The recent opinion from the Arizona Supreme Court in the case of Walker v. Auto Owners addresses the issue of whether an insurer can depreciate labor expenses when making an actual cash value (ACV) payment for a building loss. The unanimous decision concluded that, based on the policy terms in question, the insurer was not allowed to depreciate labor costs when determining the ACV for a covered loss.

In this case, the plaintiffs had an insurance policy for their house in Tucson, which covered replacement cost value (RCV) and ACV options. Following damage to their property caused by a water discharge, the plaintiffs filed a claim with their insurer, who accepted coverage for the loss. The insurer depreciated both labor and materials when calculating the ACV, which led the plaintiffs to file a class action lawsuit alleging underpayment and breach of contract.

The federal court certified two questions to the Arizona Supreme Court: whether an insurer can depreciate both materials and labor when determining the ACV of a covered loss in the absence of a policy definition for “actual cash value” or “depreciation,” and whether the broad evidence rule, allowing labor depreciation as a factor in determining ACV, is applicable in Arizona.

The Court reviewed the policy language and the insured’s reasonable expectations and determined that the ACV payment method under the policy was replacement cost less depreciation. Referring to cases in other states, the Court concluded that labor was not depreciable under this payment method. The Court noted that the insurer could modify its policy language to allow for labor depreciation, but the ambiguity in the current policy and the insured’s reasonable expectations prevented labor depreciation in this case.

Regarding the broad evidence rule, the Court found that it did not need to address its applicability since the parties had already agreed to use replacement cost less depreciation to determine ACV. However, the Court indicated that the broad evidence rule may be applicable in other insurance claims in the future.

The decision in Walker has significant implications for property loss adjustment in Arizona. If a policy is ambiguous or silent about labor depreciation, insurers are unlikely to be permitted to depreciate labor when making an ACV payment. The question of the specific policy language required to inform insured parties about labor depreciation in ACV payments remains unanswered and may be addressed in future cases.