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Illinois Supreme Court Holds Homeowner’s Insurer Could Not Reduce Loss Reimbursements by Depreciating Cost of Labor

insurance lawThe Supreme Court of Illinois recently held that a homeowner’s insurance company could not deduct depreciation from reimbursements for labor costs from the actual cash value of a covered loss, because the policy at issue did not specifically and unambiguously allow the practice.

A copy of the opinion in Sproull v. State Farm Fire and Casualty Co. is available at:  Link to Opinion.

The plaintiff was the insured under a homeowner’s policy that provided replacement cost coverage for structural damage.  Under the policy, covered losses were paid in two parts — the insured would initially receive an actual cash value (ACV) payment, and later could then receive a replacement cost value (RCV) payment if the repairs or replacement were completed within two years. The policy did not define “actual cash value.”

The plaintiff suffered wind damage to his residence.  The insurance company approved his claim and determined an RCV of $1,711.54.  In determining the ACV, the insurance company began with the RCV, then subtracted the $1,000 deductible and an additional $394.36 for depreciation.  Plaintiff received an ACV payment of $317.18.  The plaintiff claimed he was underpaid because the insurance company depreciated the cost of labor.

The plaintiff filed a putative class action against the insurance company, alleging that labor is an intangible, and may not be depreciated because it is not susceptible to aging or wear and tear. He also argued that the insurance company concealed its practice of depreciating labor in three ways: (1) by not stating in its written estimates that the software used to calculate the ACV was set to depreciate intangibles such as labor; (2) by not separating labor and materials in its estimates; and (3) by not depreciating labor in obvious labor-only charges.

The plaintiff alleged that the insurance company uses a software program to calculate replacement and repair costs, that the program’s default setting is to apply depreciation only to materials, but that the insurance company adjusted the program to also depreciate labor.

The insurance company argued that its method fully complied with the policy and Illinois insurance regulations. It quoted Illinois Department of Insurance (IDOI) regulations, which mandated a “replacement cost less depreciation” method of determining ACV.

The trial court denied the insurance company’s motion to dismiss and held that the policy was ambiguous. The trial court held that, due to the ambiguity, it was required to construe the ambiguity in favor of the insured.  The insurance company appealed.

The appellate court affirmed the trial court’s ruling, determining that the plain and ordinary meaning of depreciation in an insurance context is “a reduction in the value of property because of aging and wear and tear to the physical structure of that property.” Id. at ¶ 35.  The appellate court held that the policy language was not ambiguous, and clearly prohibited depreciation of labor.

The insurance company appealed to the Illinois Supreme Court, which granted the insurance company’s petition for leave to appeal before it.

The Illinois Supreme Court examined similar cases in other jurisdictions. The Oklahoma Supreme Court examined the issue in Redcorn v. State Farm Fire & Casualty Co., 2002 OK 15, 55 P.3d 1017 (2002), holding that an insurer should be allowed to depreciate labor, because “depreciation” is the actual deterioration of a structure by reason of age, computed at the time of loss, and that the plaintiff purchased one roof; he did not separately purchase parts and labor. Id. at ¶ 14.

Other state and federal jurisdictions have split on the question. The North Carolina Supreme Court agreed with Oklahoma and allowed labor depreciation in Accardi v. Hartford Underwriters Insurance Co., 838 S.E.2d 454 (N.C. 2020), as have the Supreme Courts of South Carolina and Nebraska in Butler v. Travelers Home & Marine Insurance Co., 858 S.E.2d 407, 408 (S.C. 2021), and Henn v. American Family Insurance Co., 894 N.W. 2d 179, 182 (Neb. 2017). Federal courts generally agree with this reasoning. See Graves v. American Family Mutual Insurance Co., 686 Fed. App x 536, 537 (10th Cir. 2017), and In re State Farm Fire & Casualty Co., 872 F.3d 567 (8th Cir. 2017).

However, other state courts have held labor is not depreciable. These courts generally held that the term “actual cash value” is ambiguous and should be construed in favor of the insured. In Lammert v. Auto-Owners (Mutual) Insurance Co., 572 S.W.3d 170 (Tenn. 2019) the Tennessee Supreme Court held that the term “depreciation” was ambiguous and should be construed in favor of the insured. The Arkansas Supreme Court reached the same conclusion in Adams v. Cameron Mutual Insurance Co., 2013 Ark. 475, 430 S.W.3d 675.

The plaintiff here argued that the policy was not ambiguous, and that it plainly stated that labor is an intangible, and therefore not depreciable.  The insurance company argued that the policy was unambiguous but supporting the opposite interpretation. The Illinois Supreme Court disagreed with both positions, holding that the language was ambiguous. It also disagreed with the insurance company’s argument that the matter was a simple question of regulatory interpretation, finding that the regulation did not address the question.

The Illinois Supreme Court held that the policy was ambiguous, as there were several reasonable arguments why labor would not be depreciable.

First, the Court noted, labor is not logically depreciable since it does not lose value over time due to wear and tear. It is a fixed cost not subject to deterioration or obsolescence.

Second, depreciating labor can result in the insured being placed in a worse position than he was before the loss. The labor cost of installing old materials would be the same as that of installing new materials. Therefore, indemnity is frustrated when labor is depreciated. Not allowing the depreciation of labor is proper indemnity, not a windfall to the insured.

Third, the Court held that the plaintiff’s position is more in keeping with actual insurance practice. The insurance company’s estimate software allows for depreciation of materials only, and the insurer must opt-in to depreciating labor. Therefore, it is not unreasonable to not depreciate labor. In this case, the insurance company depreciated labor for only seven of the 26 line-item repairs and did not depreciate labor for the labor-only items.

For these reasons, the Illinois Supreme Court held that it was required to construe the ambiguity against the insurer and upheld the appellate court’s ruling.

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The attorneys of Maurice Wutscher are seasoned business lawyers with substantial experience in business law, financial services litigation and regulatory compliance. They represent consumer and commercial financial services companies, including depository and non-depository mortgage lenders and servicers, as well as mortgage loan investors, financial asset buyers and sellers, loss mitigation companies, third-party debt collectors, and other financial services providers. They have defended scores of putative class actions, have substantial experience in federal appellate court litigation and bring substantial trial and complex bankruptcy experience. They are leaders and influencers in their highly specialized area of law. They serve in leadership positions in industry associations and regularly publish and speak before national audiences.

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