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Actual Cash Value vs. Replacement Cost Insurance.

Actual cash value is not defined by the policy. Based on a number of Texas court decisions, actual cash value is said to be synonymous with “fair market value”, the price a willing purchaser who is under no obligation to buy would pay to a willing owner who is under no obligation to sell. This price can be quantified in one of three ways: (1) comparable sales; (2) the income capitalization approach; or (3) the cost of repair or replacement less depreciation.

(Note: Depreciation is the decrease in home or property value since the time it was built or purchased because of age or wear and tear.)

Replacement cost is the amount it would take to replace or rebuild your home or repair damages with material of similar kind and quality, without deducting for depreciation.

The insurance company determines the depreciation based on a combination of objective criteria (using a formula that takes into account the category and age of the property) and subjective assessment (the insurance adjuster’s visual observations of the property or a photograph of it).

For example, if your roof has a 30-year warranty and is 17 years old, there would be depreciation for the age and condition of the roof.  Claims Adjusters generally agree that the maximum depreciation due to age & condition is 50% – 60%.

The amount of loss payable on commercial and residential property policies is generally limited to the actual cash value of covered property at the time of the loss or damage, unless a replacement cost provision applies. In policies that cover property on a replacement cost basis, the policy generally pays actual cash value of the damaged property until the property is actually replaced.  What is “actual cash value”? Actual cash value is not defined by the policy. Based on a number of Texas court decisions, actual cash value is said to be synonymous with “fair market value”, the price a willing purchaser who is under no obligation to buy would pay to a willing owner who is under no obligation to sell. This price can be quantified in one of three ways: (1) comparable sales; (2) the income capitalization approach; or (3) the cost of repair or replacement less depreciation. Over the years, Texas courts have used, modified or interpreted the above criteria to fit particular circumstances in each case.

When the appropriate measure of actual cash value is the cost of repair or replacement less depreciation, a question often arises regarding depreciation of labor and the contractor’s overhead and profit. For example, the cost to install a roof necessarily involves the cost of roofing materials plus a significant charge for labor and the contractor’s profit and overhead. If hail damages a roof and the loss is adjusted on an actual cash value basis, either finally or prior to actual replacement, are all three components subject to a reduction for depreciation?

Texas courts have generally answered “yes” to that question. In the 2011 case of Tolar vs. Allstate Texas Lloyd’s, the standard homeowners policy language stated that the company “will pay only the actual cash value of the damaged building structure(s) until repair or replacement is completed…Upon completion of repairs or replacement, we will pay the additional amount claimed under replacement cost coverage.” Allstate had estimated the full cost to replace the property and subtracted approximately 32 percent for depreciation of materials, sales tax, labor, and contractor overhead and profit to compute the ACV payment. Tolar demanded an adjustment that included a depreciated amount for materials but the full amount for labor, overhead, profit and sales tax. After Allstate refused to pay that amount and Tolar sued, the Court of Appeals sided with Allstate.

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