Free Ride on RCV? Not So Fast!

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.
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About The Property Insurance Law Observer
For more than four decades, Cozen O’Connor has represented all types of property insurers in jurisdictions throughout the United States, and it is dedicated to keeping its clients abreast of developments that impact the insurance industry. The Property Insurance Law Observer will survey court decisions, enacted or proposed legislation, and regulatory activities from all 50 states. We will also include commentary on current issues and developing trends of interest to first-party insurers.
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