What can go wrong if ‘actual cash value’ is not clearly defined in a property policy

After a 132-year-old Cape Breton Island building was heavily damaged by a sprinkler line failure, there was a huge disparity between the property owner and insurer’s versions of “actual cash value.” The claimant said $1.59 million, while the insurer said $230,000.

The final outcome is still to be revealed in New Dawn Enterprises Limited v. Northbridge General. In the most recent court decision on the matter, released May 4, Supreme Court of Nova Scotia Justice Joshua Arnold ordered that the disputed commercial property claim be adjudicated by a new umpire, a process laid out in the provincial Insurance Act.

In 2013, New Dawn bought the Holy Angels Convent in Sydney for $250,000. It was built in 1885, with an addition built in 1907. Used as a convent until 2010 or 2011, the building then had various tenants until the fall of 2016, when it was vacated with the insurer’s knowledge.

The sprinkler line failed Mar. 17, 2017.

Although property insurance often covers replacement cost, in New Dawn’s case, there was an endorsement in which “actual cash value” was substituted for replacement cost. But the policy Northbridge wrote for New Dawn does not actually define actual cash value, Justice Arnold noted.

After the accident, an appraisal firm retained by Northbridge calculated the actual cash value at $230,000 while New Dawn’s appraiser valued it at $1.59 million. An umpire selected by the two appraisers then decided $258,000 should be the actual cash value. While Northbridge was good with the $258,000 figure, New Dawn sought judicial review.

Justice Arnold’s May 4 ruling does not make a finding on which figure was correct. Instead, Justice Arnold ruled the umpire’s finding is set aside and now a new umpire has to try to assess the value.

New Dawn’s main issue with the first umpire was the fact that he had contacted vendors hired by Northbridge before making his decision.

Much of Justice Arnold’s 38-page ruling details the methods the appraisers used to calculate replacement value and actual cash value, and the umpire’s dealings with the insurer, adjusting firm, appraisers and a property damage estimate vendor retained by Northbridge.

Northbridge’s appraiser used two different approaches to determine actual cash value. One (the “cost approach”) resulted in an estimate of $290,000 while the other (the “direct comparison”) approach resulted in an estimate of $200,000. The appraiser came up with the lower value by looking at actual sales values of similar properties. Then he reconciled the two to $230,000 by attaching more weight to the lower value, contending this is the more reliable of the two. Specifically, the insurer’s appraiser multiplied $200,000 by four, multiplied $290,000 by two, added those two numbers together and then divided that total by six.

To calculate actual cash value, both the insurer’s appraiser and the client’s appraiser started by estimating “replacement cost new.” Northbridge’s appraiser defined “replacement cost new” as the cost of replacing, repairing, constructing or reconstructing the buildings on the site with new buildings of like kind and quality, and for a like occupancy, without making a deduction for depreciation (which is basically wear and tear).

But the appraisers used different methods to calculate this replacement cost.

Northbridge’s appraiser came up with a $6.67 million replacement cost using the “unit in place method.” This consists of measuring the exterior and interior of the building and measuring the area of each interior partition, taking into account finish, construction and quality.  The area of the partition is then multiplied by the cost per square foot to make it, in order to arrive at its replacement cost.  A similar method was then used to add on the estimated cost of the other building components, including excavation, foundations, frame, floor structure, interior construction, plumbing, heating and ventilation, electrical, exterior wall and roof.

One major difference between the two figures is that the client’s appraiser included the value of a heating, ventilation and air conditioning system.

Both appraisers made deductions for depreciation and obsolescence.

The appraiser for Northbridge then deducted physical depreciation and “external obsolescence.”

By contrast, the real estate appraiser retained by New Dawn said they should not deduct for external obsolescence – which he said is caused by negative influences outside the site; is not within the owner’s control; and can be caused by factors like neighbourhood decline, the property’s location within the community, or local market conditions.

The appraiser retained by New Dawn did deduct 60% for what he called “functional obsolescence,” which he said is a loss in value resulting from defects of design or “caused by changes that, over time, have made some aspect of a structure, such as materials or design, obsolete by current standards.” He noted the building was a “purpose-built convent” and therefore some aspects of the building no longer had a functional use without reconfiguration at the time of the loss.

So, from the $14.58-million replacement cost, the appraiser for New Dawn deducted 72.73% for physical depreciation and 60% for functional obsolescence to arrive at an actual cash value of $1.59 million.

By contrast, the appraiser retained by Northbridge deducted 71% for physical depreciation but 85% for external obsolescence to arrive at the $290,000 figure, down from $6.67 million.

New Dawn’s appraiser used a different method – the quantity survey method – to come up with the $14.58 million “replacement cost new.” [The Northbridge appraiser used the less precise “unit in place” method].

The quantity survey method entails measuring the interior and exterior of the building and figuring out how much it would cost in material, labour and equipment to construct a similar building. This is similar in concept to how a construction contractor would prepare a bid in a tender process.

The insurer’s appraiser had noted that, in general, the quantity survey method is more accurate that the unit in place method, but that the unit in place method is good enough for fire insurance.

What led to New Dawn’s application for judicial review is that the umpire had communicated with both a property damage estimate vendor and an independent adjuster retained by Northbridge for that claim. Northbridge noted that the umpire had copied New Dawn’s lawyer on an email to Northbridge seeking the insurer’s consent to contact Northbridge’s property damage estimate vendor. New Dawn argued that the umpire relied on information he obtained from Northbridge’s appraiser without sharing it with New Dawn’s appraiser and giving him a chance to respond.

Also, the umpire interviewed the adjuster from the adjusting firm retained by Northbridge and did not inform the client of that until after the umpire made his final decision, Justice Arnold noted in his May 4 decision. For this reason, Justice Arnold found that the umpire did not meet the reasonable expectation of the claimant.

“An umpire must not only be impartial but be perceived by the public to be impartial,” Justice Arnold wrote, citing State Farm Fire and Casualty Company v. 1432235 Alberta Ltd., a 2018 Alberta Court of Appeal ruling.

Feature image via iStock.com/Stephen Barnes