Commercial property insurance will reimburse you for direct physical loss to covered business property caused by a covered peril within your policy period. There are two basic types of coverage for property damage: replacement cost coverage and actual cash value, or ACV, coverage. When determining ACV coverage, courts have increasingly weighed whether labor costs can be included in depreciation calculations.
Replacement Cost vs. ACV Coverage
The exact definitions of replacement cost coverage and ACV coverage vary by policy. But generally speaking, replacement cost refers to the cost of replacing damaged or lost property with property of similar kind and quality. Replacement cost coverage does not take depreciation into consideration, but reimburses you for the full cost of replacing the item today. If, for instance, your desktop computer was destroyed by a covered peril, you would be covered for the cost of a new desktop model of similar quality and with similar features.
By contrast, ACV is equal to the item’s original cost, minus depreciation. Say you have ACV coverage for your damaged desktop computer, and the computer is three years old. The insurer would reimburse you for the original cost, less deductions for three years of depreciation. In most cases, ACV payouts are lower than what it would cost to replace the lost or destroyed property with new property of like kind and quality. For this reason, ACV coverage is generally less expensive than replacement cost coverage.
Can Labor Costs Be Considered in Depreciation Calculations?
How courts calculate depreciation is dictated by the terms of the policy and the laws of the jurisdiction. Courts have increasingly addressed whether depreciation of labor costs may be considered in calculating ACV. In a 2015 decision, the Supreme Court of Arkansas held that state law prohibits depreciating labor when calculating ACV of a covered loss, even in cases where a policy provision expressly allows for such depreciation.1 In a 2021 ruling involving a policy that did not define ACV, the Illinois Supreme Court sided with the policyholder, holding that labor costs could not be deducted in calculating the ACV payment. The court concluded that, as the ACV definition was ambiguous, it should be construed in the policyholder’s favor.2 Applying Kentucky law, the Sixth Circuit ruled in a class action that ambiguous policies issued by State Farm Fire & Casualty Co. did not define depreciation and should be construed in accordance with the policyholder’s reasonable expectations, that only the cost of materials would be depreciated.3 However, the Tenth Circuit, applying Kansas law, held that depreciation of labor was appropriate and that a reasonable insured would in fact expect the insurer to calculate ACV by depreciating both materials and labor.4 In a case involving a damaged roof, the Oklahoma Supreme Court ruled insurers could depreciate labor in calculating ACV. Based on the “broad evidence rule,” the court said, all relevant factors should be considered. The roof in question is a “product consisting of both materials and labor,” and the policy insured the entire roof – not just the materials.5
If you are involved in a dispute with your business insurance company, contact Schwartz Conroy & Hack. We have the expertise, experience and tenacity to make sure insurance companies keep their promises to you and your business.
1 Shelter Mut. Ins. Co. v. Goodner, 477 S.W.3d 512 (Ark. 2015)
2 Sproull v. State Farm Fire & Cas. Co., 184 N.E.3d 203, 2021 IL 126446, 451 Ill. Dec. 616 (Ill. 2021)
3 Hicks v. State Farm Fire & Casualty Co., 751 F. App’x 703 (6th Cir. 2018)
4 Graves v. American Family Mutual Ins. Co., 686 F. App’x 536 (10th Cir. 2017)
5 Redcorn v. State Farm Fire & Cas. Co., 55 P.3d 1017 (Okla. 2002)
