Defense Digest

Pennsylvania Superior Court Clarifies Application Of Depreciation In Homeowner's Policies
By James Cole, Esq.*

Every property claims representative is familiar with letters of representation from public adjusters rolling off a fax machine routinely asserting that a demand is being made on a "replacement cost" basis, without depreciation, citing cases such as Fedas v. Insurance Co. of the State of Pennsylvania, 151 A 285 (Pa. 1930); and Farber v. Perkiomen Mutual Insurance Company,  88 A.2d 776 (1952).  The letters will often assert that depreciation is "unconscionable" and that a policyholder is reserving its right to make a claim for the depreciation, as well as bad faith damages under 42 Pa. C.S.A. §8371.  Although the public adjusters boldly asserted that Pennsylvania courts have determined that the application of depreciation is "improper," they continue to settle claims on an "actual cash value" basis.

As the cases of Fedas and Farber were over 70 and 50-years old respectively, the position of insurance companies has been that the cases were based on policy language quite different than that contained in modern day policies, and thus the cases were not binding. 

However, more recent court decisions on the issue have muddied the water.  The 1997 case of London v. Insurance Replacement Facility of Pennsylvania, 703 A.2d 45 (Pa. Super. 1997) seemed to support the assertion that Fedas and Farber stood for the proposition that depreciation was not appropriate in partial loss situations.  Additionally, the Federal case of Sylvania Garden Apartments v. Hartford Fire Insurance Co., 2000 U.S. Dist. Lexis 8075 (ED PA) not only found Fedas and Farber applicable, but determined that unless there is specific policy language defining actual cash value as including a depreciation component, partial losses could not be depreciated.  Fortunately, within the last few months, the Pennsylvania Superior Court has taken steps to clarify the depreciation issue in the cases of Kane v. State Farm Fire & Casualty Company, 841 A.2d 1038 (Pa. Super. 2003); and Burton v. Republican Insurance Co. , 2004 (Pa. Super. 67). 

Kane was filed as a class action against multiple insurance companies in which the plaintiff asserted that "under Pennsylvania law, unless 'actual cash value' is specifically defined to include depreciation, depreciation is not to be included, and a policy holder is entitled to repair/replacement costs."  The Kane Court went to great length to explain Fedas and Farber, and how the opinions relate to modern insurance policies.  In short, the court determined that Fedas and Farber are determinative of the Pennsylvania Supreme Court's position on actual cash value and are still good law.  The Kane Court set forth "where an insured is promised 'actual cash value,' he is entitled to replacement costs without deduction for depreciation."   The court noted that the Fedas Court was concerned that under actual cash value policies, the insured would not be made whole in the event of a loss.  The Kane Court noted that Farber upheld Fedas but also invited an insurance company to modify its policy language if the insurer's intent was for actual cash value to mean something different than replacement cost. 

After analyzing the cases, the Kane Court held:

"We can conclude that any partial loss situation, in the absence of clear language to the contrary, an insurer may not deduct depreciation from the replacement cost of a policy, in that the phrase 'actual cash value' may not be interpreted as including a depreciation deduction, where such a deduction thwarts the insured's expectation to be made whole.  Where qualifying language is absent and an insured is promised 'actual cash value,' the insured is entitled to the cost to repair or to replace the damaged property."  Kane at 1046. 

While this holding may, at first blush, seem to support the public adjuster's assertions relative to Fedas and Farber , the opinion makes clear that, under most modern policy language, sufficient qualifying language exists so that a deduction for depreciation is proper. 

In Kane, the court analyzed several categories of policies in order to determine when a deduction for depreciation is appropriate.  In doing so, the court emphasized the fact that, under most policies, the insured has the option of collecting the full replacement cost upon competition of the repairs.  Therefore, the public policy concerns of Fedas and Farber are not present.  After analyzing the categories of polices, the court's determination regarding same can be summarized as follows:

1.  Depreciation is proper where actual cash value is explicitly defined as including a depreciation component; and

2.  Depreciation is proper where although actual cash value is not explicitly defined, qualifying language exists that would render the policy language "nonsensical" if actual cash value meant the same as replacement cost.   For example, language such as "we will pay no more than actual cash value until actual repair or replacement is complete," would be sufficient to allow an insurance company to take depreciation.

Please note that the court did analyze one policy that contained appropriate qualifying language but was endorsed with a separate replacement cost endorsement.  In that unique situation, the court found that confusion between the body of the policy and the endorsement created an ambiguity.  Therefore, the court determined that, under that specific situation, a depreciation deduction was not proper. 

The parameters of depreciation, and how much depreciation must be returned to the insured after repairs, was clarified in the case of Burton v. Republican Insurance Co., 2004 (Pa. Super. 67).  In Burton , the insured sustained fire damage, and the repair cost to the building was estimated at $114,924.70.  A total of $14,051.02 in depreciation was taken, and the insureds were paid actual cash value on the building of $100,219.  Additionally, the insured was paid $49,785.25 for damage to personal property, and $5,483.93 was withheld as recoverable depreciation.

After completing repairs, the insured did not return the building to the exact specifications as before the fire.  For example, some of the money was used to enlarge a bedroom.  Additionally, the insured did not document replacement of certain items of personal property, yet spent in excess of the agreed replacement cost. 

Among other things, the insured asserted that requiring insureds to "rebuild with like construction using a line-by-line estimate and replace damaged personal property with property of like kind is a breach of the policy."  The court did not agree.  "Insurance policies are based on principles 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." 

The court specifically held that to be entitled to replacement cost benefits relative to the building, an insured must rebuild with "like construction," setting forth "their cost using a detailed line estimate."  Thus, if an insured decides to enlarge a bedroom with settlement proceeds, he would not be entitled to replacement cost benefits relative to the amount spent on that particular line item.  Additionally, the court held that to be entitled to replacement cost benefits for personal property, the property must be replaced with items of like kind and quality.  The court uses the example of draperies that are damaged.  Draperies of similar quality must be replaced, rather than blinds.  Additionally, the court found that the policy places the burden on the insured to submit detailed inventories and receipts, clearly documenting the replacement of the items on an item-for-item basis. 

Together, Kane and Burton clarify under what circumstances depreciation is proper, as well as how much depreciation is recoverable and under what circumstances.  Accordingly, the next time you receive a fax from a Public Adjuster citing Fedas, Farber, or London, a response incorporating Kane and/or Burton may be appropriate. 

*Jim, an associate in our Doylestown, PA office, can be reached at (267) 880-2026 or jcole@mdwcg.com.