Superior Court Reinforces Insurers' Right to Withhold Depreciation
Superior Court Reinforces Insurers' Right to Withhold Depreciation Pending Actual Repair or Replacement

Donald L. Best, Jr.
DiBella, Geer, McAllister & Best, P.C.
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Pittsburgh, PA 15222
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?Claimants should not be permitted to exploit their losses and use them as an opportunity to remodel their homes at the insurer?s expense.? This quote, taken from one of two recent decisions by the Superior Court of Pennsylvania, illustrates that the Superior Court is willing to enforce policy restrictions on replacement cost recoveries following a loss. The cases are Kane v. State Farm Fire & Casualty Company, 2003 Pa. Super 502, 841 A.2d 1038 (December 22, 2003), and Burton v. Republic Insurance Company, 2004 Pa. Super. LEXIS 258 (March 16, 2004). Both cases involved disputes over an insurance company?s right to pay the depreciated or actual cash value of a loss and ?hold back? the difference between actual cash value and repair or replacement cost until actual repair or replacement occurred. The Burton case also approved an insurer?s enforcement of the requirement that damaged property be replaced with like kind for coverage to apply.

The Kane case involved an appeal from an order entered in the Berks County Court of Common Pleas dismissing the plaintiffs? amended complaint. The suit was filed as a class action against several insurance companies including Allstate, Erie, Metropolitan, One Beacon, and State Farm. As characterized by the Superior Court, the ?core? of the dispute was over the meaning of the phrase ?actual cash value? as used in the policies issued by the defendants. Plaintiffs asserted they had not received full indemnification under their replacement cost policies after sustaining partial losses because the defendants deducted depreciation from the actual cost to repair or replace the damaged portions of their buildings. They argued that, unless the phrase ?actual cash value? was specifically defined in the policy of insurance to include depreciation, the policyholder was entitled to full repair or replacement cost, and depreciation was not to be included in the calculation of the amount to be paid. In response, defendants asserted that ?the issue was one of timing?, meaning simply that plaintiffs were entitled to replacement cost coverage, but must first undertake the repair or replacement of the damaged property before being fully compensated. Until repair or replacement occurred, plaintiffs could only recover the actual cash value of the loss, meaning repair or replacement cost less depreciation. The defendant insurance companies filed preliminary objections on this basis, seeking dismissal of the plaintiffs? suit. The Berks County Court agreed, granting the preliminary objections and dismissing the plaintiffs? complaint. An appeal to the Superior Court followed.

In its analysis of the relevant provisions of the policies issued by the defendant insurers, the Superior Court divided the policies into three groups. In the first group, the policies did not define the phrase ?actual cash value?, but directed that the companies would pay only the actual cash value of the loss until actual repair or replacement had been completed. The policies in the second group included a specific reference to depreciation as a deduction from actual cash value. For example, the Allstate policy directed that, if the insured did not repair or replace damaged property, payment would be ?on an actual cash value basis [meaning] there may be a deduction for depreciation?.? The third category of policies was limited to one issued by Erie Insurance Company, which defined actual cash value to include a deduction for depreciation, but appeared to limit such coverage to losses involving specific types of property, such as household appliances, cloth awnings, and personal property.

In its summary of previous appellate court analysis of the phrase ?actual cash value?, the Superior Court reviewed Fedas v. Insurance Company of Pennsylvania, 300 Pa. 555, 151 A. 285 (1930), and Farber v. Perkiomen Mutual Insurance Company, 370 Pa. 480, 88 A.2d 776 (1952), two decisions by the Supreme Court of Pennsylvania that have long been cited for the proposition that, ?in partial loss situations, in the absence of clear language to the contrary, an insurer may not deduct depreciation from? replacement cost?, and that the phrase ?actual cash value? may not be interpreted as including a depreciation deduction, where such deduction would thwart the insured?s expectation to be made whole.? Kane, 841 A.2d at 1047. The Superior Court reaffirmed this proposition, and noted that in London v. Insurance Placement Facility of Pennsylvania, 703 A.2d 45 (Pa. Super. 1997), it held that insurance companies could amend their policies to reach a different result, but that the policies must be clear in that regard. Id.

However, the Superior Court distinguished the Fedas, Farber, and London cases by noting that the claims involved in Kane did not arise from a denial of liability for replacement cost, but the timing of such compensation. The defendants had never denied liability or failed to guarantee reimbursement for repair or replacement of the property, but simply maintained that they were only liable for such costs once repair or replacement had been completed. The public policy consideration underlying the older cases ? that an insured should be made whole by receiving full replacement value ? therefore applied with less force. The Superior Court concluded that, with the exception of Erie Insurance Company, the defendant insurance companies had not breached their contracts of insurance by paying actual cash value and withholding depreciation until repair or replacement occurred. Although the policies of insurance comprising the first group did not define ?actual cash value?, they specifically stated that only ?actual cash value? would be offered until or unless repair or replacement was made. Therefore, it was clear that the phrase ?actual cash value? was not synonymous with replacement value, as plaintiffs argued. The same analysis applied to the policies in the second group. Further, because these policies defined ?actual cash value? to include deduction for depreciation, the Superior Court found that the policies clarified the extent of intended coverage and ?unambiguously allow[ed] the insurers to deduct depreciation until repair or replacement [was] made.? The Court affirmed the lower court?s dismissal of the plaintiffs? complaint against the insurers issuing these policies.

The Superior Court reluctantly found it could not extend the same analysis and conclusion to the Erie policy, primarily because it found that the wording of the primary policy form and an endorsement created an ambiguity in the meaning of ?actual cash value? as used in the policy. Notably, the single dissent in the Superior Court?s opinion argued that the plaintiffs? claims against Erie should also have been dismissed.

The Burton case involved a fire loss claim at the Burtons? residence. Following the fire, Republic Insurance Company paid the actual cash value of the damage to the dwelling, representing replacement cost less depreciation. After plaintiffs completed repairs to their home, Republic paid a portion of the depreciation hold back, but not the full amount. A small portion of the depreciation was withheld because plaintiffs did not complete certain items included in the estimate of repair, and performed additional construction that was not included in the estimate. On the plaintiffs? personal property claim, Republic made a substantial actual cash value payment, and later paid most of the depreciation following replacement by the plaintiffs. However, Republic withheld $979.82 for property that plaintiffs could not demonstrate was replaced with ?items of like kind and quality.? Plaintiffs then filed a class action complaint against Republic for themselves and other Republic insureds who were denied the difference between actual cash value of their residential or personal property and the replacement or repair cost of such property pending completion of the repair or replacement.

Under the policy of insurance issued by Republic, the company would pay the replacement cost of that part of the covered building that was damaged ?for like construction and use on the same premises?, and no more than the actual cash value of the damage until actual repair or replacement was complete. Under the personal property coverage afforded by the policy, Republic would not pay more than actual cash value until actual repair or replacement was complete. Plaintiffs contended that because the phrase ?actual cash value? was not defined by the policy, it was ambiguous. In rejecting this argument, the Superior Court noted that it could not conclude ?that an isolated phrase is ambiguous simply because [Republic] failed to define it specifically in the policy.? The policy was to be construed in its entirety to determine whether it unambiguously conditioned full replacement benefits upon the actual repair or replacement of the damaged property. The Superior Court concluded that the Republic policy did: ?[a] routine reading of the policy and endorsement demonstrates that replacement benefits are conditioned upon complete repair or replacement.? Because the policy plainly set forth the procedure for recovering full replacement cost, the Superior Court found that the plaintiffs? argued interpretation was unreasonable.

The court also rejected plaintiffs? argument that Republic?s practice of requiring insureds to rebuild damaged property with like construction using a line-item estimate, and replace damaged personal property with property of like kind, was a breach of the insurance contract because it was not expressly provided in the policy. When repairing their dwelling, plaintiffs had altered the original construction by removing an existing wall to enlarge their bedroom. Republic refused to pay the additional cost related to this modification because it was not ?like construction? as contemplated by the line-item estimate prepared by it. The Superior Court agreed with the trial court?s holding that ?like construction means that a policyholder has to return the damaged structure as closely as possible to the condition it was in immediately prior to the loss.? The Superior Court held that Republic?s practice of requiring a claimant to rebuild the structure as it was before the loss was reasonable, and did not constitute a breach of the insurance contract. This conclusion was supported by the language of the policy expressly directing that the company would provide coverage for the replacement cost of that part of the building damaged ?for like construction?. Further, because the section of the policy defining the insureds? duties after loss included a provision requiring the insureds to submit a sworn proof of loss setting forth (among other things) ?specifications of damaged buildings and detailed repair estimates?, Republic?s practice of requiring claimants to set forth their cost using detailed line-item estimates was proper. This analysis led to the Superior Court?s conclusion that, because insurance policies are based on principals of indemnity rather than enrichment, ?claimants should not be permitted to exploit their losses and use them as an opportunity to remodel their homes at the insurer?s expense.?

These decisions appear to resolve an issue that has vexed the insurance industry during the last decade. See, e.g., London v. Insurance Placement Facility of Pennsylvania, supra, and Gilderman v. State Farm Insurance Company, 437 Pa. Super. 217, 649 A.2d 941 (1994). They clearly support the proposition that depreciation can be withheld pending actual repair or replacement, provided the language of the policy is consistent with those at issue in the Kane and Burton cases.