Paying Overhead and Profit in First-Party Claims

Gary Wickert | Claims Journal | October 31, 2019

Standard homeowner policies pay personal property claims at actual cash value (ACV), which is the replacement cost (RC) of the damaged property based on its current used condition. In other words, it is valued at what it would cost to replace the property at today’s cost minus depreciation:

Replacement Cost Value (RCV) – Depreciation = Actual Cash Value (ACV)

The only difference between RC and ACV is a deduction for depreciation. Both are based on the cost today to replace the damaged property with new property. More complicated formulas take the replacement cash value, or RCV, which is the cost to purchase the item new, and multiply it by the depreciation rate, or DPR, as a percentage, and the age of the item. That value is then subtracted from the RCV. For example, a three-year-old dishwasher that costs $500 (ACV) to replace and has a depreciation rate of 12.5% (DPR), or .125, has an ACV of $312.50 {500-[500(.125)3]=312.50}. States use three types of tests to calculate ACV when a property policy fails to define the term: (1) the fair market value; (2) replacement costs minus depreciation; and (3) the broad evidence rule.

  1. Fair Market ValueA price a willing buyer will pay to a willing seller. The term “market value” in insurance is often synonymous with “real value”, “actual value”, and “true value.” In Jefferson Ins. Co. v. Superior Ct. of Alameda County, 3 Cal.3d 398, 90 Cal. Rptr. 608 (1970), for example, it says, “It is clear that the legislature did not intend the term ‘actual cash value’ in the standard policy form, set forth in § 2071 of the Insurance Code, to mean replacement cost less depreciation.”
  2. Replacement Cost Minus DepreciationThis is the traditional insurance industry definition. It is the cost to replace with new property of like kind and quality, less depreciation. States differ as to whether or not depreciation includes obsolescence (loss of usefulness as a result of outmoded design, construction). Replacement cost is greater than ACV, and ACV means the full cost of repair or replacement (with deduction for depreciation.
  3. Broad Evidence RuleUsed in a few states. It does not blindly follow the traditional measure of ACV (replacement cost less depreciation) and allows for consideration of every standard of value having a bearing on the property under consideration, such as the age of the property, the profit likely to accrue on the property, and the property’s tax value. The majority of states, including New York and New Jersey, follow the broad evidence rule.

ACV coverage is popular because full replacement cost coverage premiums can be 15% more than a basic policy. What a policy will pay its insured for property damage also varies depending on whether the damage is to personal property or structural property damage such as a house or building. Claims for damage to personal property are fairly straightforward. For a new refrigerator purchased in 2014 and destroyed in a fire three years later, an ACV policy will generally pay the cost of the television, minus its depreciated value (and any deductible). On the other hand, an RCV policy would reimburse the present-day cost to replace the television, minus any applicable deductible, regardless of its age. Note that accounting or “book” value has no relevance to either of the previous methods of valuation. The depreciation rate reflected in “book” value would yield a terribly inadequate settlement. Another problem with using “book” value is that it may reflect only the items that are “capitalized.”

Claims for structural damage to homes or other buildings are more complex. If a home is damaged, the owner will receive an insurance claim payment for the cost of the home, minus its depreciated value (and any deductible) under an ACV policy. However, under an RCV policy, the amount of the payment depends on various factors including, but not limited to, whether the structure sustained a total loss or lesser damage such as missing shingles, whether any repairs can be performed, and the specific language of the insurance policy.

Determining ACV in first-party homeowner’s or commercial property insurance claims can be perplexing and challenging. This is especially true when ACV is not defined in the policy. In most cases, the calculation involves a formula which includes factors such as replacement cost, depreciation, fair market value, and more.

Actual Cash Value (ACV) Policies

Most policies provide Actual Cash Value (ACV) or Replacement Cost(RC)coverage to replace damaged, stole, or destroyed personal property. The latter coverage pays the insured for the actual cost of replacing personal property. For example, the claim payment for a stolen computer would be the cost of purchasing a new computer of like kind. No deduction is considered for wear and tear on the stolen computer. When replacement cost policies and payments are involved, the payment of general contractor overhead and profit (GCOP) is almost always justified. ACV is the depreciated value of property at the time of the loss. It is usually insufficient to replace the damaged item. Rather, it compensates the insured for the value of the item as if it was being sold at a garage sale. The Internal Revenue Service definition is what a willing buyer would be willing to pay a willing seller if neither the buyer nor the seller was under any duress to complete the sale. In other words, what would it sell for at a garage sale. The insurance industry’s definition begins with replacement value and then reduces it by some amount for depreciation.

ACV policies are subjective. They pay an insured for the “fair market value” of personal property which is destroyed or stolen. It is also sometimes calculated as the RC less depreciation. The deduction for depreciation remains the key difference between ACV and RC policies. Carriers that provide replacement cost coverage are usually not going to be responsible for paying more than ACV at the time of the loss unless and until the damaged or destroyed structure is actually repaired or replaced. The term “Actual Cash Value” is usually not defined in property insurance policies, so three different rules of determining measuring ACV are used:

  1. Market ValueThis is the difference in the market value of personal property before and after an occurrence.
  2. Broad EvidenceSome states give broad latitude to evidence which can be considered to establish the value of the property. Considerations include original cost, market value, income from its use, age and condition, depreciation, and the opinions of qualified expert appraisers.
  3. Replacement Cost Less DepreciationThe estimated cost to repair or replace damaged or destroyed property is calculated, and then depreciation is deducted from that amount. Note that “depreciation” in the insurance vernacular is different than in the accounting world. It is the decrease in the value of property based on its physical condition, age, use, and other factors which affect how useful the property is.

Most property carriers provide replacement cost (RC) coverage, but policy language usually does not require an insurance company to pay more than ACV as of the time of the loss unless and until the insured property is actually repaired or replaced. Even if the insured has replacement cost coverage, the policy may call for ACV on a temporary basis, until the repairs are completed, or on a permanent basis for certain types of property. Where an insured property is not repaired or replaced, insurers must provide the ACV of the repairs. As an example, a table purchased for $1,000 a year ago is now worth only $500. With ACV coverage the insured might receive $500 for loss of the table. With replacement cost coverage, the insured might receive $500 immediately and then receive another $700 when you submit a receipt showing that the same table was purchased for $1,200. Typical property policy language reads:

  1. Property Loss Conditions
  2. Loss Payment
  3. Except as provided in Paragraphs (2) through (8) below, we will determine the value of Covered Property as follows:

(1) At replacement cost without deduction for depreciation, subject to the following:

(a) If at the time of loss, the Limit Of Insurance on the lost or damaged property is 80% or more of the full replacement cost of the property immediately before the loss, as determined by us, we will pay the cost to repair or replace, after application of the deductible and without deduction for depreciation, but not more than the least of the following amounts:

(i) The Limit of Insurance that applies to the lost or damaged property;

(ii) The cost to replace, on the same “premises”, the lost or damaged property with other property; Of comparable material and quality; and Used for the same occupancy(ies) and purpose(s); and Capable of performing the same functions; or

(iii) The amount that you actually spend that is necessary to repair or replace the lost or damaged property; If a building is rebuilt at a new “premises”, the cost is limited to the cost which would have been incurred had the building been built at the original “premises”;

(b) If, at the time of loss, the Limit Of Insurance applicable to the lost or damaged property is less than 80% of the full replacement cost of the property immediately before the loss, as determined by us, we will pay the greater of the following amounts, but not more than the Limit Of Insurance that applies to the property: Actual Cash Value

(i) The “actual cash value” of the lost or damaged property; or

(ii) A proportion of the cost to repair or replace the lost or damaged property, after application of the deductible and without deduction for depreciation. This proportion will equal the ratio of the applicable Limit of Insurance to 80% of the full replacement cost of the property.

There is usually no express wording in the property insurance policy dealing with how to deal with GCOP. Therefore, some insurers withhold, exclude, depreciate, deduct, or fail to pay GCOP when settling claims involving the repair or replacement of personal property. They believe that GCOP is not a part of repair costs or replacement costs when settling a claim based on an ACV estimate or the RC less depreciation rule. They claim that paying GCOP would be a windfall to the insured and refuse to pay it unless it is actually incurred.

General Contractor Overhead And Profit (GCOP) In ACV Claims

Even though the terms “repair cost” and “replacement cost” are not clearly defined in most property policies, when repair or replacement of a home or other structure is required, labor and materials are clearly elements that should be included in the claim payment. The policy should pay for the cost of an experienced contractor to perform the required work to repair or replace the building and put it back to its pre-loss condition. Insurance companies use guideline pricing and “Xactimate” (computerized home replacement cost estimating software) to predict how much materials and labor should cost. However, the estimate prepared by a qualified local, licensed and bonded contractor who has visited the loss site and reviewed information about the pre-loss structure is generally the most accurate cost for a claim settlement.

General contractors routinely charge overhead and profit (GCOP), usually at a rate of 10% for each. This is how they get paid. An insurer that holds back GCOP until repairs are completed puts the property owner in an impossible financial position. With a RC policy, the insurer should not hold back GCOP until the structure is completely repaired. With an ACV policy, however, the standard in most states is that ACV of the damage should be determined by taking the full RC and deducting any applicable depreciation. Therefore, the two questions that must be answered in connection with the payment of GCOP in an ACV claim are:

  1. Should GCOP be paid, even if it is not incurred?
  2. Should GCOP be depreciated?

The RC from which depreciation is deducted in order to arrive at ACV, usually includes any cost that an insured is “reasonably likely to incur” in repairing or replacing the structure. Ghoman v. New Hampshire Ins. Co., 159 F.Supp.2d 928 (N.D. Tex. 2001). The Texas federal court said that this includes GCOP and taxes, and both should be included in any RC or ACV claim payment. However, it must first be determined that the services of a general contractor are necessary given the scope of the repairs and construction that will be required. When calculating ACV, some insurers have used RC as the starting point, deducted depreciation, and then deducted another 20% for GCOP. A Pennsylvania court has held that the price of anything—from a new roof to a new car—includes profit for the craftsman or retailer. Gilderman and Gilderman v. State Farm, 649 A.2d 941 (Pa. Super. 1994). The carrier should not be able to deduct overhead and profit any more than somebody who buys a new car can. Therefore, the two ways to deal with GCOP in ACV claims (depending on whether GCOP is depreciated) are as follows:

RC of Damaged Property (no GCOP): $100,000 RC of Damaged Property (no GCOP): $100,000

Plus GCOP: +$20,000 Less Depreciation (30%): -$30,000

Full RC of Damaged Property: $120,000 Depreciated ACV Payment $70,000

Less Depreciation (30%): -$36,000 Plus GCOP + $20,000

ACV Payment (RC-Depreciation): $84,000 ACV (RC – Depreciation + GCOP) $90,000

As you can see, the insured comes out better in the second example where GCOP is not depreciated. When, whether, and in what amount homeowner and property insurers must include a GCOP line item on first-party repair or rebuild estimates, when the insured does not engage a general contractor, remain challenging issues in most jurisdictions. Inclusion of GCOP is particularly challenging when the insured does not intend to repair or replace the insured property, and thus does not intend to hire a general contractor, yet still feels GCOP is properly included as ACV under the policy. It can also arise when ACV payments are made prior to repairs being undertaken, and the insurer must decide whether or not to include GCOP in those initial payments. The problem is that an insurance policy provides for payment of ACV, but it might not clearly define how much profit a contractor can earn, nor does it specifically cover the contractor’s overhead expenses. Yet, these costs must be paid in some amount if the repairs or replacement of the damaged property is to occur.

In calculating repair or replacement cost (RC) in first-party property claims, it is often necessary to determine what must be replaced or repaired, who is qualified to perform that work, and how much that work costs. If the insured oversees the repairs or construction himself, and puts in the time and resources necessary to coordinate one or more subcontractors, is the insured entitled to GCOP even though he does not hire a general contractor?

A typical policy states something like, “We will pay the actual cash value of the damage to the buildings, up to the policy limit, until actual repair or replacement is completed.” The applicable state law regarding the inclusion of GCOP in such situations can be found in court decisions, state statutes, insurance regulations, consumer protection legislation, insurance commissioner rulings, attorney general opinions, and/or industry standards and guidelines. Sometimes it isn’t found at all, and insurers are left to adjust a claim reasonably given the language of their policy and the specific facts involved.

General Contractor

A general contractor (GC) is someone who contracts for completion of an entire project, purchases all materials, hires and pays the subcontractors, and coordinates all work on the project. A general contractor’s responsibilities include overseeing the entire construction project, hiring the carpentry, masonry, plumbing, and electrical subcontractors. The GC also sequence, coordinate, and supervise the work of the subcontractors. It is also responsible for researching zoning requirements, obtaining necessary permits, and taking on any liability for failures or damage. General Contractors usually charge for GCOP as a line item on repair or construction estimates. Claims professionals are simply doing their job when they question whether GCOP is reasonably owed under the policy, and if so, in what amount. GCOP is often a legitimate cost of doing business and insureds are entitled under applicable policy language to collect claim payments sufficient to cover these costs. GCOP is traditionally expressed as a percentage of the total cost of a job. This chart represents an overview of how each state handles the GCOP issue, providing some guidance to claims professionals simply looking to pay what they owe, and no more. Within GCOP, overheadand profitare two different types of costs, even though they are frequently lumped together. Ideally, they should be stated as two separate numbers.


Overhead costs are operating expenses for necessary equipment and facilities. They can amount to a sizeable portion of the cost of any project, and failure to reimburse the general contractor for overhead costs can result in their losing money on a project. They are generally expressed as a percentage of the project cost and added to the sum for labor, material, and equipment. Overhead costs are divided into two separate types: General Overhead (Indirect Costs) and Job Overhead (Direct Costs).

General Overhead (Indirect Costs). These are simply the cost of doing business and are not readily chargeable to any particular project. Staff salaries, utility payments, insurance costs, phone bills, office equipment, vehicle costs, etc., paper and pens, computers, and vehicle costs are some examples. If a contractor does $500,000 in annual business, and his annual expenses are $50,000, then his general overhead as a percentage of his annual business would be 5%. Smaller contractors have less general overhead than large contractors. Large contractors sometimes lower their general overhead percentage in order to remain competitive.

Job Overhead (Direct Costs). Job overhead is sometimes referred to as “General Conditions” expense, referring to the General Conditions in the construction contract for a particular job. Estimating job overhead has been reduced to a science, with several different approaches. They are often calculated after all trade costs have been compiled and estimated, allowing the contractor to account for items that are required to support the various trades involved. Included in job overhead are project specific salaries (wages paid to project superintendents, foreman, field engineers, schedulers, etc.), temporary office buildings, temporary utilities, sanitation facilities, drinking water, etc. Some contractors include contingency costs for things like sidewalks, trees, and other property that may be damaged during construction.


Profit is what allows the GC to earn their living and stay in business. It is defined generally as “the excess of revenue over expenditures in a business transaction.” Black’s Law Dictionary (9thed. 2009). General contractors are being paid for their expertise, and a qualified GC will often contribute significantly to holding down the cost of a project. GCOP is usually expressed a percentage of a total job. For example, “10 and 10” means that the contractor is paid overhead based on 10% of the project cost and profit based on 10% of project cost. In other words, the insured is charged an additional 20% on top of the total job estimate.

A typical repair estimate that includes line items for both sales tax and an allocation for the GC’s overhead and profit looks something like this:

Three-Trade Rule

For many years, the insurance industry struggled with determining when the hiring of a general contractor is necessary and the payment of GCOP is appropriate. An informal rule of thumb developed whereby any time a job would require three or more “trades” (subcontractors such as plumbers or electricians), the insured was entitled to be paid for GCOP. The rational is that the insured should receive some compensation for the time spent and the expense incurred while acting as their own general contractor. Burgess v. Farmers Ins. Co., 151 P.3d 92 (Okla. 2006).

Majority View: The majority view is also known as the “Reasonably Likely Rule.” If the use of a general contractor is reasonably likelyin repairing or replacing a covered loss, GCOP should be included in the cost of repair or replacement to arrive at the appropriate ACV estimate and claim settlement with an insured. Windridge of Naperville Condo. Ass’n v. Philadelphia Indem. Ins. Co., 2017 WL 372308 (N.D. Ill. 2017); Mee v. Safeco Ins. Co., 2006 WL 2623901 (Pa. Super. 2006).This is generally true even though no GC is used and/or no repair or replacement is made. In many jurisdictions, insurers are not statutorily permitted to hold back any portion of the RC payment, including costs for overhead and profit, contingent on the insured’s actually repairing or replacing the property. Trinidad v. Florida Peninsula Ins. Co., 121 So.3d 433 (Fla. 2013). Therefore, these expenses should be included in the RC amount used to calculate the ACV payment.

The “Loss Payment” and “Valuation” provisions of a policy may require the insurer to pay the cost of repairing or replacing the damaged property. If repairing or replacing the property requires a GC, then the cost of repair or replacement includes the industry-standard overhead and profit. In Windridge, no policy language suggested that if a GC is required, Philadelphia may decline to pay the overhead and profit component of a GC’s charges. According to the district court, if a GC is required to repair or replace the damaged property, then Philadelphia must pay the overhead and profit components of the general contractor’s charges. The only disputed question is whether a GC is necessary to perform the repairs, or whether a single tradesman would suffice, which the district court concluded was a question appropriate for appraisal.

An argument in favor of including GCOP payments to insureds when no GC is hired is the fact that underwriters for several insurers routinely include both general and specialty contractor/subcontractor GCOP when estimating the replacement cost that determines the limit of liability upon which a policyholder’s premiums are based. This remains an argument in favor of including GCOP in every loss, not just when specialty contractors/subcontractors are needed.


The minority viewis that GCOP is owed only if it is actually incurred in repairing or replacing damaged or destroyed property. Some refer to it as the Pay When Incurred (PWI)approach. The genesis of this minority view was a 1987 Kentucky federal district court decision. Snellen v. State Farm Fire & Cas. Co., 675 F. Supp. 1064 (W.D. Ky. 1987). There are also cases in which insurers refuse to pay GCOP because they feel that the repairs were not large or complex enough to justify the expense of a GP. Even under the minority view, GCOP is a reimbursable expense if the services of a GC are actually employed to coordinate or supervise the repair or replacement. Snellen, supra.Under the minority view, GCOP is considered a “non-damage” having no relation to the value of the damaged property. Instead, GCOP represents only a cost that wouldbe incurred if repair or replacement took place. Alternatively, some insurers argue that the inclusion of GCOP, where it was not actually used, could result in an insured receiving what amounts to a windfall if permitted to recover a cost that may never actually be incurred.

Some policies expressly provided that until the damaged or destroyed property is actually repaired or replaced, the insurer’s obligation is limited to an ACV payment. An example of such language is: “We will pay the actual cash value of the damage to the buildings, up to the policy limit, until actual repair or replacement is complete.”

In Hess v. North Pacific Ins. Co., 859 P.2d 586 (Wash. 1993), the court was asked to interpret a provision of a fire policy which stated “We will pay no more than the [ACV] of the damage unless: (a) actual repair or replacement is complete[d.]” The court interpreted this as stating that “the company would only pay the [ACV] until repair or replacement was completed.” The court used the FMV rule to establish that the insured was not entitled to collect the full cost to repair the property but was only allowed to recover the value of the property as it stood following the covered event. Accordingly, the court held that an insured under a fire policy was not entitled to recover the full replacement costs of his destroyed dwelling unless actual repair or replacement was undertaken and completed and upheld the insurer’s ACV calculation. However, in that case the plaintiff did not argue that the ACV payment under the policy should have included GCOP.

How Much Gcop Should Be Paid?

The industry custom for the amount a GC making repairs will charge is “10 and 10,” or 10% for profit and 10% for overhead, on top of the amounts the general contractor pays to its subcontractors. As explained by an Illinois federal court in Windridge of Naperville Condo. Ass’n v. Philadelphia Indem. Ins. Co.2017 WL 372308 (N.D. Ill. 2017):

It is industry custom for a general contractor making repairs to charge “10 and 10,” or 10% for profit and 10% for overhead on top of the amounts the general contractor pays to the subcontractors. By contrast, if only a single tradesman is required to complete a job, overhead and profit are not charged.

Appraisal Per Policy

The appraisal clause in a typical residential and commercial property insurance policy provides for a BINDING appraisal if the parties disagree as to “the amount of loss.” Usually, either the insurer or insured can demand a binding appraisal of damaged property in the event of a dispute as to ACV and establishing the required appraisal procedure. Some states now allow either party to reject the demand for appraisal, reflected in state amendatory endorsements for commercial property policies, homeowner’s policies, or both.Some states have established that a disagreement over whether GCOP is owed is a disagreement over the “amount of loss” and subject to an appraisal per the policy. Windridge of Naperville Condo. Ass’n, supra.

Depreciation Of General Contractor Overhead And Profit (Gcop) And Sales Tax

In the normal property damage claims adjusting process, the insured prepares a detailed accounting of every damaged or destroyed item noting approximate age, value, and replacement cost. The adjuster then depreciates some of these items to account for wear and tear, their age, and any other physical conditions which devalue it. The resulting amount is the ACV. In a RC policy, once the damaged or destroyed items are actually replaced, the insured provides receipts for the replaced property and the adjuster will usually pay the difference between the ACV and what it actually cost to replace or repair the item. This process varies slightly depending on the precise policy terms. If all of the damaged or destroyed property is replaced, the claim is simple. The insured provides the adjuster is the receipts for replacing the property and the insurance company pays the balance due. In that instance, depreciation doesn’t matter.

In ACV policies, depreciation is calculated by evaluating an item’s Replacement Cost Value (RCV) and its life expectancy. RCV is the current cost of repairing the item or replacing it with a similar one, while life expectancy is the item’s average expected lifespan. In determining ACV, in addition to depreciation of labor, some courts also allow depreciation of overhead and profit, sales, tax, and labor. This is because GCOP, sales tax, repair costs, and property value together represent the total RC value. As the argument goes, GCOP, sales tax, repair costs, and property value must be depreciated in order to arrive at the true ACV payment. Trinidad v. Florida Peninsula Ins. Co., 121 So.3d 433 (Fla. 2013). The Florida Supreme Court has explained that “overhead and profit are like all other costs of a repair, such as labor and materials, the insured is reasonably likely to incur …. [and] like a portion of all other costs, [it] could be depreciated in an actual cash value policy.”

Not all states have weighed in on whether and/or when non-material items like labor, GCOP and sales tax may be depreciated when ACV is calculated. This is still a nascent issue and only a few jurisdictions have addressed it. In some jurisdictions, the appropriate method is to apply GCOP in the same percentages as was calculated in determining the RCV loss. This is because they believe GCOP does not represent physical assets that can deteriorate and, therefore, it cannot be depreciated. Overhead and profit, however, are added to the cost to repair or replace a structure, as such, logically, the amount of overhead and profit which applies to the depreciated loss would be less than the amount added to the RCV value. This is not a depreciation of overhead and profit, but rather an application of a consistent percentage.

Sales taxes are calculated in the same manner as GCOP. If the value of the material is depreciated, the percentage for sales tax is applied to the depreciated amount, not the tax paid on the full, undepreciated material. These calculations have the virtue of putting the policyholder back in the same position as prior to the loss – no better, no worse, or, in other words, the truly indemnify.

Calculating Gcop In Underwriting

One aspect of a GCOP case is evidence with regard to how an insurance company calculates the same GCOP at the time of underwriting costs of construction. Carriers objecting to higher GCOP payments—or any GCOP payments at all—might be wise to peek under the hood and see how their underwriting department is valuing these charges when calculating their “premium formula.”

Class Actions

A class action was filed in Pennsylvania in 2017, alleging that insurers are trying to exclude GCOP from property damage claim payments made on an ACV basis. Konrad Kurach v. Truck Ins. Exch., No. 150700339, and Mark Wintersteen v. Truck Ins. Exch.,No. 150703543, both before the Court of Common Pleas of Philadelphia County, Pennsylvania. The named plaintiffs had replacement cost insurance policies and the insureds had not yet completed construction repairs at the time they received their ACV payments. The carrier argued that it was not responsible for including GCOP in their ACV payments because these payments were made on an ACV basis and the policy terms specifically excluded GCOP payments for contractors when payments were made on an ACV basis. The insureds disagreed and argued that GCOP exclusion language in the policy was ambiguous at best; because of the use of the term “replacement cost” as a component of “actual cash value.” They also argued that such a provision was contrary to Pennsylvania law and was unenforceable. The trial court agreed with the policyholders, stating “Insurance companies are required in Pennsylvania to include general contractor overhead and profit in actual cash value payments for losses where repairs would be reasonably likely to require a general contractor.” On July 1, 2019, the Pennsylvania Supreme Court agreed to hear an appeal on this issue in the Kurachcase.

When and how non-material items like labor and GCOP should also be included and/or depreciated during the first-party ACV calculation process remains a challenge in virtually every state. A 50-state chart detailing some of the available state law and precedent regarding the inclusion, quantification and potential depreciation of GCOP in ACV calculations can be found HERE.

Insuring To Value is a Difficult Underwriting Requirement Making Underinsured Structures Quite Common

Chip Merlin | Property Insurance Coverage Law Blog | September 23, 2019

Insuring to value is becoming an increasingly discussed topic with so many buildings underinsured. I noted this problem in a recent post, Do I Have Enough Insurance? Underinsured Homes Are Epidemic

I was with Amy Bach at a United Policyholders fundraising evening on Saturday night. It reminded me that that United Policyholders has been fighting this problem for a very long time. The issue was a fundamental reason for the founding of United Policyholders over twenty years ago:

UP has been working hard to help solve the underinsurance crisis for over two decades. Educating and guiding underinsured loss victims through this website, publications and Roadmap to Recovery workshops and communications, and working to change the laws that bar consumers from holding insurers and agents responsible for lulling them into a false sense of security.

UP is fighting for underinsured consumers in courts and legislatures. In its recent decision to uphold the California Department of Insurance Commissioner’s regulation requiring insurers to provide more accurate estimates of home replacement costs, the California Supreme Court cited UP’s amicus brief and survey finding nearly 75% of disaster victims were underinsured. With the regulation reenacted by the Court, homeowners should have more certainty about their policy coverage, and litigation between policyholders and insurers should be reduced as a result.
UP is educating consumers to get second opinions on dwelling replacement values when insuring their homes and offering strategies to underinsured loss victims.

A reference book on the issue, Commercial Fire Underwriting, has little guidance about how one should go about insuring to value and determining a Replacement Cost Determination:

Determination of Values. It is essential that underwriters be able to determine the values of properties to be insured, at least as an approximation. They cannot watch for underinsurance or overinsurance if they do not know the values.

A starting point is the cost to construct a similar building or to secure the personal property. Appraisals may be necessary, but average costs per square foot may be adequate for some buildings.

Depreciation should be applied unless the insurance is written on a replacement cost basis. Underwriters need to know how actual cash value is computed in the states where insurance is written.

When reviewing policies which have been on the books for some time, underwriters must determine if property values have been adjusted to remain in line with current costs. A reputable building cost index may be helpful in this calculation.

To me, it seems like the industry is paying lip service to a very important underwriting requirement and simply suggest vague ballpark approximations. If more states follow California’s requirements about insuring to value, as noted in, California Passes Law Requiring Insurance Companies Take Specific Measures To Periodically Review The Estimated Replacement Cost Of Structures Insured Under Residential Property Insurance Policiesmy prediction is that we will start seeing more ads for services which make a much more professional study of property insurance valuations at the time of underwriting rather than waiting until after the loss to see if the valuation guess was correct.

One British Columbia firm, Integral Building Services, recently sent me the following advertisement for valuation services:

Underwriting reports provided are loss control surveys which will include supplemental reports of underwriting information with respect to specific occupancies when required: Commercial Occupancy – Restaurant; Solid Fuel Appliance; Farm Outbuildings… The reports are intended to be an underwriting tool verifying the use of the building, exposures in the building and exposures surrounding the building. The surveys are noninvasive, based on a visual inspection of the property and information provided by the insured or the insured’s representative. Recommendations are provided based on conditions found at the time of inspection and address loss prevention issues, as well as improving safety or enhancing protection.

An Underwriting Appraisal Report (UAR) is a building replacement cost analysis which provides an accurate estimate of the amount of insurance required to replace each structure and/or amenity exactly as it stands on the day the report is prepared. The appraisal provides a separate value for: Replacement Cost, New; Bylaws and Code Upgrade; a combined Emergency Service, Stability, Security, Abatement, Deconstruction, Demolition, Debris Removal, Catastrophe, Reproduction Cost, New evaluation. The UAR provides all the required amounts for policy limits and sub-limits. When required the report can also include Occupancy Design Fixtures: Restaurants – Commercial Kitchen Cooking Equipment; Theatres – Theatre Seating, Stage Equipment; Churches – Organs, Chimes, Carillons, ……

These reports are designed to assess the condition and age of the components of the building so the owners can ensure that there are sufficient funds available to address any repair or replacement required. The reports provide a reserve funding schedule that is amortized over 20 to 30 years, depending upon which amortization period applies. The reports provide the estimated life expectancy (in years) of all common areas for any type of property, including Strata properties, and assess: the Roof System; the Exterior Wall System; Interior Finishes, Basement Finishes; Mechanical Systems; Electrical Systems; Common Amenities; and Landscaping. The reports also address additional expenses: Maintenance and Upkeep expenses; Projected Future Depreciation Report Costs; Insurance Deductibles; Projected Engineering and Geotechnical Services to Ensure the Integrity of Aging Building components.

This company published an article on the issue, Insuring To Value, that goes into far more detail on the issues of insuring to value. The article warns that real estate and market value appraisals are not the basis for determining an insurance to value analysis required to properly insure a building as required under a property insurance policy. It further warns against using the generic models of average price used by many in the insurance industry.

Policyholders are not construction experts. Few have an education or knowledge about how to determine what the full cost to replace as required under the insurance policy. Insurance agents are not being adequately trained about how to go about this important issue although they know about it and are selling policies often as a guess as to what the proper amount of insurance should be sold. My guess is that the industry is going to spend a lot more time on the issue and more companies like Integral Building Services will be paid to make this important analysis at the point of sale and renewal.

All Acquisition Costs Should Be Included For Replacement Cost Values

Chip Merlin | Property Insurance Coverage Law Blog | August 17, 2019

Insurance company adjusters often leave off the reasonably expected acquisition costs when determining replacement cost. While the actual pricing can become theoretical, the bottom line is that these acquisition costs can be a material cost and every adjuster should include them when determining the top line replacement cost value.

One accounting site lists acquisition costs as follows:

Acquisition cost refers to the all-in cost to purchase an asset. These costs include shipping, sales taxes, and customs fees, as well as the costs of site preparation, installation, and testing. When acquiring property, acquisition costs can include surveying, closing fees, and paying off liens. This amount is considered to be the book value of an asset.

Another accounting site noted:

The correct amount of cost to allocate to a productive asset is based on those expenditures that are ordinary and necessary to get the item in place and in condition for its intended use. Such amounts include the purchase price (less any negotiated discounts), permits, freight, ordinary installation, initial setup/calibration/programming, and other normal costs associated with getting the item ready to use. These costs are termed capital expenditures and are assigned to an asset account.

Insurance adjusters doing their job properly will try to determine what these costs are when determining loss for contents and business property. For example, for some residential and commercial properties, the costs of interior decorators should be included and always considered as an acquisition costs. I noted this before in Hurricane Sandy Personal Property Claims–Include All Acquisition and Setup Costs to Determine Value, but have recently come across some insurance company estimates without any of these costs.

Free Ride on RCV? Not So Fast!

Craig Bennion | Property Insurance Law Observer | May 29, 2019

Most property insurance policies condition the payment of replacement cost value (RCV) on the property first being replaced or repaired, and courts typically enforce that requirement.  Replacement cost is not owed until the insured completes repair or replacement.  Yet what property adjuster has never encountered an insured who attempts to claim reimbursement for items not damaged in the loss on the theory that such items are within the RCV estimate and are a part of the property’s “restoration”?

A recent Washington Court of Appeals decision illustrates.  In Mount Zion Lutheran Church v. Church Mutual Ins. Co., 2019 WL 2177893 Wash. App. (filed March 18, 2019; ordered published May 14, 2019), a fire damaged the interior of a church sanctuary.  Church Mutual obtained a replacement cost estimate of $729,106, and an ACV estimate of $593,361.  The insurance policy allowed the insured, Mount Zion Lutheran Church, to collect ACV regardless of whether it chose to repair or replace.  The insured had the option to rebuild, in which case it could then collect repair or replacement costs that exceeded ACV.  Church Mutual paid the ACV to Mount Zion.  It withheld the difference between RCV and ACV, approximately $135,744, pending the church’s completion of repairs.

The RCV estimate included over $196,000 to replace arched glulam beams in the church sanctuary and to replace the sanctuary roof.  The church’s pastor told Church Mutual’s adjuster that he preferred to repair, rather than replace, the glulam beams, because replacement would require removal of the roof.  Church Mutual hired an expert to assess the glulam beams.  The expert concluded that the beams did not need to be replaced.  Mount Zion obtained four contractor bids, all of which reflected the cost to repair, rather than replace, the glulam beams.  The bids all came in below the ACV amount already paid to Mount Zion.

Mount Zion then retained a public adjuster.  The public adjuster claimed that the glulam beams had to be replaced.  Although its expert and the four bidding contractors did not believe replacement of the beams was necessary, Church Mutual acquiesced to the public adjuster’s demand and allowed replacement of the beams.

In a routine post-construction inspection, Church Mutual’s adjuster discovered that the beams had been repaired, not replaced.  Mount Zion decided not to replace the beams because removing the roof would have significantly lengthened the timeline for construction.  However, it made a full RCV claim in which it reallocated the estimated cost to replace the glulam beams and roof to a set of “substitute expenditures.”  The substituted costs included the cost to replace a small kitchenette, damaged in the fire, with a redesigned full-size kitchen featuring upgraded cabinets, sink and faucets, and upgraded appliances.  It also upgraded hardware on the front entry doors, flooring and base trim in the sanctuary and foyer, wall and ceiling insulation, reframed the mezzanine, installed underground conduits for phone and internet cables, and made other improvements.

Church Mutual refused to pay the cost of replacing the glulam beams that Mount Zion did not replace.  It also refused to pay the “substitute expenditures” as being unnecessary under the policy.  Mount Zion sued for breach of contract, bad faith, and violation of Washington’s Insurance Fair Conduct Act.  The trial court denied Mount Zion’s motion for full replacement cost, ruling that it was not entitled to RCV for substituted costs that were not necessary to repair or replace lost or damaged property.

On appeal, the issue was whether Mount Zion was entitled to receive the full RCV calculated by the insurer, including the amount to replace the glulam beams and roof, where it did not replace those building components but spent further amounts on items unrelated to the beams or roof, many of which did not exist before the loss.

The insurance policy stated that Church Mutual would not pay on a replacement cost basis “[u]ntil the lost or damaged property is actually repaired or replaced; . . . .”  It also stated that the policy would not pay more on a replacement cost basis than the least of:

a.) The Limit of Insurance applicable to the lost or damaged property;

b.) The cost to replace “on the same premises” the lost or damaged property [of comparable material and quality]; or

c.) The amount you actually spend that is necessary to repair or replace the lost or damaged property.

The Court of Appeals first held that Church Mutual had no obligation to pay replacement cost of the glulam beams that Mount Zion chose not to replace.  The beams were repaired, but the insurer was not obligated to pay the higher replacement cost unless the beams were actually replaced.  Second, the court rejected Mount Zion’s argument that RCV applied to “Covered Property,” meaning the building as a whole.  The court noted that the policy applied ACV to Covered Property as one unit, but applied RCV to “lost or damaged property” within the Covered Property.  Church Mutual had the right to evaluate each item of the claim to determine if there was lost or damaged property, and to determine if the amount spent by the insured was necessary to repair or replace that lost or damaged property.

The Mount Zion decision offers several useful reminders about the settlement of property claims under policies with replacement cost provisions.

  1. RCV is available only if the damaged property is actually repaired or replaced. If the RCV of damaged property exceeds the cost to repair, only the repair cost is available if the insured opts to repair instead of replace.
  2. RCV is applied to specific lost or damaged property, not to the entire Covered Property as a whole unit. In other words, RCV does not represent a maximum amount available if only a portion of the property is actually repaired or replaced.  It is not a “budget” for “substitute expenditures.”
  3. A replacement cost policy does not reimburse an insured for the cost of improvements that did not exist prior to the loss event.

Calculating RCV and ACV for Structures and Personal Property in California in 2019

Daniel Veroff | Property Insurance Coverage Law Blog | March 25, 2019

California has statutory and case law that defines replacement cost and actual cash value, and these laws are read into every insurance policy notwithstanding what the policy language says. This blog has several posts on the subject,1 and this post aims to give you one cohesive post to consult for all your questions on calculating ACV and RCV.

Actual Cash Value – Total Versus Partial Losses to the Structure

Insurance Code section 2051 proscribes how ACV is determined for partial and total losses to a structure. In some cases, the claim value changes significantly based on whether a loss is deemed total or partial. So, the preliminary question is, when is a loss total versus partial?

A California appellate court finally answered that question in 2014 after nearly a hundred years of uncertainty. In California Fair Plan v. Garnes,2 the court held that a loss to the structure is “total” if the structure has been totally destroyed; it is a partial loss if some usable portion is left.

Garnes therefore prohibits insurance companies from using the economic total loss formula frequently used in auto cases. Under that formula, some of the car remains, but the fair market value of the car before the loss is less than the cost to repair or replace minus depreciation. Under Garnes, this cannot be used in property claims.

Actual Cash Value – Total Losses to the Structure

When there is a total loss to a structure as defined in Garnes, Section 2051 requires the insurance company to make an immediate ACV payment of the fair market value of the property at the time of the loss, or the policy limits, whichever is less.

How do you determine fair market value? The law does not say. It is generally accepted in the industry that fair market value is determined by obtaining a fair market value appraisal from a certified California appraiser.

Actual Cash Value – Partial Losses to the Structure

For a partial loss to a structure, Section 2051 requires payment of the cost to repair, replace, or rebuild with materials of like kind and quality, minus a fair and reasonable deduction for physical deprecation. In other words, it is RCV minus physical depreciation. Therefore, the accepted practice is to determine the full cost to rebuild and make a deduction for physical depreciation.

Limits on Depreciation for Structural Losses

Under section 2051 and Regulation 2695.9(f)(1), depreciation must be based on the actual age and condition of the item at the time of the loss and reflect a measurable difference in the market value of the item. Regulation section 2695.9(f)(1) requires this to be set forth in writing and provided to the insured.

Under section 2051, structural components that do not normally get repaired or replaced—like interior wall studs—cannot be depreciated. Insurers must consider how that component is treated in all cases; not just in the property at issue in the claim.

Under both sections 2051 and 2695.9(f)(1), the insurance company can only take a deduction for physical depreciation. This means that items like material sales tax, labor, and overhead and profit cannot be depreciated.

Future changes to ACV laws?

We caution that there is a bill currently pending in California that may eliminate the distinction between total and partial loss payments for structural ACV claims. AB 188 would require ACV to be calculated based on the partial loss formula in either a total or partial loss. Tomorrow, Derek Chaiken of our California office will publish a separate blog post that addresses our thoughts on the proposed changes. In short, we have mixed feelings on it.

Actual Cash Value – Personal Property

Unlike structural property, there is no distinction in California law between total and partial losses. Therefore, RCV is RCV as set forth above, and ACV is RCV minus physical depreciation.

Replacement Cost Value – Structures and Personal Property

RCV is the same whether applied to a total or partial loss, and whether applied to personal or structural property. Under section 2051, the measure of indemnity for RCV is the necessary cost to repair, replace or rebuild with materials of like kind and quality.

Challenging the Insurer’s Structural RCV Estimate

Technically speaking, the law requires that the insured incur expenses above the amount of the ACV payment to receive any further RCV payments. However, in practicality insurers may be willing to make undisputed advanced payments as the replacement progresses as long as you can provide proof that the repairs are in progress and the payments are necessary to move forward.

In many cases, however, the carrier will simply issue a replacement cost estimate, deduct depreciation, and do nothing until amounts above the ACV are incurred. What if the RCV estimate from the carrier is not enough to actually replace?

Insurance Regulation 2695.9(d) states that the insurance company must provide the insured with a copy of any written estimate it bases a claim payment on. If the insured contends that the repairs will exceed the insurer’s estimate, the carrier must do one of the following three things:

  1. Pay the difference between its written estimate and a higher estimate obtained by the claimant; or,
  2. if requested by the claimant, promptly provide the claimant with the name of at least one individual or entity that will make the repairs for the amount of the written estimate. The insurer shall cause the damaged property to be restored to no less than its condition prior to the loss and which will allow for repairs in a manner which meets accepted trade standards for good and workmanlike construction at no additional cost to the claimant other than as stated in the policy or as otherwise allowed by these regulations; or,
  3. reasonably adjust any written estimates prepared by the repair individual or entity of the insured’s choice and provide a copy of the adjusted estimate to the claimant.

Replacing at a New Location

There is presently a lot of controversy around rebuilding at a new location or buying a property elsewhere. Insurance Code section 2051.5 states that an insured can choose to rebuild at another location or buying a new house, and the insurer must base its claim payment on the replacement cost at the loss location. In other words, you must determine the RCV to replace at the loss location, and that number becomes the maximum the insured can recover by replacing elsewhere.

Controversy arises as many carriers will not pay for the cost of new land. If an insured buys somewhere else, many insurers will determine the value of the land and deduct that amount from the purchase price. A similar result happens if new land is purchased and a new home is built on it. Under our view of the law, this is improper. The law does not allow for such a deduction. Carriers argue, however, that insurance does not cover land and the insured gets unjustly enriched because they end up with two pieces of land, since they get to keep the land at the original loss site. Be that as it may, insureds simply cannot replace at a new location without also buying the land, and the law does not authorize the insurer to make such a deduction. We expect to see this play out in future court battles.

Since this post aims to be a one-stop-shop for determining RCV and ACV in California in 2019, we appreciate any comments you have on issues we may not have addressed here. We will update the post as necessary in response.
1 Seee.g., Claims Handling Requirements by State – California; California Supreme Court Affirms California Fair Plan Ass’n v. Garnes, and Preserves Homeowners’ Interests; In California, Can an Insured Homeowner Recover Full Replacement Cost by Purchasing a Home at Another Location?; Does Actual Cash Value Mean Fair Market Value or Replacement Cost Minus Depreciation?
2 11 Cal.App.5th 1276 (Cal. App. 2017).