Value Judgment

We may believe insurance terms related to the word “value” are straightforward. After all, what could be more basic, for example, than “actual cash value,” “replacement cost value,” and “market value” in terms of their application to loss settlement? Included below are examples of “value,” which appear in Canadian caselaw, to illustrate the court’s various interpretations of the term. According to the Canadian courts, “the subject of ‘value’ should include four vital and related areas:

* Prevention of over-insuring

* Adequacy to cover largest possible loss

* Satisfaction of co-insurance clause requirements/prevention of under- insurance

* Establishment of dollar amount of an insured loss.”

We can see here how “value,” at least for insurance purposes, is a very elusive term. Any number of factors – replacement cost, reproduction cost, depreciation, obsolescence, market value, use value, functional value, etc. – may come into play in an interpretation of the word value.

Some policies include a clause that establishes in advance a value for a particular property in the event of its damage or destruction. This is done to avoid the problem of post-lost valuation. Referred to as “valued policies,” they nevertheless represent contracts of indemnity because only value is predetermined; it is still necessary to prove the fact of pecuniary loss.

REPLACEMENT COST

It is generally accepted in the insurance industry that buying the broadest protection available will in the long run be of greater value than alternative forms of protection that may cost less, but will not deliver the response expected of the insurance policy. Nevertheless, even the policy wordings in broad forms have their drawbacks: words such as “like material” and “replacement” could mean something different to policyholders than they do for insurers. For example, in one court case – which involved the replacement of a leopard-skin coat with a lynx coat, because leopard skin was unavailable – it was ruled the insurer was not liable to pay for any replacement. Contrast this ruling to another court ruling – in which the owner of a building severely damaged by fire was allowed to purchase a new building rather than reconstruct the damaged building – and you can see why the word “replacement” is not always as straightforward as it may appear.

ACTUAL CASH VALUE

When the form of property insurance is not replacement cost, it’s usually called “actual cash value.” Actual cash value is deemed in the insurance business to be replacement cost new, less depreciation – with other factors introduced to define how actual cash value will be used to measure loss. This does not eliminate ambiguity in the interpretation of the term. An example lies in the word “replacement.” This could mean the cost of repair or the cost of complete replacement. Taking this example further, the term replacement could refer to the cost of purchasing a substitute or the cost of making a substitute. Situations may arise in which replacement is not in union with the standards of loss settlement. The reconciliation of all factors is necessary to avoid misunderstanding.

The following might serve to assist in unraveling problems related to “value”:

* defining repairs, and relevant cost

* relating market value to the cost of purchasing an alternative

* relating market value to the cost of producing an alternative

* acknowledging the reduction in value as a result of damage

* commercial worth lost due to damage

Repair costs are not exempt from definitional problems in the event of loss or damage. In fact, problems related to interpretation can become acute when a policyholder undertakes a portion or all of the repairs.

Consider a precedent-setting court case involving a fur-cleaning business and the owner’s claim for recovering profit. The insurer denied the owner’s claim for profit on the grounds that their liability did not extend beyond “the cost of repair.” Initially, the court agreed with the insurer. But a provincial appellate court reversed the lower court decision, based on the arrangement for repair to which the insurer and policyholder both agreed. According to the appellate court, profit was a component of the repair arrangement and therefore the court allowed the owner’s claim. It can happen that repairs will increase the value of the item beyond its pre-loss value. In this situation, a deduction is made in the loss settlement to avoid betterment, an action not unlike a deduction for depreciation.

MARKET VALUE

In the time-honoured insurance system, when the cost of repairs exceeds the cost to substitute, there is no dispute about substituting an item for one that has been damaged. This system of substitution employs the use of “market value,” meaning the policyholder can take the loss sum into the marketplace and buy a substitute. However, as previously discussed, not all loss situations may be simple and straightforward. In some circumstances, market value is not an appropriate method, and courts will therefore turn to other measures.

Property that is so severely damaged or destroyed and, because of its uniqueness and rarity, cannot be replaced or purchased as a substitute in the marketplace requires that a substitute be made. The making of a substitute thus becomes the measure of loss, subject to allowance for depreciation. Where a building is insured for replacement cost, reconstruction would be the measure of loss for that building. In most cases, buildings are reconstructed. If the form of insurance is not replacement cost, then a deduction would apply for depreciation. One court case dealt with a barn that was destroyed by fire; the barn adequately suited the farm’s operations. Integral to the court’s decision in determining value was the paramount ingredient of replacement cost, less depreciation. In this case, the court found that in absence of any other factors to the contrary, reconstruction is the only viable means of loss settlement.

Insurance policies are legal contracts that result from a culmination of offer and acceptance between the policyholder and the insurer. However, the process does not end there: the intention of the insurer will always be apparent in the interpretation of the contract at the time of a loss. Take, for example, the words “insured for,” as opposed to “valued at.” One Canadian court heard a case involving paintings in an art gallery that were damaged but not destroyed. The policyholder made a claim for the full value of the policy. The court found in favour of the insurer, which called for the loss to be settled based on the percentage of the diminution applied to the value stated in the policy.

Property producing rental income for the owner could suffer a reduction in value from loss or damage. Indemnification for the owner will include the capital value of the building, as well as the amounts of rents that would have been collected had the building remained in existence. At least two Canadian court cases demonstrate that even though a building may be slated for demolition, loss settlement will nevertheless be based on the presumption that the building will continue to exist. In other words, the value of the building remains intrinsic. In one case, capital value was based on multiplying annual rental – including fixed charges and overhead – by the minimum number of years a prudent buyer would allow to recoup an investment (according to expert evidence), and using the resultant figure as a measure of loss.

Although this method shadows somewhat the concept of “market” value, the court threw out the argument of using market value as a measure of loss on the basis that there was no evidence of a relevant market.

A CHECK-LIST

A policyholder would be well advised to consider th
ese items in order to receive the best value for the premium dollar.

– Professional building appraisal

– Asking the insurer the method used for loss settlement

– Recording all structural and cosmetic changes

– Alerting the insurer of conditions appreciating or depreciating value

– Communicating and understanding the meaning of various “value” terms.