Since insurance was invented in ancient Sumeria, when insurance policies were written on clay tablets, insurers and their insureds have struggled with establishing a fair method to properly and fairly compensate the person insured for the property lost or damaged as a result of a peril insured against.
Since insurance is a contract whereby one undertakes to indemnify another against loss, damage, or liability arising from a contingent or unknown event, the key question to be answered is how much is needed to indemnify the person insured? The concept of indemnity requires that the person indemnified receives sufficient funds to put him or her back in the financial place he or she was in moments before the loss. As the U.S. Supreme Court said: "Indemnity means an obligation to make good a loss...."1
Although, on its face, calculating indemnity seems to be a simple task, diminution in value is a concept that has given litigants, insurers, and courts serious problems and what seems to be a constant deluge of litigation. That few jurisdictions agree on methodology and proper computation of damages justifies this exercise.
The measure of damages should be that amount necessary to compensate the injured party for the damages proximately caused by the conduct of the person causing injury.2 The measure is often difficult to determine and seldom fits into a hard rule of thumb.
Looking to the Courts for Answers
Every possible means of providing complete indemnity is required when dealing with tort damages, contract damages, and the proper amount of payment required by a contract of insurance. The courts of the various states and federal jurisdictions do not use identical rules to calculate the proper measure of damages. To understand the issue and to apply the proper remedy requires an understanding of how each state applies, what it believes to be, the proper measure of damages for tort, for contract breaches and for insurance claims situations. Although each court should reach the result of true indemnity the same way, diversity is the rule rather than the exception.
For example, automobile insurance policies usually promise to pay the insured, when an automobile is damaged by collision or some other insured cause, the costs to repair the vehicle or, if it is not repairable, the actual cash value of the vehicle. Most policies say nothing about the difference in value of a vehicle that is repaired after an accident. Because the policies were silent and only promised repair or actual cash value, insurers decided it was unnecessary to even mention the difference in value before the accident and the value after repairs.
Since no promise was made to pay for more than actual cash value or the cost of repair, the issue was ignored until the 2001 decision of the Georgia Supreme Court in State Farm Mut. Auto. Ins. Co. v. Mabry, 274 Ga. 498, 556 S.E.2d 114 (Nov. 28, 2001). Mabry caused serious concern among insurers since it awarded the insured both the cost to repair and the diminution in value of the car after it was repaired. Insurers believed this decision was a judicial rewriting of the wording of the policy and generated suits across the country seeking recovery for diminution of value in suits against insurers and third-party defendants.
Ever since Mabry, virtually all of the courts finding no coverage for diminution of value have done so because the word "repair" has a plain meaning that does not encompass repair of diminished market value after the repair is completed. Rather, the plain meaning of "repair" contemplates physical restoration. Many insurers, to avoid argument, now add to their policies wording that establishes that the insurer does not intend to, nor will it, pay for diminution of value.
When property of any kind is damaged and repaired, the resale value of the property can easily be diminished because of the stigma carried by the repair. An automobile is likely to suffer this type of diminution in value after it is damaged in an accident and repaired. The resale value most likely will be less than that for a comparable automobile that has not been damaged. In other words, the damage results in a reduction—or "diminution"—in the resale value of the automobile. On the other hand, when real property is repaired replacing old materials with new the resale value of the real property is often increased. No one, however, has suggested that the insurer or tortfeasor is entitled to a reduction in its payment for repair because the insured profits from the repair and is not, therefore, truly indemnified.
When the property is insured, the insured's claim for this reduction in value may be made against a third party that negligently caused the damage to the insured's automobile or it may arise from a first-party claim against the insured's own physical damage coverage. The key to recovery of the diminution in value depends on the particular state where the damage occurs, the wording of the insurance policy involved, mandates by state insurance departments, and the holding of the various courts.
With regard to first-party claims by a person insured against an insurer, while it is perhaps arguable, the Insurance Services Office, Inc. (ISO) contract language—specifically the limit of liability condition—appears to cover only the actual cash value of the damage or the actual cost to repair the damage, some states require payment of additional sums to indemnify the owner for loss in value. Although there is nothing in the policy wording that even appears to contractually cover any reduction in market value, some courts require that the insurer pay extra. Even if the insured could prove the amount of reduction in value, collecting from an insurer should require a change in the policy wording.
The policy usually allows the insurer to deduct for "betterment" or depreciation, although the burden of proof is on the insurer to demonstrate such depreciation or betterment. In physical damage claims, the policy would allow the insurer to deduct for an "improvement" in value (i.e., betterment) due to repairs with newer parts, but will not compensate the insured for a reduction in value due to the same accident.
Third-party claims (claims against an insured person for damages done to the property of some third person) for "diminution of value," on the other hand, have generally been found by the courts to be covered by auto insurance since the measure of damage in tort claims (which the insurer promises to pay) is the difference in value of the property before the loss and the value of the property after the loss.
For example, Texas court cases have found that legal liability for third-party damages includes diminution of value. However, no single measure of damages can serve in every case to adequately compensate an injured party.3 For the award of damages to be fair, recognizing that diminution of value is not always accurate, an award of restoration damages, according to some courts, must be available to compensate a plaintiff fully for damages to property when diminution in value fails to provide an adequate remedy.4
The general rule in tort cases where one party damages the property of another is not the cost of repair of the property but, rather, the standard measure is the difference between the value of the property before and after the injury, or the diminution in value,5 unless the cost of repairing the injury and restoring the premises to their original condition amounts to less than the diminution in value of the property, and then the cost of repair is the proper measure of damages. If the cost of restoration will exceed such diminution in value, then the diminution in value of the property is the proper measure.
That rule seems to be in flux and most courts seem to be moving toward a more flexible rule where the measure of damages is considered the amount necessary to compensate the injured party for the damages proximately caused by the conduct of the person causing injury regardless of the method used to calculate those damages.
There is a disparity between the various states on the subject. Some apply the rules strictly, while others apply the general rule of fairness. Some apply the rule in one way when dealing with tort damages, in another when dealing with contract damages, and in a third way when dealing with insurance claims. When faced with a question of diminution of value, it is necessary to determine the rule followed by the state where the claim is made.
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1Williams v. U.S. Fid. & Guar. Co., 35 S. Ct. 289, 236 U.S. 549 (Feb. 23, 1915).
2Lochaven Co. v. Master Pools by Schertle, Inc., 233 Va. 537, 541, 357 S.E.2d 534, 537 (1987).
3 Texas law is clear: no double recoveries are allowed, Parkway Co. v. Woodruff, 901 S.W.2d 434, 441 (Tex. 1995). But, under certain circumstances, a plaintiff may recover for both diminution in value and cost of repairs. Royce Homes, L.P. v. Humphrey, 244 S.W.3d 570 (Tex. App., Dist. 9, Jan. 3, 2008), Ludt v. McCollum, 762 S.W.2d 575 (Tex. 1988); Terminix Int'l, Inc. v. Lucci, 670 S.W.2d 657 (Tex. App. 1984).