FEATURE ARTICLE
Property Insurance
By: Tracy E. Stevenson Chuhak & Tecson P.C. Chicago
Cost to Repair or Replace - Who Decides What is Equal to New?
Imagine you live in a historical building, or even one of the older brownstones, greystones or walk-ups so prevalent in the Chicago area. Next imagine the unimaginable, your home is severely damaged by fire or otherwise. The first step (after securing your own safety) is easy: call your insurance company and make a claim. Your adjuster informs you that your policy provides coverage for the cost to repair, rebuild or replace the property in a condition equal to, but not superior to or more extensive than its condition when new. In other words, you are protected with replacement cost coverage.
What does replacement coverage provide for? Insureds and insurers often struggle with interpretation of coverage language such as “equal to but not superior to or more extensive than its condition when new.” To what extent and when does the repair have to be completed? Can insurers substitute “like” parts rather than replace with “identical” parts? If so, who determines what these terms mean? This article will address some of these issues and discuss the background of Replacement Cost Coverage in an effort to ascertain some of the trends facing both insureds and insurers when a property loss occurs.
What is Replacement Cost Coverage
It is axiomatic that the general idea of property insurance coverage is to make an insured whole in case of loss in exchange for payment of premiums. While the premise seems simplistic, courts are fraught with differences of opinion as to what constitutes “whole.” Prior to the advent of depreciation, the courts had adopted a straightforward “new for old” analysis in assessing loss. In the past, if an insured’s home was destroyed, the insured would receive an amount necessary to rebuild their home or replace its contents in new condition. Current indemnity provisions state that property insurance policies allow an insured to be made whole but almost never permit an insured to receive undue benefit. By not taking into account depreciation, the courts’ former adoption of “new property for old” granted a windfall to an insured. Therefore, the terms of the insurance policies were altered to specifically provide for reimbursement only for the actual cash value of the property at the time of damage. Actual cash value is defined as replacement cost less depreciation. (General Casualty Co. v.
Tracer Industry, Inc., 285 Ill. App. 3d 418, 674 N.E.2d 473 (1996).
To enable an insured to be made whole, replacement cost policies were developed which provide coverage for both the actual cash value of damaged property as well as the return of the deducted depreciation value. Thus, replacement cost provisions usually allow for the full cost to repair or replace damaged property without deducting for depreciation, if actual repairs are made.
Higginbotham v. American Family Insurance, 143 Ill. App. 3d 398, 493 N.E.2d 373 (1986). Simply
stated, the insurance industry recognized that depreciation was an insurable risk that is secondary to the actual cash value reimbursement. It is in the recovery of this secondary risk, i.e., depreciation, which raises many questions as to the manner and means necessary to “repair or replace” damaged property.
“Replacement cost is a forward-looking measure of loss and considers cost at the time and place of loss.” F.S.C. Paper Co. v. Sun Insurance Company of New York, 744 F.2d 1279 (7th Circ. 1984). This forward-looking concept often makes the value of depreciation difficult to ascertain. Therefore, subject to the indemnity analysis, prior to reimbursement or recovery, the terms of virtually all replacement cost policies require that property actually be repaired or replaced before an insurer becomes obligated to pay any sum over the actual cash value of the damaged property. See,
Higginbotham v. American Family Insurance, supra.
Actual Repair or Replacement Required
The Court in Tamco Corp. v. Federal Insurance Co. of New York, 216 F. Supp.767 (N.D. Ill. 1963),
was one of the first which dealt with the issue of the insured’s right of replacement of old with new. In the Tamco case, the insured had purchased a replacement cost policy, as well as an endorsement, to cover the depreciation value of the machinery and improvements in an insured industrial plant. A fire ultimately destroyed the plant. During claim settlement negotiations, the insurer agreed to pay the actual cash value of the property, but determined that pursuant to the terms of the depreciation endorsement, no monies were due under the provision until the insured had “actually rebuilt or replaced” the property.
The Tamco Court strictly construed the plain language of the policy requiring that an insured
“actually replace or rebuild before recovery for depreciation value.” The “old for new” standard continued to apply but only to the extent that the “new” was actually realized. Otherwise, recovery was limited to actual cash value.
In response to the legal trend requiring actual repair, insureds attempted to demonstrate that replacement cost monies were due upon a showing that the actual repair was intended, planned or even partially completed in order to gain access to the insurance proceeds more quickly. However, in
Bourazak v. North River Insurance Company, 379 F.2d 530 (7th Cir. 1967), under policy provisions
similar to the Tamco, supra, policy language, the Seventh Circuit ruled that even if an insured began preparatory work to rebuild, until completion of the work, the insurer was only obligated to pay the actual cash value of the property. No payment was required for depreciation costs until repair or rebuilding was actually completed. Again, even upon showing of a good-faith intent to repair, the policy provision was upheld strictly and determined to be unambiguous.
Many insureds next attempted to attack the “actual repair” provision by arguing that without the benefits of the insurance monies, actual repair or replacement was impossible. The Court in National
Tea Co. v. Commerce & Industry Insurance Co., 119 Ill. App. 3d 195, 456 N.E.2d 206 (1983),
addressed this issue in a lawsuit filed by a grocery store owner who claimed that repairs could not actually be completed until the insurance company paid the monies to complete the repairs. The insured argued that he did not have the funds to complete the actual repairs without the insurance proceeds. Nevertheless, the National Tea Court again upheld the express language of the policy that “a condition for recovery of the replacement cost was actual repair.”
A review of case law throughout the United States demonstrates that only if the insured is unable to rebuild due to specific actions of the insurer in improperly withholding funds can the insured recover without completing actual repairs. Mere lack of funding is not an excuse sufficient to overcome the language of the policy requiring completed repairs.
An act by the insurer which was determined to be sufficient to preclude actual repair prior to payment of depreciation costs is exemplified in the facts of Zaitchick v. American Motorist Insurance
Company, 554 F. Supp 209 (S.D.N.Y. 1982). There, after evidentiary hearing, the Court found that the
insurance company improperly denied the insured’s claim following a fire. The insurer’s initial denial based on arson being overturned, the company argued that it nevertheless owed no additional monies under its replacement cost policy because the insured had not completed rebuilding. In response to
various equity arguments brought by the insured, the Court finally determined that the insured was excused from performing the replacement condition of the policy because that condition was made impossible by the insurer’s initial denial. (The Court also took into account the insureds’ ages and limited income and unrealistic possibility of obtaining other outside financing). Despite the contrary nature of this ruling, the “actual repair” provisions typically remain strictly enforceable unless an insurer by its acts negates its applicability.
Thus, with few exceptions, if an insurer fails to pay the actual cash value for damaged property upon receipt and adjustment of a viable claim, its conduct may estop it from asserting the actual repair or replacement requirement relative to a claim for replacement cost coverage. Impossibility, frustration or fraud are all defenses which the insured may assert when confronted with the actual repair or replacement requirement. See, Zaitchick v. American Motorist Ins. Co., 554 F. Supp 209 (S.D. N.Y. 1982); State Farm Fire & Casualty Ins. Co. v. Miceli, 164 Ill. App. 3d 874, 518 N.E.2d 357 (1987) and National Tea Co., supra. It should also be noted that should an insurer begin to pay proportional payments for repairs, for whatever reason, before the actual replacement is complete, the Court’s have held that the insurer is bound in equity to continue the proportional payments until the repair is complete.
What Replacement Costs Must be Reimbursed
Once actual repairs are completed, must an insurance company automatically repay the full expenditure? Not necessarily. A typical insurance provision which includes coverage for replacement cost will place specific limits on that which an insurer is required to pay in the event of loss. Generally replacement cost policies restrict coverage to the lesser of: (1) the cost to replace the property with equivalent property; (2) the amount actually spent to replace the property; or (3) the policy limits. See
Hilley v. Allstate Ins. Co., 562 So.2d. 184 (Ala 1990). It should further be noted that the courts across
the country have interpreted the meaning of these provisions in a multitude of manners oftentimes appearing to commingle the definitions when applying specific case facts to the limitations.
For example, a Nebraska Court in the case of Eledge v. Farmers Mutual Home of Nebraska, 571 N.W.2d 105 (1997), held that an insurance company was only obligated to replace the damaged portion of an insured’s roof, rather than the whole roof. The Court found that the language of the policy which required “replacement cost of that part of the building damaged for like construction and use on the same premises” did not require replacement of the entire roof. The facts presented in the case were sufficient to show that the damaged roof could be satisfactorily repaired by replacing only those specifically damaged areas. The insurer was permitted to replace portions of the roof parts as long as the building was returned to “like construction and use.”
There can be no surprise that the insured did not feel that replacement of only a portion of the roof was satisfactory to return the home to its former “like construction.” However, as becomes clear, each of these cases are very fact specific. The trend of the courts is to consider all of the specific facts of any given case while relying heavily on the express provisions of the policy.
In the Eledge case, the insured’s roof was also known to have leaks prior to the time of damage. The
evidence at trial led the Court to determine that the insurer was required to repair only those portions of the roof which were damaged. Importantly, the Eledge Court, in response to a request made by the insured, ordered that because the intact portions of the roof leaked prior to the date of loss, replacement costs included only those costs necessary to repair the damage in a workmanlike manner but no replacement costs were to be awarded to guarantee that the roof be leak free. Yet again, the Court upheld a literal reading of the policy language to make the insured whole but no more than whole, and in this case not even leak free.
Louisiana has also dealt with the difficult task of determining whether an insurer must provide for replacement of the entire structure or repair the damaged part. In either case a variant exists as to calculation of the “amount actually and necessarily expended in repairing or replacing the building
structure.” Higginbotham v. New Hampshire Indemnity Co, 498 So.2d 1149 (1986), cert. den’d 501 So.2d 236. In that case, a home was damaged by wind and hail, a covered loss. The insured, after a few changes of mind during settlement negotiations, determined that to adequately repair the roof, the entire roof needed to be fully replaced using shingles which were of better quality than those destroyed. The insurer believed that roof could be repaired rather than fully replaced. After hearing evidence, the Court took a central position. Interpreting the policy provisions, the Court ordered that “to necessarily repair or replace the building structure,” the insurance company was bound to replace the roof as a whole. Nevertheless, the Court ruled that while improved shingles from those initially on the roof existed on the market, the insurer was liable only to repair the roof to its “like condition” at the time the damage occurred. Although a better product existed on the market at the time of loss, to require that the improved product be used to repair the roof would impart a windfall to the insured.
When is a Partial Repair Sufficient?
The above cases demonstrate the manner in which courts and individuals can interpret similar fact patterns yet come to inapposite conclusions. When considering partial repairs, the lines become more blurred and case law less prevalent. When partial repairs rather than full replacement is required, issues arise as to the amount necessary to be paid under the replacement cost provision relative to “matching” new items to old. Again, this area of law has received only minimal attention. The issue turns on the manner in which a party should repair a portion of the roof or a section of aluminum siding or even an auto part. Over time, such items may become weathered, discolored or no longer available on the market. Clearly, to repair the damaged portion with new “like” parts will show a disparity visible to the eye.
The Holloway v. Liberty Mut. Fire Ins. Co., 290 So.2d 791 (La.App 1974) court considered this
issue relative to a homeowner’s claim for replacement cost for a partially damaged roof. The court reasoned that critical to the determination of coverage was the effect that the “non-matching” replacement would have on the market value of the home. If the insureds could demonstrate that the mismatched materials would decrease the market value then total replacement of the roof, even the non-damaged sections, was required. Under the facts of the Holloway case, the insured did present sufficient evidence to demonstrate that repair of only sections of the roof would decrease their homes’ market value. Those facts being determined, the Court ordered the insurer to pay replacement cost for the entire roof. The Court in Hutcherson v. Tennessee Farmers Mutual Ins., 1986 WL 9608 (Tenn.-Ct. App. Sept. 3, 1986), used similar analysis and also considered aesthetics to rule that repair to only a small spot of damaged roof was not satisfactory. Here, the specific case facts, according to the Judge’s interpretation of the policy provisions, and his consideration as to how the spot repair would look, mandated that the actual replacement cost must incorporate the value of replacing one half of the roof rather than only the specific sheet of defective plywood. In venues in which the courts recognize the “broad evidence rule” such as the 7th Circuit, the trier of fact is entitled to consider all evidence relevant to the value of the property at the time of loss including both market value and reproduction value. Chicago Title and Trust Company v. United States Fidelity & Guaranty Co., 511 F.2d 241 (7th Cir., 1975). These factors may all be taken into account when attempting to determine value as well as issues related to matching parts.
Conclusion
Notwithstanding the tendency for each case to turn on specific facts, the trend in the courts has been to adhere strictly to the language of the policy provisions using the plain and ordinary meaning of the terms contained within the provisions. The leniency in interpretation has tended to favor the insurer especially in cases in which an insured attempts to circumvent the requirement of “actual completed repair” prior to coverage being owed. Nevertheless, there is no pattern established as to
when an identical replacement part is required or whether substitution of a like, less expensive part is viable. Thus, the courts have been fairly consistent in finding that if like parts are available on the market, upgrades constitute a windfall to the insured. All parties must therefore keep in mind that value, replacement or otherwise, is in the eye of the beholder. As case law remains minimal relative to many of these fact specific issues, it appears that resolution will be discretionary and based upon the language of the written policies of insurance.
ABOUT THE AUTHOR: Tracy E. Stevenson is a litigation attorney with the Chicago firm of Chuhak
and Tecson, P.C., concentrating in medical malpractice defense and insurance defense. She has defended
cases on behalf of physicians and hospitals and represented various major insurance companies in claims for personal injury. She is licensed in Michigan as well as Illinois.
