On Behalf of | Dec 22, 2022 | Firm News

Courts are split on the question of whether it is permissible to depreciate labor costs when determining actual cash value (“ACV”). The Illinois Supreme Court’s decision in Sproull v. State Farm Fire and Casualty Co., 184 NE 3d 203 (Ill. 9/23/21), affirming the appellate court decision 172 NE 3d 1186 (Ill. App. 5th Dist. 7/24/20), is an excellent reference and starting point for any adjuster who wants to understand the jurisprudence regarding labor depreciation.

The Illinois Supreme Court ruled in Sproull on first impression, that homeowner insurance companies cannot depreciate labor costs in calculating ACV when the policy did not define ACV. The Illinois Administrative Code indicated that ACV of a damaged structure was to be determined as “replacement cost of property at time of loss less depreciation, if any.” See 50 Ill. Admin. Code §919.80(d)(8)(A). However, neither the Code nor the insurance policy in question set forth a definition of “depreciation” or established a method for calculating it. Because of this, the Illinois Supreme Court found that the policy was ambiguous on the question of labor depreciation because it could be subject to more than one reasonable interpretation.

This issue is going to be decided on a case-by-case basis. In reaching its conclusion, the Illinois Supreme Court conducted a review of the law from jurisdictions that had adopted the view that labor can be depreciated from those that found that it could not.

The Court in Sproull provides an excellent review of the case law throughout the country, both supporting and rejecting labor depreciation.

In one line of cases, courts view the damaged property as the product of materials and labor. Take a damaged roof, for example. Some courts would require a damage analysis for purposes of establishing ACV to consider what the expected life of the destroyed roof, both as to materials and labor, would have been. This view is predicated on the idea that the insured bought an insurance policy covering a roof surface, and did not separately insure materials and labor. Under this view, a roof is a combination of product (i.e., shingles) and a service (i.e., labor to install the shingles). To preclude labor depreciation would unjustly enrich the policyholder by not having to pay an essential cost associated with the replacement of the roof that had already been paid at some time in the past when the roof was originally installed.

On the other hand, some courts require the analysis of ACV to consider only those items that logically tend to establish the value of the property at the time of loss. Under this view, the roof shingles are logically depreciable, given that they experience physical age, and thereby lose value because of natural and expected wear and tear. Labor, however, does not lose value because of natural and expected wear and tear. Labor does not lose value over time. It would be illogical to analyze whether the roofer was young and stout versus a 70-year old roofer with arthritis who had trouble climbing a ladder or hammering a nail.

One way for an insurance company to clarify whether labor is depreciable under an insurer’s policy is to specifically define ACV in a policy in a manner to exclude labor from the ACV calculation. Otherwise, whether labor is depreciable becomes a question of judicial geography. Excluding labor from an ACV calculation in the policy would avoid the uncertainty of judicial geography or reliance upon vague, common law rules for determining ACV. The three principal rules include the broad evidence rule, market value rule, or replacement cost minus depreciation rule. Under the broad evidence rule, all relevant factors are considered in determining ACV, including purchase price, replacement cost, appreciation or depreciation, the age of the building, the condition in which it has been maintained and market value. The market value rule similarly looks at factors effecting the value of the property, including a decline in value based on use, wear, obsolescence, or age.