The Moving Target

Settlement of an insurance claim requires the agreement of both the insurer and policyholder on the measure of recovery as agreed upon within the contract of insurance. Typically insurance policies insure the actual cash value (ACV) of the item on which coverage has been provided. Policy wordings do not, in the normal course of construction, articulate a definition of ACV.

Policies can provide replacement cost endorsements, as well as guaranteed replacement cost and stated value agreements. These are normally defined. Notwithstanding these other terms of settlement clauses, in the vast majority of policies issued by insurers, the ACV is the usual terms of settlement. At least in the interim stage of the claims process, if not the final stage.

To achieve ACV settlement, the adjuster must be aware of exactly what is meant by actual cash value. In some cases it can mean the cost to the policyholder to replace the item with exactly that which was lost. This must take into consideration age, condition, size, and all other measurable dynamics that the item in question is gauged by when a person initially purchases the item. Take, for example, a vehicle. If the policyholder lost a 2004 Ford F150 4×4 long box, with a 5.0 litre engine, complete with box liner, leather seats, with 75,000 km on the odometer and in good condition. Then the cost to purchase the exact same vehicle FOB the policyholder’s location would be perfect indemnity.

To achieve this perfect indemnity would, of course, require finding this exact vehicle described above, available for sale within reasonable proximity to the policyholder’s domicile. The price to purchase this vehicle would be considered the ACV. As we all know, this fictitious vehicle rarely exists. We can always find a 2004 Ford F150 for sale, but need to add or subtract options to arrive at what we believe is a reasonable comparable valuation of ACV. Further, the asking (published) price by the vendor is not necessarily the final price open for acceptance. So assessment of ACV is nebulous.

In property losses, the valuation process is more problematic. After the total loss of a structure, assessment of the ACV needs a more pragmatic approach. Buildings are so different that finding comparable structures for sale in the area of the insured structure is highly unlikely. Plus, the sale of structures is almost always tied to the value of the underlying land. Thus, the adjuster must utilize some other methodology in valuation of the building’s ACV.  In most cases, replacement cost less reasonable deduction for depreciation based on age and condition is utilized.

Respecting ACV, on review of jurisprudence by Canadian courts, recent cases reported includes Ollerhead v. Ecclesiastical Insurance¹ heard in the Supreme Court of Newfoundland and Labrador.  This judgement, given Aug. 31, 2005, restated the principals of interpretation of insurance contracts as laid out by the Supreme Court of Canada. The courts take the position that in interpreting an insurance contract, the rules of construction relating to contracts are applied as follows:

• The court must search for an interpretation from the whole of the contract, which promotes the true intent of the parties at the time of entry into the contract.
• Where words are capable of two or more meanings, the meaning that is more reasonable in promoting the intention of the parties will be selected.
• Ambiguities will be construed against the insurer
• An interpretation, which will result in either a windfall to the insurer or an unanticipated recovery to the insured, is to be avoided.

From current jurisprudence, it is the court’s position that it would depend on the intention of the parties at the time of the execution of the insurance contract to ascertain what the intent of actual cash value is.

The adjuster should, when necessary, enquire to the broker who sold the policy of insurance as to what their understanding of ACV is.  This can be critical especially if the issue of ACV is headed to litigation or the appraisal process. Most brokers I have discussed ACV with, tend to articulate it to be replacement cost plus or minus appreciation or depreciation.

That being the case, it is more likely than not that courts in Canada would identify the actual cash value of a building (or other insured property) to reflect replacement cost less depreciation based on current jurisprudence.

To complicate matters somewhat, in the United States, courts, according to IRMI.com, have defined ACV through three different approaches:

1.    Replacement cost minus depreciation.
2. Fair market value.
3. According to the “broad evidence” rule which is a judicious combination of one and two above.

In the USA, method number one is the traditional insurance industry definition. Over the years, courts have upheld this meaning and interpretation. According to IRMI.com, a Kansas court summed up ACV as follows: “The definition of ‘replacement cost’ stated in the policy as the ‘full cost of repair or replacement (without deduction for depreciation)’ implies that replacement cost is greater than actual cash value, and that actual cash value must mean ‘full cost of repair or replacement (with deduction for depreciation).” Fair market value also seems to be a rather straightforward method, as it has always been thought of as “what a willing buyer will pay to a willing seller,” IRMI.com noted. So given the above, ACV certainly can be elusive.  For the most part however, in Canada, ACV is generally defined as replacement cost less reasonable depreciation for age and condition.

So with that focus, an adjuster must complete all necessary research and evaluation to ascertain the replacement cost, the age, the pre-loss condition and the obsolescence, if any. This, of course, can be challenging if the item has been completely destroyed such as in a fire. Especially if all the policyholders records documenting the structure happened to be in the structure at the time of the loss! Or the property under coverage has been stolen, such as art or jewelry.

Art and jewels made of precious metals and stones can, in fact, appreciate in value over the original purchase price. Therefore, ACV could in fact be valued by determining the original purchase price plus appreciation, based on the value of the precious metal (such as gold) at the time of purchase appreciated by the percentage of change in increased value as of the date of loss.

Many paths can lead to proper investigation of the condition of the item under exploration. Buildings generally have documentation available at municipal building inspections departments, land title offices and law firms involved in the transaction of the sale.  Property appraisal reports can be obtained from the appraiser who generated the report, from lending institutions who have the chattel as security or from previous owners of the property. PIPEDA, or provincial/territorial privacy legislation, will require the policyholders authorization for the adjuster to obtain this information.

On contents claims, the quantity of items lost such in a residential house fire can make ACV valuation arduous, but the process is still the same. Generally the policyholder completes a Schedule of Loss that inventories all items destroyed. The ACV of each item is usually assessed based on information provided by the policyholder. The utmost good faith maxim applies. The adjuster must accept the information provided by the policyholder, unless evidence obtained by the adjuster shows, on a balance of probability test ,that the information provided is not accurate.

With the age of each item provided by the owner, the adjuster must then determine the design service life (DSL) of the item. DSL is the lifespan of the item that the manufacturer has taken into consideration when the selection of materials was made and the quality of fab
rication was selected. A manufacturer usually has a price point in mind that they target when the decision on DSL is made. For instance, if a manufacturer is targeting volume sales at a price point below their competitors, they will reduce the manufacturing costs by selecting lower quality materials and cheaper fabrication costs. The item built, therefore, will not last as long as an item which has higher quality, more robust, materials constructed with tighter tolerances and a more rigorous production inspection of the final product.

For example, two couches may look generally the same, but the higher quality couch has a hardwood frame affixed with brass screws and the lower quality couch has a softwood frame fastened with staples. The higher quality one has memory foam padding covered with leather while the lower quality has batting covered with cloth.  Clearly, under the same conditions of use, it is reasonable to expect the higher quality couch will have a longer DSL than the lower quality one.

Given the above, on determination of ACV, if the policyholder purchased both couches at the same time, then the depreciation of the higher quality couch should be less than the lower quality couch. Unfortunately, it seems, from my experience, most ACV schedules of loss have the same depreciation factor applied to both. This is unfair to either the policyholder or the insurer.

The depreciation factor typically would be the age of the item in question divided by the DSL. Then condition adjustments must be applied. This adjustment is, in most cases, a judgment call by the adjuster and will ultimately be a negotiable factor. Obsolescence may also have to be factored in. Obsolescence is the state of being which occurs when an object is no longer wanted even though it may still be in good working order. For example, a monochrome computer monitor collecting dust in the basement. Although the DSL may not attract significant depreciation, the value of the object to the policyholder through resale or use may be diminished. Of course, if the monochrome monitor is still in use by the policyholder, then that is a different story from the insured’s point of view.

Adjusters must be able to defend the methodology utilized to arrive at the ACV on each and every item claimed. Far too often adjusters have applied a 50/50 approach (either half full or half empty) on contents schedules, taking the position that in the end it will all balance out. I, for one, doubt this balance is achieved. I suspect either the insurer achieves a windfall or there is an unanticipated recovery by the insured.

It is uncommon that even with proper research into all the factors mentioned above, a settlement can be achieved just by providing the policyholder with a valuation set by the adjuster. Some negotiation has to be anticipated. When preparing for settlement discussions, the adjuster must be adequately prepared. Review all research and documents obtained to establish ACV.

Ascertain the most supportable position (MSP). For the adjuster, the MSP would be the lowest valuation supportable by evidence that can be offered to the policyholder. It must be supported by documentation of replacement valuation with a fair application of the DSL towards ascertaining the depreciation on the item(s) in question.

The adjuster must as well set the valuation for which is the least acceptable result (LAR) from valuation research. The LAR would be, from the adjuster’s point of view, the highest valuation supported by study.

Because of the complexity of arriving at ACV in most situations, it is unrealistic to believe that the valuation determined by the adjuster can be cast in stone. For an equitable conclusion, a valuation range between the MSP and LAR must be established. The more research and evidence obtained, the narrower the range between the two positions can be achieved. With the policyholder’s valuation range intersecting the adjuster’s range, the settlement of the ACV can be achieved.

Greg Merrithew is the managing director of Arctic West Adjusters Ltd. and the president of the Canadian Independent Adjusters’ Association.

1. Ollerhead v. Ecclesiastical Insurance Office PLC 2005NLTD145