"'Insured' means you and residents of your household who are: a) your relatives; or b) other persons under the age of 21 and in the care of any person named above."

DEFINED AND DISTINGUISHED - JOSHUA MALLIN

1. Actual Case Value.

It is universally accepted that the basis and foundation of property insurance is to indemnify or restore the insured to as good a position, so far as practical, as he was in prior to the loss of damage of his property. (1) Nevertheless, there continues to be considerable disagreement as to how indemnity is defined. (2) Over the years, two distinct concepts of indemnity have been embraced by the insurance industry and the courts. On the one hand, there is "theoretical indemnity"; the idea that after recovering the insurance proceeds for a loss, the insured should be neither better off, nor worse off, than he was prior to the loss. On the other hand, there is "practical indemnity"; the idea that unless the insurance proceeds for a loss enable the insured to restore his property to as nearly as possible the same condition as it was before the loss, the insured, as a practical matter, will be worse off than he was prior to the loss. (3)

The disagreement as to the meaning of the term indemnity has culminated into disputes as to the measure of actual cash value. Standard property insurance policies compensation to the insured for the actual cash value of property damaged or lost. For example, the New York 1943 Standard Fire Policy, the form mandated for such policies by many states, provides that the insured shall be compensated:

[t]o the extent of the actual cash value of the property at the time of loss, but not exceeding the amount which it would cost to repair or replace the property with material of like kind and quality

within a reasonable time after such loss.

Over the years, three methods of determining actual cash value have emerged: A) Replacement Cost Less Depreciation, under which a deduction is made form the cost of replacement so as to accomplish theoretical indemnity; B) Fair Market Value, under which the insured receives the difference between the fair market value of the property before and after the loss; and C) The Broad Evidence Rule, under which all evidence relevant to ascertaining the true extent of the insured's loss may be considered in fixing the actual cash value of the damaged property. As will be seen by the analysis below, none of the valuation formulas are free from criticism or easily apply to all fact situations.

1. Replacement Cost Less Depreciation.

In adjusting losses, it is very common for insurance companies to define actual cash value as "replacement cost less depreciation". Under this standard, a deduction is made from the cost of replacement so as to accomplish "theoretical indemnity"; that is, to prevent the insured whose old building has been damaged from obtaining, in effect, a new one. (4) The concern is that unless depreciation and similar factors that lessen the value are considered during loss adjustment, the principle of indemnity is violated, because the insured would be able to recover a new building in place of the old building that was destroyed. Despite its general acceptance by the insurance industry, however, this valuation method has had its share of detractors. One argument against the use of this formula is based upon a reading of the New York 1943 Standard Fire Policy itself. (5) As se forth above, the Standard Policy provides, in pertinent part, that the insured may recover actual cash value for a loss, "but not exceeding the amount which it cost to repair or replace the property." It has been argued that the limiting clause would be meaningless were it not contemplated by the drafters that on some occasion's actual cash value would exceed replacement cost. By definition, however, "replacement cost less depreciation" can never exceed replacement cost. Therefore, as some courts have argued, actual cash value and "replacement cost less depreciation" must be two different things. (5)

The argument against using the "replacement cost less depreciation" formula for determining an insured's recovery under a policy insuring the actual cash value of the lost or damaged property seems to make the most sense when the property is only partially lost or damaged. It fact may courts have held that when the insured's property has only been partially lost or destroyed, the insured is entitled to recover an amount that will enable him to fully restore the property, without allowing any deduction for depreciation with regard to the materials used. (6). The common rationale underlying these decisions is that if depreciation is deducted from the cost to restore the partially damaged property, the insured will not be able to completely restore his property, thus falling short of the objective of property insurance; which is indemnity. (7)

For example, in  Thomas v. American Family Mutual Ins. Co.,  (8) the Supreme court of Kansas squarely held that the term 'actual cash value', when applied to a partial loss, means the cost of repair without any deduction for depreciation. The insurance policy in that case provided, in pertinent part, as follows: "[T]his company does insure the insured to the extent of the actual cash value of the property at the time of the loss, but not exceeding the amount which it would cost to repair or replace the property with material of like kind and quality within a reasonable time after such loss" In response to the insurer's appeal regarding the trail court's holding that depreciation could not be considered in arriving at the amount of plaintiff's recovery, the Supreme Court of Kansas explained, in pertinent part, as follows:

1. Nowhere in the policy does it provide that the cost of repair is to be reduced by a depreciation factors;
2. The instant policy does not appear to us to be ambiguous. It does not provide for any reduction in the cost of repairs based upon depreciation and it is not for us to read such a provision into the policy;
3. We think the better rule, absent policy provisions to the contracts, is that set forth in  Sperling v. Liberty Mutual Ins. Co.,  281 So2d 297 (Fla. 1973). In   Sperling, the court was called upon to determine the meaning of the "actual amount" of a partial loss. The court stated:

1. "[s]ince the purpose of an insurance contract is to indemnify the owner of property against loss, the measure of value of partial destruction of a building by fire should be the cost of placing the building in as nearly as possible the same condition that it was before the loss, without allowing depreciation for the materials used'"  (Emphasis added).   Id.  at 298.

1. Under our rules of construction governing insurance contracts, we are of the opinion [that] a reasonable person in the same predicament would not expect depreciation to be considered to reduce and impair his ability to repair his partially damaged dwelling. (9)

1. Fair Market Value.

Despite the insurance industries embracement of 'replacement cost less depreciation', courts have not uniformly subscribed to this formula for determining the actual cash value of lost or damaged property. Another method that has been used by the courts is known as the "fair market value test", under which the insured receives the difference between the fair market value of the property before and after the loss. (10) This method, however, also has its hare of critics.

Criticism of the "fair market value test" usually begins with the recognition that a building has not recognized market value in the ordinary sense. Therefore, the argument goes, were fair market value the sole measure of actual cash value, buildings, for which there is no actual market, would have no insurable value. (11)

Some courts have suggested that a hypothetical market value could be used. (12) However, the courts which have advanced the arguments against the fair market value test have an apparent aversion to the use of a hypothetical standard. The problem, in their view, with the use of a hypothetical market value is that it does not guarantee the insured's ability to replace the property destroyed. In other words, while payment by the insurer of actual market value practically guarantees that the insured will be able to make the replacement, i.e., from the actual market, the payment of a hypothetical market value does not at all guarantee that the insured will be able to make the replacement. (13) Accordingly, the protection which the insurance ostensibly provided would be illusory and not fulfill the purpose of obtaining insurance n the first place.

1. Broad Evidence Rule.

B. Replacement Cost Coverage: Does the Insured Have to Actually Repair or Replace the Lost or Damaged Property in Order to Recover the Full Replacement Cost?

While standard property insurance policies provide compensation to the insured for the actual cash value of property damage or lost, the insured may secure increased compensation through a replacement cost endorsement which provides coverage for any expense in replacing the property. Replacement cost coverage was devised to remedy the shortfall in coverage which results under a property insurance policy compensating the insured for actual cash value alone. (2) That is, while a standard policy compensating an insured for the actual cash value of damaged or destroyed property makes the insured responsible for bearing the cash difference necessary to replace old property with new property, replacement cost insurance allows recovery for the actual value of property at the time of loss, without deduction for deterioration, obsolescence, and similar depreciation of the property's value. (21) Thus, while replacement cost coverage is designed, as much as possible, to place the insured in the position he would have been in but for the loss, it reimburses the insured for the full cost of repairs, even if that results in putting the insured in a better position that he was in before the loss.

Such coverage, however, is more often than not accompanied by a qualification that the insurer is at first only obligated to pay the actual cash value of the property, (22 and is to pay the remainder of full replacement cost only upon the completion of the actual repaired or replacement within a reasonable time. (23) Therefore, the requirement of actual repair or replacement does not affect the insurer's liability to pay for the actual cash value of the loss. It only affects that difference between that figure and the higher replacement cost amount. The obvious purpose of the precondition is to ensure that the insured is in need of the practical indemnity that replacement cost coverage is designed to accomplish, and to prevent the insured from directly profiting through the receipt of cash funds beyond the actual cash value of the loss. Thus, the insured is forced to repair and/or replace in order to recover the amount held back for depreciation.

Despite the facial attractiveness of the sound policies enunciated above, several courts have refused to enforce the pre-condition of actual repair or replacement. In rejecting this pre-condition, courts have reasoned that if the insured lacks the funds necessary to make up the difference between actual cash value and full replacement cost, it will be as a practical matter, prevented from making replacement, and thus denied the practical indemnity that replacement cost coverage is designed to provide. This argument is even more compelling in a case where the insurer has not even paid the actual cash value yet. (24) In  Zaitchick v. American Motorists Ins. Co.,  (25) the insurer refused to pay anything to the insured---not even actual cash value---because the insured had not yet restored the property in question. In   Zaitchick,  the court excused the insured from the pre-condition of actual repair or replacement on the ground of impossibility. Those cases cited by the insurer in favor of its position were declared by the   Zaitchick  court to be distinguishable because of a common fact. In those cases, the insurer had paid the actual cash value. The only issue, therefore, was whether or not the insurer was further obligated to pay the additional replacement cost amount. (26)

In  Coblentz et ux. V. Oklahoma Farm Bureau Mut. Ins. Co.,  (27) the Oklahoma Court of appeals went even further when it too refused to enforce the pre-condition of actual repair or replacement. In that case held that such a pre-condition is "unconscionable" in light of the fact that an insurance contract, by its very nature, is a contract of adhesion. (28) The reasoning behind this decision was explained by the court as follows:

Those courts that have enforced the pre-condition of actual repair or replacement have stressed what they felt was the clearly expressed intent of the insurer that full replacement cost would not be paid unless and until actual repair or replacement had been made. (30) One of the earliest of these cases was  Tamco Corp. v. Federal Ins. Co. of New York.  (31) In that case, the court agreed with the insurer and held that the insured could only recover the depreciation holdback amount upon compliance with the rebuilding and replacement condition expressed in the policy. Until that time, explained the court, the insurer was only obligated to pay the actual cash value. Similarly, in   Bourazak v. North River Insurance Co.,  (32) the policy's extended coverage for replacement cost provided that the insurer would not be liable for loss "unless and until actual repair or replacement is completed". The 7 ^th  Circuit upheld dismissal of the complaint against the insurer based on the insured's failure to demonstrate compliance with the clearly expressed policy conditions.

Another recurring issue, with regard to repairs as a pre-condition to an insurers obligation to pay full replacement cost, has been whether or not the insured can recover the replacement cost when someone other than the insured makes the repairs at no cost to the insured and for no consideration. (33) Not surprisingly, the answer to that question is not so clear. While a number of courts have held that an insurer is not obligated to pay any more than actual cash value unless the insured has actually incurred replacement "costs", (34) there is certainly authority to the contrary. (35) Indeed, the issue has yet to be resolved by the highest court of any state, and many of the decisions concerning the issue include a dissenting opinion setting forth the contrary view. Therefore, this issue continues to be the subject of considerable debate.

The recent case of  Harrington v. Amica Mut. Ins. Co.,  (36) provides a poignant example of the contradicting views regarding this issue. In that case, a fire totally destroyed the insured's home. The fire policy insuring the home provided that the insurance carrier would pay no more that the actual cash value of the damage unless "actual repair or replacement [was} complete." Following the fire, the insured sold the premises in its damaged condition. In was undisputed that the insured had not made any repairs following the fire. In fact, it was the purchasers of the property who rebuilt the dwelling. Therefore, the insurer refused to pay any more than the actual cash value. In response, the insured sued to recover the difference between the actual cash value and the full replacement cost amount arguing that the policy did not require him to perform the repairs himself. The insurer, on the other hand, argued that it had satisfied its obligation under the policy when it paid the insured the actual cash value of the property, and that the insured was not entitled to replacement cost benefits because he did not sustain any pecuniary loss in connection with repairing or replacing the dwelling. In affirming an order of summary judgement in favor of the insurer, the   Harrington  court ruled as follows:

However, the  Harrington  opinion was not without dissent. Justice Green was of the opinion that the subject insurance policy clearly obligated the insurer to pay full replacement cost once actual repair or replacement was complete. Therefore, with respect to the insurers contention that the insured is not entitled to replacement cost benefits since the insured did not sustain any pecuniary loss in connection with repairing or replacing the property, the dissent responded as follows:

While the insurance practitioner may initially be of the opinion that after issues of coverage are resolved, the insurance claim itself is easily resolvable, issues concerning valuation may still cause enough division between the carrier and its insured as to require litigation, arbitration or appraisal. Because no hard and fast valuation rules exist, valuation issues may end up being harder to resolve than coverage issues. In addition, when the question of coverage can go either way, the approach utilized for loss valuation can and often is leveraged together with the coverage issues. Such situations will be eliminated only when there exists some uniform body of insurance law resolving the age-old question of what is actual cash value and what is replacement cost.