance contract with which we are here concerned provided for actual cash value reimbursement. By addenda, commonly referred to as the extended coverage endorsement, (Endorsement FO-2) the extent of reimbursement was modified to provide for replacement cost reimbursement or actual cash value reimbursement, whichever was the greater. This provision of the addenda, however, was expressly applicable only to Coverage A, the plaintiff's personal residence and not to Coverage F, the rental dwelling which incurred the fire damage. The amount that the defendant was obligated to pay under the contract, accordingly, is determined by the language of the basic policy, actual cash value. Although there are two cases from other jurisdictions, Fedas v. Insurance Co. of State of Pennsylvania, (1930) 300 Pa. 555, 151 A. 285 and Glens Falls Ins. Co. v. Gulf Breeze Cottages, (1949) Fla., 38 So.2d 828 holding, in effect, that an agreement to pay actual cash value requires the insurer to repair or replace the property as nearly as possible to its condition as of the date of the casualty, the vast weight of authority and better reasoned case law is to the contrary. Neither this Court nor our Court of Appeals has construed the term actual cash value as used in insurance contracts, [2] although there are decisions from the latter that are consistent with the defendant's position that depreciation is a factor when determining the loss payable upon a contract insuring such value. Meridian Ins. Co. v. McMullen, (1972) 152 Ind. App. 141, 145, 282 N.E.2d 558, 561. And in Atlas Construction Co., Inc. v. Indiana Ins. Co., Inc., (1974) 160 Ind. App. 33, 40, 309 N.E.2d 810, 814, actual cash value was equated with fair market value; and it was recognized that it was a thing apart from replacement cost. The contract provision was as follows: In consideration of the provisions   , this company,   , to an amount not exceeding the amount(s) above specified, does insure the Insured named   , to the extent of the actual cash value of the property at the time of loss, but not exceeding the amount which it would cost to repair or replace the property with material of like kind and quality,   , against all direct loss by fire,   . (Emphasis added). Under the foregoing insuring agreement, the defendant was obligated to pay for plaintiff's direct loss, limited, however by three factors: (1) the amount expressly provided, $15,000.00, (2) the actual cash value of the property lost, and (3) the cost of repair or replacement, etc. The Court of Appeals, however, regarded limit (2) and limit (3) as being one and the same which, in effect, eliminated No. (2) as a limiting factor. It also failed to take into account that depreciable components would, of necessity, be replaced with new ones hence resulting in a restored building and a value greater than that existing before the loss. By way of example, if a fire damages the roof of a building to the extent that replacement is required, it makes a vast difference, in determining the loss, whether the roof was new or near the end of its usable life. If the former, replacement of the damaged roof only indemnifies the owner but if the latter, replacement would be a substantial windfall to the owner. The difference between factors No. 2 and No. 3, is that No. 2, according to the weight of authority, permits a reduction in liability in view of the very real consideration that following complete restoration of an extensively damaged building, the building will often be worth more than it was before the loss occurred. The degree to which this comes into play obviously varies with the physical condition and degree of obselescence of the building, prior to the loss, and the extent of the damage insured against. The determination is further complicated by reasons of factors, other than mere age or physical deterioration, that also affect values. Historically, four methods have been judicially sanctioned for determining the actual cash value of losses under policy provisions the same or similar to the one with which we are here concerned. Three of these are described and annotated at 61 A.L.R.2d 711, 725, (§ 7. Buildings). Not recognized in the annotation is the one utilized by the Court of Appeals, although it appears to have been approved in Fedas v. Insurance Co. of State of Pennsylvania, supra , and Glens Falls Ins. Co. v. Gulf Breeze Cottages, supra . (1) Replacement cost, without deduction for depreciation. The method utilized by the Court of Appeals, has been criticized as follows: The most striking development in the partial loss cases has been the emergence of a minority view that recovery may be had for the cost of reconstruction without any depreciation allowance. The rationale of these cases is that if a depreciation deduction is taken, the insured will realize a sum that is insufficient to pay for repairing the property at the time of the loss. Where the damage is to a substantial portion of the structure, the repair of which would appreciably extend the normal life of the building, recovery of full repair cost would permit the insured to profit by his loss since he is thereby receiving the cost of a new building for an old building. Where, on the other hand, the damaged portion is structurally insignificant, the failure to consider depreciation is justifiable. 49 Colum.L.Rev. 818, 826. Even when that article was written in 1949, the hazard of windfall profit was recognized. Footnote 60 states: Since depreciation is always deducted in computing total loss (see notes 37-40, supra.), an insured may recover more for a partial loss under this minority rule than for a total loss. Thus, if the insured has a building valued at $100,000 which has depreciated $20,000, he would recover $80,000 in a case of total loss. If his loss was $90,000 under this minority view, he would collect the full $90,000. Id. (2) The market value test has been adopted in relatively few jurisdictions, the most prominent being California. Jefferson Ins. Co. of New York v. Superior Court of Alameda County, (1970) 3 Cal.3d 398, 90 Cal. Rptr. 608, 475 P.2d 880. In the case of partial damage or destruction of a building by fire, it is speculative, since there may be no established market. The rule has been criticized in this way. It is commonly said that a building has no recognized market value in the ordinary sense since each structure is in theory unique. Further, the market value of its structure is bound up with the value of the land on which it stands and if the land is not marketable the building will have a decreased value. The majority of the courts, therefore, have rejected market value as the sole definition or standard of `actual cash value', but have allowed juries to consider it as a factor in computing the actual cash value of a building. 49 Colum.L.Rev. 818, 820. (3) The replacement cost with deduction for depreciation used to be the majority rule. At least fourteen jurisdictions have adopted the reproduction or replacement  cost less  depreciation standard of measuring the actual cash value. The New York Standard Fire Insurance Policy says recovery shall not exceed `the amount which it would cost to repair or replace the property with material of like kind and quality ...' This provision is acknowledged to have been intended as an upper limit of the insured's recovery, but courts have generally adopted it as the rule of measurement of actual cash value in those states using replacement cost method. Its primary advantage is that of certainty but the inflexibility of the rule is also its most objectionable feature. It results in over-compensation in those cases where substantial obsolescence has taken place apart from corresponding depreciation. Insur.L.J., July, 1973, p. 368. The replacement cost with deduction for depreciation has been described by its adherents as follows: Of the three rules generally applicable to partial losses, the one that squares with the basic principal of indemnity and affords a reasonable guide to insureds in determining insurable value and to insurers in determining the amount of loss is replacement cost less depreciation, with depreciation given its broad meaning as exemplified in the McAnarney case in situations where obsolescence is a material factor. Ins.L.J., 1953, 685, 688. It, nevertheless, cannot always be said that the insured has been indemnified if he is required to expend a substantial sum from his own pocket to restore his building, albeit to an improved condition, when it suited his purpose in its pre-loss condition. (4) The fourth method that has been employed is the so-called Broad Evidence Rule which originated with the case of McAnarney v. New York Fire Insurance Company, (1928) 247 N.Y. 176, 159 N.E. 902. The Broad Evidence Rule has now become the majority rule, having been adopted in at least twenty-three states. More than twenty-three states have adopted some form of the broad evidence rule. It is clear that obsolescence cases like the early McAnarney case and demolition and abandonment of building cases have been responsible for most breaking of traditional valuation rules. These appear to be the primary areas where existing doctrines simply could not be stretched enough to meet indemnity and equity principles. Insur.L.J., 1973 at p. 369. The fourth approach, the Broad Evidence Rule, instead of being a fixed rule, is a flexible rule. It permits an appraiser or a court or a jury to consider any relevant factor. An excellent analysis of these various rules was set forth recently by the Supreme Court of New Jersey in Elberon Bathing v. Ambassador Ins., (1978) 77 N.J. 1, 389 A.2d 439. The court there considered the same fire policy involved in this case. In New Jersey the 1943 New York Form had been adopted by statute. The replacement cost extended coverage endorsement, approved for use in Indiana by the Indiana Insurance Commission, had also been expressly approved in New Jersey, by statute. The Supreme Court of New Jersey expressly held that these provisions, when considered together, prohibited an award simply based on replacement cost without consideration for depreciation where the policy covered only actual cash value and not replacement cost. It did not, however, say that the amount constituting actual cash value was necessarily equal to the cost of repair less deduction for depreciation. Instead it adopted the Broad Evidence Rule. It is a significant and scholarly opinion. It is a unanimous opinion. It reviews in detail the interplay between actual cash value coverage and replacement cost insurance. It specifically considers the fixed measures of replacement cost, market value, and replacement cost less depreciation. It expressly considers the problem of total loss and partial loss, the effect of over and under insurance, and the applicability of principals of valuation to both old and new structures. After a thorough analysis of the problems inherent in all of the standards for determining actual cash value, the court expressly adopted the Broad Evidence Rule quoting it from McAnarney, supra, as follows: `Where insured buildings have been destroyed, the trier of fact may, and should, call to its aid, in order to effectuate complete indemnity, every fact and circumstance which would logically tend to the formation of a correct estimate of loss. It may consider original cost and cost of reproduction; the opinions upon value given by qualified witnesses; the declarations against interest which may have been made by the insureds; the gainful uses to which the buildings might have been put, as well as any other fact reasonably tending to throw light upon the subject. 159 N.E. at 905.'  McAnarney was intended to insure application of the principal of indemnity (i.e., to make the measure of recovery for fire insurance losses correspond to the actual pecuniary loss sustained by the insured'). Id. [159 N.E.] at 904-905 See Bonbright and Catz, op. cit., supra, 29 Colum.L.Rev. at 899. Under valuation denies the insured the indemnification due him under the policy. Over valuation tempts the insured to cause the very loss covered, or at least, to provide inadequate safeguards against the loss. Id. at 863. The commentator's generally view the broad evidence rule with approval. See Id. at 898-899 (a flexible test which can be modified in such a way as to accord more nearly with the principal of indemnity); Cozen op. cit., supra, 12 Forum at 657 (Sacrificing an easily applied standard for a far more equitable result). It has been adopted in numerous jurisdictions. We find the rationale of the broad evidence rule to be compelling. It requires the fact-finder to consider all evidence an expert would consider relevant to an evaluation, and particularly both fair market value and replacement cost less depreciation. If the appraiser finds it appropriate under the particular circumstances he may, after weighing both factors, settle on either alone. 77 N.J. 1, 389 A.2d 439, 443-444. This is a sound rule of law and was given tacit approval by our Court of Appeals in Atlas Construction Co. Inc. v. Indiana Insurance Company, supra . Defendant challenges the award of compensatory damages as being unsupported by the evidence, contrary to the evidence, and contrary to law. These challenges present common questions of law. It is Defendant's claim that it was entitled, as a matter of law, to have the actual cash value of the loss determined by the aforementioned replacement cost with deduction for depreciation method. However, it acknowledges that the question has not been previously determined in this state and relies upon cases from other jurisdictions, citing Braddock v. Memphis Fire Insurance Corporation, (1973) Tenn., 493 S.W.2d 453. As previously stated, this used to be the majority rule, but has since lost out to the broad evidence rule method which did not control the decision but, as previously mentioned, was looked upon favorably by our Court of Appeals in Atlas Construction Company v. Indiana Insurance Company, Inc., supra. We hold, therefore, that although Defendant was entitled to have the element of depreciation considered, it was not entitled to have its liability determined by the exclusive use of that method. Plaintiff testified that the value of the house immediately before the fire was at least $15,000.00 and that immediately after the fire it was $5,000.00, thus fixing the loss at $10,000.00. She also presented an expert witness who testified that the damage to the house was $8500.00, based upon the estimated cost of necessary repairs. Defendant's evidence was that the estimated cost of repairs was $8729.00 but that the house was 50% depreciated, due to its age. It further gave evidence that its initial offer was incorrect and arose from erroneously applying the extended coverage endorsement terms to the damaged house, hence the alternative offer to pay a greater amount if the premises were restored. It further gave evidence that after the dispute arose, it increased its offer by applying a 25% factor, in an effort to keep everybody satisfied. Under the broad evidence rule, the parties were entitled to introduce evidence of every fact and circumstance which would logically tend to a formation of a correct estimate of the loss. McAnarney, supra ; under the evidence presented, the jury was at liberty to award as much as $10,000.00, based upon Plaintiff's before and after valuation or as little as $4,250.00, based upon her expert's testimony of repair costs of $8,500.00 and a depreciation factor of 50%, as presented by Defendant's evidence. The verdict was within the limits of the evidence and cannot be disturbed.