Kentucky Court: Depreciating Labor to Get Actual Cash Value Is Like Making the Insured Use a Very Old Roofer With Debilitating Arthritis to Repair the Roof

Surprisingly few states have addressed the question of whether an insurer can depreciate labor – as opposed to materials – to arrive at actual cash value (ACV).  Two weeks ago in Bailey v. State Farm Fire & Cas. Co., 2015 WL 1401640, 2015 U.S. Dist. LEXIS 37568 (E.D.Ky., Mar. 25, 2015), a federal court in Kentucky held that it was impermissible to do so, quoting an Oklahoma opinion that analogized such a step to requiring the policyholder to use “a very old roofer with debilitating arthritis who can barely climb a ladder or hammer a nail” to effect repairs to a roof.

shutterstock_34430626The case was a proposed class action by a West Liberty, Kentucky dentist whose office was damaged by a tornado and an Owingsville, Kentucky homeowner whose residence was hit by a fire.  In both cases, the State Farm policies afforded replacement cost coverage but authorized the carrier to make its initial payment on an ACV basis.  In the two cases, the insurer calculated ACV by determining replacement costs and then depreciating both materials and labor.  The policyholders argued that labor, unlike construction materials which logically age and wear and tear, was not subject to depreciation.

In his opinion, Judge Henry Wilhoit observed that Kentucky law defined ACV as “replacement cost of property at the time of the loss less depreciation.”  He then observed that the question presented – “whether the installation of materials, i.e. the labor, is subject to depreciation?” – was one of first impression in Kentucky.  He concluded that the answer was no.  In the words of the court:

The damaged or destroyed materials are given the value they had immediately prior to the loss.  Therefore, if the affected property was a ten year old garage, the insured would not be given the cash equivalent of a brand new garage but one that had stood for ten years.  The calculation would take into account wear and tear of the materials.

However, labor is not subject to wear and tear.  Indeed, the cost of labor to install a new garage would be the same as installing a garage with 10 year old materials.  In other words, depreciated labor costs would result in under indemnification.  As the insurance contract is one for indemnity, depreciating the cost of labor violates the contract.

The court noted that other jurisdictions had reached differing results.  Thus in Adams v. Cameron Mut. Ins. Co., 2013Ark. 475, 430 S.W.3rd 675 (Ark. 2013), a unanimous Supreme Court of Arkansas answered a certified question from the state’s Western District by holding that labor was not depreciable.  We published a Post discussing the case 18 months ago.  In Redcorn v. State Farm Fire & Cas. Co., 55 P.3d 1017 (Okla. 2002), however, five of the eight judges on the Oklahoma Supreme Court disagreed, answering a certified question from that state’s Western District by holding that a roof was a “single product, consisting of both materials and labor,” and that depreciation of the whole product therefore included depreciation of the labor costs.

Judge Wilhoit found the Redcorn dissent by Justice Daniel Boudreau to be more persuasive.  The dissent argued that

A roof, unlike a preassembled consumer good, is not an integrated product.  Redcorn cannot go to the lumber yard or the retail store and buy a roof.  A roof does not exist until the shingles are transported to the site and installed on top of the house.  A roof is not a unified product but a combination of a product (shingles) and a service (labor to install the shingles).

According to Justice Boudreau, that meant that labor was not depreciable.  Indeed, he analogized depreciating labor to giving the policyholder enough money to hire “a very old roofer with debilitating arthritis who can barely climb a ladder or hammer a nail” in order to reflect the fact that the value of the labor had depreciated over time.

Another decision in this line is in the offing.  Last month, in Wilcox v. State Farm Fire & Cas. Co., 2015 WL 927342, 2015 U.S. Dist. LEXIS 26229 (D.Minn., Mar. 4, 2015), the District of Minnesota certified the following question to that state’s highest court:

May an insurer, in determining the “actual cash value” of a covered loss under an indemnity insurance policy, depreciate the costs of labor when the term “actual cash value” is not defined in the policy?

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About The Property Insurance Law Observer
For more than four decades, Cozen O’Connor has represented all types of property insurers in jurisdictions throughout the United States, and it is dedicated to keeping its clients abreast of developments that impact the insurance industry. The Property Insurance Law Observer will survey court decisions, enacted or proposed legislation, and regulatory activities from all 50 states. We will also include commentary on current issues and developing trends of interest to first-party insurers.
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