- Illinois affirmed that insurers may not depreciate the cost of labor when calculating the actual cash value of damaged property.
Property insurance policies often provide that the policyholder is entitled to recover the actual cash value (ACV) of damaged property covered by the policy. To calculate the ACV, the insurer subtracts depreciation from the cost to replace the covered property. Depreciation recognizes that physical assets lose value over time, but is the cost of labor to repair or replace the damaged property depreciable as well? Many insurance carriers answer in the affirmative and depreciate the cost of labor in order to lower the ACV payable on a property damage claim. Courts across the country are split as to whether this practice is permissible when the property insurance policy at issue does not explicitly provide for it. Recently, the Illinois Supreme Court joined the fray on the side of policyholders.
In Sproull v. State Farm Fire & Casualty Company (Sproull v. State Farm Fire & Cas. Co., 2021 IL 126446), the plaintiff filed a putative class action lawsuit against his insurer, alleging State Farm had improperly depreciated labor costs to calculate the ACV on his property damage claim. Plaintiff’s homeowner policy provided in pertinent part that State Farm would pay the cost to repair or replace the insured’s dwelling, but State Farm would “pay only the actual cash value at the time of the loss of the damaged part of the property” until the repair or replacement was completed. The policy did not define “actual cash value.”
The plaintiff received an ACV payment from State Farm for $317.18, but alleged he was underpaid, because State Farm depreciated the cost of labor, an intangible asset not subject to wear and tear. He further claimed that depreciating labor for the purposes of calculating ACV discourages policyholders from repairing their property, as the ACV payment may leave policyholders with insufficient funds to begin repairs. The plaintiff posited that such a practice allows State Farm to increase its profits, as policyholders are less likely to seek the replacement cost value if they lack sufficient funds to repair after receipt of the ACV payment.
Both the trial court and Fifth District Appellate Court agreed with the plaintiff, and the latter held that labor cannot be depreciated when a policy does not define ACV (Sproull v. State Farm Fire & Cas. Co., 2020 IL App (5th) 180577). The Illinois Supreme Court allowed State Farm’s petition for leave to appeal to consider the following certified question: “[w]here Illinois’ insurance regulations provide that the … ‘ACV’ of an insured, damaged structure is determined as ‘replacement cost of property at time of loss less depreciation, if any,’ and the policy does not itself define actual cash value, may the insurer depreciate the cost of labor in calculating ACV?”
The Illinois Supreme Court began its analysis by concluding the policy is ambiguous regarding whether labor may be depreciated because both parties advanced a reasonable interpretation. The court then acknowledged that since the policy is ambiguous regarding the question of labor depreciation, it is required to resolve the ambiguity in the insured’s favor where the insured provides a reasonable interpretation. The court held the plaintiff met that burden for three reasons: (1) labor, unlike materials, does not logically deteriorate with time; (2) depreciating labor can result in the insured being placed in a worse position than before the loss; and (3) the insured’s interpretation is more in keeping with actual industry practice. The court adopted a quote from a federal court decision from the Southern District of Alabama that came to a similar conclusion on this issue and reasoned: “the belief that labor does not depreciate ‘is a plausible conception for a wealth of thoughtful, knowledgeable judges, and it is even more so for lay insureds with no special competence in property or insurance matters.’” (Sproull, 2021 IL 126446 at ¶ 50 (quoting Arnold v. State Farm Fire & Casualty Co., 268 F. Supp. 3d 1297, 1312 (S.D. Ala. 2017)).
Accordingly, the Illinois Supreme Court affirmed the decisions of the lower courts and answered the certified question in the negative, adding Illinois to the list of jurisdictions that hold insurers may not depreciate the cost of labor when calculating the ACV of an insured’s damaged property.