One of the most perplexing questions asked by those trying to understand how
commercial property losses are valued is why many property policies do not include a
definition of "actual cash value (ACV)." Insurance Services Office, Inc. (ISO), for
example, does not include a definition in its widely used Building and Personal Property
Coverage Form (CP 00 10 10 12).
ACV is the policy's valuation method if the optional coverage of replacement
cost is not activated and is also how most losses are settled if an insured, even one
who chooses replacement cost coverage, doesn't replace the property. And yet the policy
doesn't tell us what ACV means.
The concept of ACV in property coverage appears in some of the earliest commonly used forms. The language below is from the New York Standard Fire Policy adopted in 1886.
This company shall not be liable beyond the actual cash value of the property at the time any
loss or damage occurs, and the loss or damage shall be ascertained or estimated
according to such actual cash value, with proper
deduction for depreciation however caused, and shall in no event exceed what it
would then cost the insured to repair or replace the same with material of like kind
and quality.
The language of the New York Standard Fire Policy changed over time, with the
reference to depreciation removed in the 1943 policy, often referred to as the 165‑line
New York Standard Fire Policy. In this more recent form, the insurer promises to pay the
lesser of "the actual cash value of the property at
the time of loss" or "the amount which it would cost to repair or replace the
property with material of like kind and quality."
The New York Standard Fire Policy did not provide a definition of ACV, and
that problem exists to this day. If an insurer does not add policy language to define
ACV, the meaning of this term depends on how state statutes define it or how state
courts interpret it. The three most common approaches to calculating ACV are replacement
cost minus depreciation, fair market value, and the broad evidence rule, as discussed
below.
Replacement Cost Minus Depreciation
The formula that most insurance practitioners learn is that ACV = replacement cost minus depreciation, even
though this language does not appear in most property policies and is not the
interpretation used in many states. In describing the Optional Coverage of
Replacement Cost, the CP 00 10 10 12 describes the amount to be paid, as
follows:
(2) The cost to replace the lost or damaged property with other property:
Here, ISO gives us a starting point to understanding ACV by
describing what replacement cost means. However, it does not explain how
depreciation should be calculated. The only reference to depreciation in the policy,
in fact, is in the description of the Optional Coverage of Replacement Cost:
"Replacement Cost (without deduction for depreciation) replaces Actual Cash Value in
the Valuation Loss Condition of this Coverage Form."
In many cases, ACV is calculated based on the useful life of an
item. If a roof has a useful life of 20 years, after 5 years, it has depreciated by
25 percent. The actual condition of the property can be considered as well. For
example, a well-maintained wooden deck will depreciate less quickly than one that
has never been properly cleaned or resealed. Obsolescence, in many cases, can be
considered in determining the amount of depreciation. A property that is no longer
useful because the design or materials are outdated will often have a lower ACV than
property not considered obsolete.
What should be depreciated, absent clear policy language, is
another question that has been answered differently. While materials and supplies
are clearly depreciable, there have long been questions and disagreements about
whether labor and contractor overhead and profit should be depreciated. In some
states, state statutes or interpretations from state insurance departments answer
these questions. In other states, case law in the jurisdiction may address the
issue. In many states, though, no relevant authority exists, so absent policy
language, the question of what should be depreciated remains unanswered.
For a discussion of the depreciation of labor issue, see "Depreciation of Labor in Calculating ACV: Yes or
No?" The argument for or against depreciation of contractor overhead and
profit follows similar logic. Whether general contractor overhead and profit should
be paid at all in an ACV claim is another question where opinions differ. The
majority view is that such overhead and profit, where the policyholder is reasonably
likely to need a general contractor, should be included in the replacement cost and,
as such, be included when ACV is calculated.
This viewpoint was expressed by a Texas court in Ghoman v. New Hampshire Ins. Co.,
159 F. Supp. 2d 928 (N.D. Tex. 2001).
"Actual cash value" under the policy means repair or replacement costs less depreciation. Repair or replacement costs include any cost that an insured is reasonably likely to incur in repairing or replacing a covered loss. Contractor's overhead and profit and sales tax clearly fit this definition. These amounts should be included in the actual cash value award.
The opposing view on whether general contractor overhead and profit should be included in ACV is that they are only owed if the property is repaired or replaced. This minority view results in such overhead and profit not being included in ACV calculations. In Snellen v. State Farm Fire & Cas. Co.,
675 F. Supp. 1064 (W.D. Ky. 1987), the court explained as follows:
Since the goal is to arrive at the actual cash value of the damage, non-damage factors which are applicable only in the instance of repair or replacement such as clean up, profit, overhead, and permits, were properly deducted. These factors have no relation to the value of the damage but only the expense which would be incurred if repair or replacement were involved.
Fair Market Value
In some states, absent a policy definition, ACV is interpreted to
mean the fair market value of the property. The previously mentioned Texas court
described fair market value as follows:
"Fair market value" is 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.
One obvious concern with this approach is how to value a property when there is no willing purchaser. Can it truly be the case that the property has no ACV?
Broad Evidence Rule
The broad evidence rule, as a method of calculating ACV, is used
in more states than any other. The broad evidence rule takes into account numerous
factors that affect the value of property, including but not limited to replacement
cost, physical depreciation, original cost, market value, useful life, condition of
the property, location, use, and economic value of the property, assessed value, and
offers to buy and sell. While an advantage of this rule is that many factors are
considered, critics point to the fact that it can be difficult to calculate a value
using so many variables. For example, what weight should each factor get in the
determination of ACV? This results in uncertainty.
The broad evidence rule was first introduced in a 1928 New York
case, McAnarney v. Newark Fire
Ins. Co., 247 N.Y. 176, 159 N.E. 902 (N.Y. Ct. App. 1928). In 1919,
the insured purchased 7 large buildings for $8,000, designed to manufacture malt.
Due to the passage of the National Prohibition Act, the buildings, which served no
purpose beyond malt production, were unused when fire destroyed them in April
1920.
The buildings were insured under several policies with a combined
limit of $42,750. The insured valued the buildings at $60,000 based on their
replacement cost less physical depreciation and sought payment of the full limit of
the policies, but the insurer claimed that the market value of the buildings should
be the exclusive measure of the loss. (The insured had offered the buildings for
sale for $15,000 and had received only one offer of $6,000.)
The policy included the following language to describe how losses should be valued.
The Insurance Company does insure … to the extent of the actual cash value (ascertained with proper deductions for depreciation) of the property at the time of loss or damage, but not exceeding the amount which it would cost to repair or replace the same with material of like kind and quality within a reasonable time after such loss or damage.
The trial court instructed the jury to measure ACV as the cost to
build the structures, less depreciation, with the judge stating that the fact the
buildings couldn't be used for any useful purpose was wholly immaterial. However,
the New York Court of Appeals disagreed, ruling as follows:
Under our interpretation of the phrase, the insurer "does insure" to the limit of actual value. To insure is "to guarantee or secure indemnity for future loss or damage." (The Century Dictionary.) Where insured buildings have been destroyed, the trier of fact may, and should, call to its aid, in order to effectuate complete indemnity, every fact and circumstance which would logically tend to the formation of a correct estimate of the loss. It may consider original cost and cost of reproduction; the opinions upon value given by qualified witnesses; the declarations against interest which may have been made by the assured; the gainful uses to which the buildings might have been put; as well as any other fact reasonably tending to throw light upon the subject.
In addressing use of the phrase "deductions for depreciation" in
the policy, the court explained its reasoning as follows:
The word (depreciation) means, by derivation and common usage, "a fall in value; reduction of worth.…" [I]t is a self-evident proposition that factory buildings peculiarly adapted to the manufacture of malt must have depreciated in value when malt may no longer be manufactured; that buildings useful only for factory purposes have lost value when they are no longer used or usable for such purposes.
New ISO Endorsements
ISO has introduced three endorsements with a proposed effective
date of July 1, 2027. These endorsements are for use in most states and are
considered conditional mandatory endorsements, meaning that one of the three should
be added to each commercial property policy. By way of background, ISO offered the
following explanation for the endorsements in its LI-CF-2026-124 Circular.
A consistent definition for Actual Cash Value (ACV) within the portfolios of ISO's major product lines has been sought by insurers and insureds to avoid inconsistencies and ambiguity in claims handling and interpretations of policy coverage. ISO is introducing three new endorsements designed to establish consistency in defining and applying Actual Cash Value to first party losses.
The definition of ACV in all three endorsements includes the following language.
A. In the event of a partial or total loss to a building or structure, the lesser of the following:
1. The amount it would cost to repair, rebuild or replace Covered Property. Such amount shall include, but not be limited to:
a. Building materials and supplies of like kind and quality, including tax;
b. Labor and services, including tax; and
c. Overhead and profit from general contractors or others;
The endorsements then list the deductions—reflecting preloss
depreciation—for use, age, wear and tear, obsolescence, and physical condition at
the time of direct physical loss or damage.
Note that the inclusion of general contractor overhead and profit
answers the previously addressed question of whether ACV should include general
contractor overhead and profit. The policy now clearly states that it does.
Where the endorsements vary is in how depreciation applies. The endorsement title describes what is depreciated, with depreciation applying to one, two, or three of the following.
Building materials and supplies of like kind and quality, including tax
Labor and services, including tax
Overhead and profit from general contractors or others
The following are the endorsements.
Actual Cash Value with Depreciation of Materials and Supplies (CP 12 76 05
27)
Building materials and supplies are depreciated in
determining ACV.
Labor and services are not depreciated in
determining ACV.
Overhead and profit are not depreciated in
determining ACV.
Actual Cash Value with Depreciation of Materials and Supplies and Labor and
Services (CP 12 77 05 27)
Building materials and supplies are depreciated in
determining ACV.
Labor and services are depreciated in determining
ACV.
Overhead and profit are not depreciated in
determining ACV.
Actual Cash Value with Depreciation of Materials and Supplies, and Labor and
Services, and Contractor Overhead and Profit (CP 12 78 05 27)
Building materials and supplies are depreciated in
determining ACV.
Labor and services are depreciated in determining
ACV.
Overhead and profit are depreciated in determining
ACV.
Conclusion
Without policy language that describes how ACV should be calculated, insureds and insurers are left to rely on state and court interpretations of how commercial property claims should be valued. And, while some insurers have drafted policy language to define ACV, many have not, resulting in uncertainty and inconsistent approaches to settling claims. ISO's new endorsements are an important step in providing much-needed clarity.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.
One of the most perplexing questions asked by those trying to understand how commercial property losses are valued is why many property policies do not include a definition of "actual cash value (ACV)." Insurance Services Office, Inc. (ISO), for example, does not include a definition in its widely used Building and Personal Property Coverage Form (CP 00 10 10 12).
ACV is the policy's valuation method if the optional coverage of replacement cost is not activated and is also how most losses are settled if an insured, even one who chooses replacement cost coverage, doesn't replace the property. And yet the policy doesn't tell us what ACV means.
The concept of ACV in property coverage appears in some of the earliest commonly used forms. The language below is from the New York Standard Fire Policy adopted in 1886.
The language of the New York Standard Fire Policy changed over time, with the reference to depreciation removed in the 1943 policy, often referred to as the 165‑line New York Standard Fire Policy. In this more recent form, the insurer promises to pay the lesser of "the actual cash value of the property at the time of loss" or "the amount which it would cost to repair or replace the property with material of like kind and quality."
The New York Standard Fire Policy did not provide a definition of ACV, and that problem exists to this day. If an insurer does not add policy language to define ACV, the meaning of this term depends on how state statutes define it or how state courts interpret it. The three most common approaches to calculating ACV are replacement cost minus depreciation, fair market value, and the broad evidence rule, as discussed below.
Replacement Cost Minus Depreciation
The formula that most insurance practitioners learn is that ACV = replacement cost minus depreciation, even though this language does not appear in most property policies and is not the interpretation used in many states. In describing the Optional Coverage of Replacement Cost, the CP 00 10 10 12 describes the amount to be paid, as follows:
Here, ISO gives us a starting point to understanding ACV by describing what replacement cost means. However, it does not explain how depreciation should be calculated. The only reference to depreciation in the policy, in fact, is in the description of the Optional Coverage of Replacement Cost: "Replacement Cost (without deduction for depreciation) replaces Actual Cash Value in the Valuation Loss Condition of this Coverage Form."
In many cases, ACV is calculated based on the useful life of an item. If a roof has a useful life of 20 years, after 5 years, it has depreciated by 25 percent. The actual condition of the property can be considered as well. For example, a well-maintained wooden deck will depreciate less quickly than one that has never been properly cleaned or resealed. Obsolescence, in many cases, can be considered in determining the amount of depreciation. A property that is no longer useful because the design or materials are outdated will often have a lower ACV than property not considered obsolete.
What should be depreciated, absent clear policy language, is another question that has been answered differently. While materials and supplies are clearly depreciable, there have long been questions and disagreements about whether labor and contractor overhead and profit should be depreciated. In some states, state statutes or interpretations from state insurance departments answer these questions. In other states, case law in the jurisdiction may address the issue. In many states, though, no relevant authority exists, so absent policy language, the question of what should be depreciated remains unanswered.
For a discussion of the depreciation of labor issue, see "Depreciation of Labor in Calculating ACV: Yes or No?" The argument for or against depreciation of contractor overhead and profit follows similar logic. Whether general contractor overhead and profit should be paid at all in an ACV claim is another question where opinions differ. The majority view is that such overhead and profit, where the policyholder is reasonably likely to need a general contractor, should be included in the replacement cost and, as such, be included when ACV is calculated.
This viewpoint was expressed by a Texas court in Ghoman v. New Hampshire Ins. Co., 159 F. Supp. 2d 928 (N.D. Tex. 2001).
The opposing view on whether general contractor overhead and profit should be included in ACV is that they are only owed if the property is repaired or replaced. This minority view results in such overhead and profit not being included in ACV calculations. In Snellen v. State Farm Fire & Cas. Co., 675 F. Supp. 1064 (W.D. Ky. 1987), the court explained as follows:
Fair Market Value
In some states, absent a policy definition, ACV is interpreted to mean the fair market value of the property. The previously mentioned Texas court described fair market value as follows:
One obvious concern with this approach is how to value a property when there is no willing purchaser. Can it truly be the case that the property has no ACV?
Broad Evidence Rule
The broad evidence rule, as a method of calculating ACV, is used in more states than any other. The broad evidence rule takes into account numerous factors that affect the value of property, including but not limited to replacement cost, physical depreciation, original cost, market value, useful life, condition of the property, location, use, and economic value of the property, assessed value, and offers to buy and sell. While an advantage of this rule is that many factors are considered, critics point to the fact that it can be difficult to calculate a value using so many variables. For example, what weight should each factor get in the determination of ACV? This results in uncertainty.
The broad evidence rule was first introduced in a 1928 New York case, McAnarney v. Newark Fire Ins. Co., 247 N.Y. 176, 159 N.E. 902 (N.Y. Ct. App. 1928). In 1919, the insured purchased 7 large buildings for $8,000, designed to manufacture malt. Due to the passage of the National Prohibition Act, the buildings, which served no purpose beyond malt production, were unused when fire destroyed them in April 1920.
The buildings were insured under several policies with a combined limit of $42,750. The insured valued the buildings at $60,000 based on their replacement cost less physical depreciation and sought payment of the full limit of the policies, but the insurer claimed that the market value of the buildings should be the exclusive measure of the loss. (The insured had offered the buildings for sale for $15,000 and had received only one offer of $6,000.)
The policy included the following language to describe how losses should be valued.
The trial court instructed the jury to measure ACV as the cost to build the structures, less depreciation, with the judge stating that the fact the buildings couldn't be used for any useful purpose was wholly immaterial. However, the New York Court of Appeals disagreed, ruling as follows:
In addressing use of the phrase "deductions for depreciation" in the policy, the court explained its reasoning as follows:
New ISO Endorsements
ISO has introduced three endorsements with a proposed effective date of July 1, 2027. These endorsements are for use in most states and are considered conditional mandatory endorsements, meaning that one of the three should be added to each commercial property policy. By way of background, ISO offered the following explanation for the endorsements in its LI-CF-2026-124 Circular.
The definition of ACV in all three endorsements includes the following language.
The endorsements then list the deductions—reflecting preloss depreciation—for use, age, wear and tear, obsolescence, and physical condition at the time of direct physical loss or damage.
Note that the inclusion of general contractor overhead and profit answers the previously addressed question of whether ACV should include general contractor overhead and profit. The policy now clearly states that it does.
Where the endorsements vary is in how depreciation applies. The endorsement title describes what is depreciated, with depreciation applying to one, two, or three of the following.
The following are the endorsements.
Conclusion
Without policy language that describes how ACV should be calculated, insureds and insurers are left to rely on state and court interpretations of how commercial property claims should be valued. And, while some insurers have drafted policy language to define ACV, many have not, resulting in uncertainty and inconsistent approaches to settling claims. ISO's new endorsements are an important step in providing much-needed clarity.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.