NO. A ~~~~e ~~ ~Y~x~e~a~~ Brent R. Wilcox, et al., vs. (860)

Transcription

1 NO. A ~~~~e ~~ ~Y~x~e~a~~ x~ ~ x~~rr~ ~x~ Brent R. Wilcox, et al., vs. Plaint~.s-Appellants, State Farm Fire and Casualty Company, Defendant-Kespondent. THE AMERICAN INSURANCE ASSOCIATION'S AMICUS CURIAE BRIEF T. Joseph Snodgrass (#231071) Shawn M. Raiter (#240424) Paula Duggan Vraa (#219137) Kelly A. Lelo (#330838) CARSON KING, LLP 2800 Wells Fargo Center 30 fast Seventh Street St Paul, MN (651) 312-C 500 William M. Hart (# ) MEAGHER & GErR, P.L.L.P. 33 South Sixth Street, Suite 4400 Minneapolis, MN (612) Stephen E. Goldman (pro hac vice motion pendin~ Wystan M. Ackerman Attorneys for Plaint~.r Appellants (pro hac vice motion pending) ROBINSON & COLT T T P Todd A. Noteboom (#240047) 280 Trumbull Street W. Anders Folk (#311388) Harford, CT Jeffrey G. Mason (#390041) (860) STINSON LEONARD STRrET LLI' Fax (860) South Fifth Street, Suite 2300 L-?-mail: soldman~rc.com Minneapolis, MN wackerman@rc.com (612) Attorneys foralnicu,r Curi~re Attorne J' s.f or De.f endant-kes p ondent Aynerican In.ru~ance Associatio~a Attorney listing continue on following page 2015 BACHMAN LEGAL P 2iNTWG 1' AX (fi12) PHONE (612) or I

2 Dale O. Thornsjo (#162038) Lance D. Meyer (#389200) O'MEARA L~rR WAGN~R & KOHL, P.A Metro Boulevard, Suite 600 Minneapolis, MN (952) Attorneys foralnicus Cztriae The Insurance Federation of Minnesota

3 TABLE OF CONTENTS Pale INTRODUCTION...1 INTERESTS OF THE AMICUS CURIAE...3 ARGUMENT... 3 I. FAILING TO DEPRECIATE THE FULL VALUE OF DAMAGED PROPERTY WOULD BF, CONTRARY TO THE HISTORY AND PURPOSE OF "ACTUAI, CASH VALUE" INSURANCE :...3 IL III. A. Background on the History and Purpose of "Actual Cash Value" Insurance...3 B. Courts Have Long Recognized That "Actual Cash Value" Means Actual Economic Value...6 C. Courts Have Long Recognized That Depreciation is Properly Applied to the Full Cost of Repair or Replacement...8 D. Applying Depreciation Only to the Cost of Materials is Inconsistent With "The Well-Settled Meaning of "Actual Cash Value" and Longstanding Precedent On Measuring Actual Cash Value... l l IN OTHER RELEVANT CONTEXTS, DEPRECIATION IS APPLIED TO THE FULL VALUE OF A BUILDING, INCLUDING BOTH LABOR AND MATERIALS...12 A. Property Tax Assessments...13 B. Eminent Domain and Other Valuations...15 C. Real Lstate Appraisals... l h CONTRACT CERTAINTY IS ESSENTIAL TO A VIA}3I,E INSURANCE MARKETPLACE...18 CONCLUSION...18

4 TABLE OF AUTHORITIES Pages) Cases Adams v. Cameron Mut. Ins. Co., 430 S. W.3 d 675 (Ark. 2013) Aetna Ins. Co. v. Johnson, 74 Ky. 587 (1874)...6 American Crystal Sugar Co. v. Cnty. of Polk, 2009 WL (Minn. Tax. Ct. Aug. 5, 2009) American States Ins. Co. v. Mo-Lex, Inc., 427 S.W.2d 236 (Ky. 1968)...7 Birmingham Fire Ins. Co. v. Pulver, 18 N.E. 804 (I )...6 Boise Assn of Credit Men v. United States Fire Ins. Co., 256 P. 523 (Idaho 1927)...9 Books Realty, Inc. v. Aetna Ins. Co., 276 Minn. 245, 149 N.W.2d 494 (1967)... 7, 8, 11 Ca~ef~ee Count~^y Club v. Cnty. of She~bu~ne, 1988 WL (Minn. Tax. Ct. Sept. 7, 1988) Commercial Fire Ins. Co. v. Allen, 1 So. 202 (Ala. 1886)...9 D & S Realty, Inc. v. Markel Ins. Co., 816 N.W.2d 1 (Neb. 2012)... 5, 6 Ga~^vey v, State Farm Fire & Cas. Co., 770 P.2d 704 (Cal. 1989) Higgins v. Insurance Co. of ~N. Am., 469 P.2d 766 (Ur. 1970)...5 Knuppel v. American Ins. Co., 269 F.Zd 163 (7th Cir. 1959) Lampe Mkt. Co. v. Alliance Ins. Co., 22 N.W.2d 427 (S.D. 1946)...7 London & L. F. Ins. Co. v. Sto~~s, 71 F. 120 (8th Cir. 1895)...9 Marshall Produce Co. v. St. Paul Fire &Marine Ins. Co., 256 Minn. 404, 98 N.W.2d 280 (1959)... 7, 11 McAna~ney v. Newark Fire Ins. Co., 159 N.E. 902 (N.Y. 1928)... 6, 7, 8, 11 ii

5 Mutual Safety Ins. Co. v. Hone, 2 N.Y. 235 (1849)...4 Nat'l Sec. Fire & Cas. Co. v. DeWitt, 85 So. 3d 355 (Ala. 2011)...5 North Central Az~lines, Inc. v. Cnty. of Hennepin, 1981 WL 1219 (Minn. Tax Ct. May 19, 1981) Northwest Racquet Swim &Health Clubs v. Cnty. of Dakota, 557 N.W.2d 582 (Minn. 1997) Pat~iotzc O~de~ Sons of Am. Hall Ass 'n v. Ha~tfo~d Fire Ins. Co., 157 A. 259 (Pa. 1931)...: Peoria Marzne &Fire Ins. Co. v. Wilson, 5 Minn. 53 (1861)...4 Providence Washington Ins. Co. v. Gulinson, 215 P. 154 (Colo. 1923)...9 Real Asset Mgmt. v. Lloyd's of London, 61 F.3d 1223 (5th Cir. 1995)...9 State v. Red Wing Laundry &Day Cleaning Co., 253 Minn. 570, 93 N.W.2d 206 (1958) Svea Fire &Life Ins. Co. v. State Say. &Loan Ass 'n, 19 F.2d 134 (8th Cir. 1927) Ti^avele~s Indem. Co. v. Armstrong, 442 N.E.2d 349 (Ind. 1982)... 5, 8 Tyler v. Shelter Mut. Ins. Co., 184 P.3d 496 (Okla. 2008)...7 In ~e Wa~ne~'s Trust, 263 Minn. 449, 117 N. W.2d 224 (1962)... 1 h Wendt v. Wallace, 185 Minn. 189, 240 N.W.2d 470 (1932) Wisconsin Screw Co. v. Fireman's Fund Ins. Co., 297 F.2d 697 (7th Cir. 1962) Statutes and Court Rules Minn. R. Civ. App. P Minn. Stat. 65A Minn. Stat. 458D.06, subd iii

6 Minn. Stat , subd N.Y. Ins. Law 3404(e)...4 Other Authorities T~ ApPxA1sAL of REAL EsTA`rE (Appraisal Institute, 13th ed. 2008) IRS Publication No. 551 (rev. May 2002) IRS Publication No. 946 (Feb. 15, 2013 version) Magee & Bickelhaupt, GENERAL INsuR~NCE (7th ed. 1964)...6 Garth E. Thimgan, CAE et al., PROPERTY ASSESSMENT VALt1ATION (International Assn of Assessing Officers 3d ed.) iv

7 INTRODUCTION In this amicus curiae brief, the American Insurance Association ("AIA") will provide the Court with the broader context surrounding the certif ed question.' AIA will explain the history and purpose of "actual cash value" insurance, how "actual cash value" has been defined and applied through the years, and how the cost approach to determining "actual cash value" (i.e., replacement cost less depreciation) is consistent with how buildings are customarily valued for property tax assessments, eminent domain valuations, and real estate appraisals. The question presented is not new. Property insurance policies providing for payment of the "actual cash value" of covered damage have been issued in Minnesota and throughout the United States since the mid-1800s. Throughout that time, courts have consistently interpreted the words "actual cash value" to have their plain and ordinary meaning the actual (i.e., true and accurate) value, in cash, of the damaged property. In other words, the "actual cash value" is the actual economic value of the property just before the loss occurred. While courts in Minnesota and elsewhere have typically permitted any relevant and probative evidence to be introduced at trial in measuring "actual cash value," one method Pursuant to Minn. R. Civ. App. Y , AIA hereby certifies that counsel for a party did not author this brief in whole or in part, and no party other than AIA made a monetary contribution to the preparation or submission of this brief State Farm Fire and Casualty Company is not a member of AIA.

8 that has been used consistently since the late 1800s is estimating the replacement cost of the damage and applying an appropriate percentage of depreciation to the total estimated replacement cost. That method, often referred to as the "cost approach" to valuing a building, is also frequently used for property tax assessments, eminent domain valuations, real estate appraisals, and other purposes. If this Court were to adopt the approach advocated by Plaintiffs, i.e., requiring insurers to estimate the replacement cost and then apply depreciation only to the portion of the replacement cost that consists of the cost of materials, that would be contrary to the manner in which courts have interpreted "actual cash value" and determined depreciation of real property for more than a century. It is the economic value of the structure, not merely the materials, that depreciates over time. The true economic value of property cannot be accurately measured by determining its replacement cost and subtracting therefrom a fraction of the actual depreciation in the property's value. Plaintiffs' approach would not only disrupt well-settled law and longstanding insurance industry practice, it would mean that courts would determine the value of property for insurance purposes far differently from how they value the very same property for tax, eminent domain, or appraisal purposes. And such a result would undermine the certainty in the construction of 100+ year old insurance policy language that is essential to a viable insurance market. 2

9 INTERESTS OF THE AMICUS CURIAE AIA is a leading national trade association representing property and casualty insurers writing business in Minnesota, nationwide and globally. AIA's members range in size from small companies to the largest insurers with global operations. On issues of importance to the property and casualty insurance industry and marketplace, AIA advocates sound public policies on behalf of its members in legislative and regulatory forums at the state and federal levels and files amicus curiae briefs in significant cases before federal and state courts. "Phis allows f1ia to share its broad national perspective with the judiciary on matters that shape and develop the law. AIA's interest is in the clear, consistent, and reasoned development of law that affects its members and the policyholders they insure. ARGUMENT I. FAILING TO DEPRECIATE THE FULL VALUE OF DAMAGFll PROPERTY WOULD BE CONTRARY TO THE HISTORY AND PURPOSE OF "ACTUAL CASH VALUE" INSURANCE A. Background on the History and Purpose of "Actual Cash Value" Insurance Some background on the history of "actual cash value" insurance may be helpful to the Court in deciding the certified question. While the certified question appears to be an issue of first impression in this Court, the insurance policy language being applied here is older than the State of Minnesota. Insurers have been writing property insurance policies providing "actual cash value" coverage in K~

10 the United States since at least the 1840s. See, e.g., Mutual Safety Ins. Co. v. Hone, 2 N.Y. 235, 243 (1849)(quoting insurance policy providing for "the loss or damage to be estimated according to the true and actual cash value of the said property at the time the same shall happen"). In Minnesota, such policies have been issued since at least the early 1860s. Actual cash value coverage was first construed by this Court within three years of Minnesota becoming a state in See Peoria Maine & FiNe Ins. Co. v. Wilson, 5 Minn. 53, 60 (1861)(quoting insurance policy providing for "the said loss or damage to be estimated according to the true and actual cash value of the property at the time the same shall happen"). Standard fire insurance policies, the terms of which have been enacted by state legislatures since the 1940s, provide for payment of the "actual cash value" of covered damage. The first prominent standard fire policy was the New York Standard Fire Insurance Policy, enacted in To this day, that standard form provides "actual cash value" insurance. See N.Y. Ins. Law 3404(e). Minnesota's standard fire policy, modeled on the New York form, provides similar "actual value" coverage. See Minn. Stat. ~ 65A.01 ("The amount of said loss or damage, except in case of total loss on buildings, to be estimated according to the actual value of the insured property at the time when such loss or damage happens.").

11 In more recent decades, insurers have provided two distinct types of casualty protection for buildings. "One insures to the extent of the `actual cash value'... and the other insures to the extent of `the full cost of repair or replacement without deduction for depreciation... "' T~avele~s Indem. Co. v. A~mst~ong, 442 N.E.2d 349, 352 (Ind. 1982). Either "actual cash value" or replacement cost insurance is typically subject to a maximum limit of insurance. What is now the predominant form of property insurance coverage provides hybrid coverage in the sense that coverage is provided on an "actual cash value" basis unless and until the insured repairs or replaces the damaged property. After repair or replacement is completed, a supplemental payment is made so that the total amount paid is the full cost of repair or replacement of covered damage (subject to any other applicable provisions of the policy). See Nat'l Sec. Fire & Cas. Co. v. DeWitt, 85 So. 3d 355, 374 (Ala. 2011). As the Nebraska Supreme Court has explained,...because replacement cost coverage places the insured in a better position than before the loss, there is a moral hazard that the insured will intentionally destroy the insured property in order to gain from the loss. For this reason, most replacement cost policies require actual repair or replacement of the damaged property as a condition precedent to recovery under the replacement cost rider. D & S Realty, Inc. v. Markel Ins. Co., 816 N. W.2d 1, 12 (Neb. 2U 12); see also Higgins v. Insurance Co. of N. Am., 469 P.2d 766, 773 (Or. 1970) ("[T]here is an element of moral hazard in providing insurance that will replace in its entirety an E

12 old and partly obsolete building in a new condition.") (quoting Magee & Bicicelhaupt, GcNERAL INst1R~NCE (7th ed. 1964)). Consistent with the goal of mitigating moral hazard, actual cash value coverage is intended "to make the insured whole" from a purely economic perspective, "but never to benefit the insured because the loss occurred." D & SRealty, 816 N.W.2d at 11. B. Courts Have Long Recognized That "Actual Cash Value" Means Actual Economic Value Courts have recognized since the 19th century that the words "actual cash value" mean just what they say i.e., the actual (true and accurate) value, in cash, of the damaged property that was insured. In other words, the actual cash value is the actual economic value of the damaged property. See, e.g., l3i~mingham Fire Ins. Co. v. Pulver, 18 N.E. 804, 807 (Ill. 1888) ("The actual cash value then is the fair or reasonable cash price for which the property can be sold in the market."); Aetna Ins. Co. v. Johnson, 74 Ky. 587, 591 (1874) (explaining that "actual cash value" means "the value of the building as it stood upon the ground on the day it was destroyed," and "[i]f the building was old and dilapidated by use and decay, its value in that condition is what the [insureds] should recover") A leading case nationally on actual cash value insurance that has been followed in Minnesota and many other jurisdictions is McAna~ney v. Newark F'i~e Ins. Co., 159 N.E. 902 (N.Y. 1928). In that case, the New York Court of Appeals explained that "[w]e interpret `actual cash value' to have no other significance than ~.

13 `actual value' expressed in terms of money." Id. at 903 (emphasis added). McAnarney thus defined "actual cash value" as the actual economic value of the damaged property. This Court has previously relied on McAna~ney, and defined "actual cash value" as the "actual loss sustained by the insured in view of all of the circumstances of the case." Books Realty, Inc. v. Aetna Ins. C'o., 276 Minn. 245, 255, 149 N.W.2d 494, 501 (1967); see also Marshall Produce Co. v. St. Paul Fire & Marine Ins. Co., 256 Minn. 404, 413, 98 N.W.2d 280, 288 (1959)(insurance policy covered "loss in value" or "pecuinar[y]" loss to insured); ~lme~ican States Ins. Co. v. Mo-Lex, Inc., 427 S.W.2d 236, 237 (Ky. 1968) (actual cash value is "the economic value of the building as distinguished from its replacement value"); Lampe Mkt. Co. v. Alliance Ins. Co., 22 N.W.2d 427, (S.D. 1946) (actual cash value means "`actual value' expressed in terms of money"); Patriotic O~de~ Sons ofam. HallAss'n v. Ha~tfo~d Fire Ins. Co., 1S7 A. 259, 260 (Pa. 1931) ("Actual cash value means what the thing is worth in money, allowing for depreciation."). That remains the plain and ordinary meaning of the words "actual cash value" today. See, e.g., Tyler v. Shelter Mut. Ins. Co., 184 P.3d 496, 501 (Okla. 2008) (actual cash value means "the actual value of property expressed in terms of money"). 7

14 While courts appear to be in essentially universal agreement that the actual cash value of damage to property is the change in the property's economic value resulting from the loss, courts and insurers have adopted several different methods for measuring that value: (1) replacement cost less depreciation; (2) change in market value; and (3) the "broad evidence rule." A~mst~ong, 442 N.E.2d at Each of these methods, however, is merely a tool that is used to ascertain the actual economic value of a loss. The "broad evidence rule," which is the majority rule followed in Minnesota and most other states, is a "flexible rule" that "permits an appraiser or a court or a jury to consider any relevant factor" to determine the actual cash value at the time of loss. Id. at 356. The "broad evidence rule" originated in McAna~ney, which held that, in determining "actual cash value," "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." McAna~ney, 159 N.E. at 905. This Court followed McAnarney and adopted the broad evidence rule in Books Realty, 276 Minn. at 254, 149 N. W.2d at 501. C. Courts Have Long Recognized That Depreciation is Properly Applied to the Full Cost of Repair or Replacement Courts have long recognized since the 19th century that, in determining the actual cash value of damaged property, depreciation is properly applied to the 0

15 full cost of repair or replacement of damaged property, not merely one component of value (such as the value of materials but not labor). Back in 1886, in Commercial FiNe Ins. Co. v. Allen, 1 So. 202 (Ala. 1886), the Alabama Supreme Court explained that "[i]f property had been destroyed which, from use or otherwise, had become less valuable than when new, then the cost of ~repai~ing it, less the percentage of dep~^eciation of the destroyed article by such use, will determine the extent of the damages." Id. at 208 (emphasis added); see also London & L. F. Ins. Co. v. Sto~~s, 71 F. 120, 123 (8th Cir. 1895) ("The question to be settled was the value of the buildings at the time they were burned. Many elements necessarily entered into the determination of this question among theirs, the age of the buildings, and the depreciation of value resulting therefrom."). Courts across the country have recognized for many years that depreciation can properly be determined as a percentage of the full replacement cost amount. See, e.g., Providence Washington Ins. Co. v. Gulinson, 215 P. 154, 155 (Colo. 1923) ("If $3,016 was the cost of repairs it should have been reduced for depreciation at something like the same rate as the cost of the whole reconstruction 50 per cent."); Boise Ass 'n of Credit Men v. United States Fr.'~^e Ins. Co., 256 P. 523, 527 (Idaho 1927) (determining lowest permissible valuation of building based on the evidence of replacement cost and percentage of depreciation per year applied thereto); Real Asset Mgmt. v. Lloyd's of London, 61 F.3d 1223, 1230 (5th 9

16 Cir. 1995) (recognizing that actual cash value was properly determined by applying a depreciation percentage to full replacement cost); Wzsconsin Screw Co. v. Fireman's Fund Ins. Co., 297 F.2d 697, 701 (7th Cir. 1962) (affirming district court judgment determining actual cash value as replacement cost less 50% depreciation); Knuppel v. American Ins. Co., 269 F.2d 163, 1 h6 (7th Cir. 1959) (affirming district court judgment determining actual cash value based on testimony regarding replacement cost less depreciation of 2% per year of the building's age); Svea Fire & Lzfe Ins. Co. v. State Say. &Loan Ass 'n, 19 F.2d 134, 136 (8th Cir. 1927) (affirming jury verdict that was consistent with testimony regarding cost of repair less 25%depreciation). Although one state supreme court found the term "actual cash value" ambiguous (notwithstanding its longstanding meaning) and enforced an insurance department rule prohibiting depreciation of labor costs, even that decision did not conclude that the true and accurate value of property can be determined by estimating the replacement cost and depreciating only the materials. See Adams v. Cameron Mut. Ins. Co., 430 S.W.3d 675 (Ark. 2013). There is no authority supporting the proposition that the true and accurate value of property can be determined by estimating the replacement cost and depreciating only the cost of materials. 10

17 D. Applying Depreciation Only to the Cost of Materials is Inconsistent With The Well-Settled Meaning of "Actual Cash Value" and Longstanding Precedent On Measuring Actual Cash Value Applying depreciation only to the cost of materials, as Plaintiffs advocate in this case, is contrary to the well-settled meaning of "actual cash value," and contrary to longstanding precedent on measuring actual cash value. Under the law of Minnesota and other jurisdictions, a correct measure of the "actual cash value" must measure the "actual value expressed in terms of money" or the "pecuniar[y~" value of the damaged property, which is how courts have defined the term "actual cash value" for decades. See, e.g., McAna~ney, 159 N.E. at 903; Marshall Produce, 256 Minn. at 413, 98 N.W.2d at 288. Suppose, for example, that an old roof is in poor condition and has reached the end of its useful life, when it is damaged by a hailstorm. Under Plaintiff's proposed rule, even if the insured chose not to replace the roof, the insurer would be required to pay for most of the cost of a brand new roof, when the roof had minimal economic value. This is because only the cost of the materials could be depreciated. Put another way, Plaintiffs' proposed rule is contrary to Minnesota law, and that of numerous other jurisdictions, because it would require the insurer to pay, at the initial, actual cash value stage of the claim, substantially more than the "actual value expressed in terms of money" of the damaged property. See McAna~ney, 159 N.F. at 903; Brooks Realty, 276 Minn. at 11

18 253-54, 149 N.W.2d at 501; Marshall Produce, 256 Minn. at 413, 98 N.W.2d at Importantly, the fact that, at the initial actual cash value stage of the claim, the insured would be entitled to only the actual value of the old roof does not mean that the insured would not be able to recover the cost of replacing the old roof with a brand new roof (minus the applicable deductible) under many insurance policies sold in the marketplace. Under policies providing replacement cost coverage after repairs are completed, the insured would be able to recover on a replacement cost basis, and thereby receive an economic gain (a brand new roof, that would have been necessary even in the absence of a loss), simply by making the repairs. In other words, there are insurance policies that provide the exact benefit Plaintiffs seek, as long as they make the repairs. II. IN OTHER RELEVANT CONTEXTS, DEPRECIATION IS APPLIED TO THE FULL VALUE OF A BUILDING, INCLUDING BOTH LABOR AND MATERIALS This Court should also take into account how depreciation is applied in other contexts in which the actual economic value of a building (or portion thereo f is determined, including property tax assessments, eminent domain, real estate appraisals, and other valuations of real property. In those contexts, labor costs are not segregated from material costs for purposes of calculating depreciation and determining actual economic value. Rather, consistent with the longstanding 12

19 practice in the insurance industry, depreciation is applied to the total estimated replacement cost. A. Property Tax Assessments For purposes of property tax assessments, the cost approach to valuation (i.e., replacement cost less depreciation) is one of the methods used to value buildings (along with comparative sales and income valuation approaches, where appropriate). In Northwest Racquet Swim &Health Clubs v. Cnty. of Dakota, S57 N.W.2d 582 (Minn. 1997), for example, where a building had an effective age of 12 years and a useful life of 45 years, this Court affirmed a decision of the tax court applying depreciation of 27% (12 divided by 45) of the total replacement cost. Id. at Consistent with Northwest Racquet, the Minnesota Tax Court has repeatedly applied a depreciation percentage to the entire replacement cost value, not merely the cost of materials. See, e.g., American C~^ystal Sugar Co. v, Cnty. of Polk, 2009 WL , *25(Minn. Tax. Ct. Aug. 5, 2009) (where building had effective age of 45 years and economic life of 6U years, 75% depreciation (45 divided by 60) was applied to the estimated replacement cost); Ca~ef~ee Counti^y Club v. Cnty. of Sherburne, 1988 WL , *4-7(Minn."1 ax. Ct. Sept. 7, 1988) (recognizing that depreciation is applied as percentage of replacement cost); Noah Central Airlines, Inc. v. Cnty. of Hennepin, 1981 WL 1219, *5(Minn. Tax Ct. May 19, 1981) (where building had expected useful life of 13

20 35 years, "[t]his means 1/35th of the cost is subtracted each year for physical depreciation") The leading treatise on property tax assessment, entitled PROPERTY AssEssMENT VALUAT1oN, is published by the International Association of Assessing Officers.2 Here is an example from that treatise regarding calculation of depreciation when using the cost approach: Effective ale = Depreciation Total economic life (effective age +remaining economic life) By using the [above] formula for depreciation, what is the depreciation suffered by the following single-family residence and its corresponding improvement value if the cost new of the residence is $400,000? The total economic life of the residence is estimated to be 50 years, and the appraiser has determined that 5 years is the effective age for the residence. Effective age 5 years Divided by total economic life SU years Equals depreciation 10% Cost new $400,000 Less depreciation $40,000 Improvement value $360,000 Garth E. Thimgan, CAE et al., PROPERTY ASSESSMF,NT VALiJATION (Int'1 2 Courses offered by the International Association of Assessing Officers are approved by the Minnesota State Board of Assessors for purposes of continuing education requirements for Minnesota assessors. See state.mn.us/local_gov/boa/pages/continuing_ Education.aspx. 14

21 Assn of Assessing Officers 3d ed.) at 273 (emphasis added). As this example demonstrates, when using the cost approach to calculate property value, depreciation is applied to the entire replacement cost value. This is the same manner in which "actual cash value" of property has been determined under property insurance policies for decades. B. Eminent Domain and Other Valuations In the context of valuing property being taken by eminent domain, this Court has long held that evidence of the replacement cost less depreciation is admissible, and recognized that depreciation is typically applied as a percentage of the replacement cost value. See, e.g., State v. Red Wzng Laundry &Day Cleaning C'o., 253 Minn. 570, 571, , 93 N.W.2d 206, 207, 209 (1958). Minnesota statutes also provide for valuing property by replacement cost less depreciation for other purposes, and expressly provide for a percentage of depreciation to be applied to the entire replacement cost. See Minn. Stat. 458D.06, subd. 4 (providing for valuation of sewer treatment facilities, for purposes of certain credits given to local governments, based on "the replacement cost depreciated by 2.50 percent per annum from the date of construction of treatment works and 1.25 percent per annum from the date of construction of interceptors"); Minn. Stat , subd. 4 (providing for similar method of depreciation of other sewer treatment facilities). The Minnesota Legislature, in 15

22 enacting these statutes, recognized that it is the entire replacement cost that declines in value over time and is appropriately depreciated, not merely the portion of the replacement cost that is attributable to materials. Similarly, in the context of valuing property for purposes of determining the income from a trust, this Court has also held that depreciation is properly applied as a percentage of the total replacement cost. In ~e Wa~ne~'s Trust, 263 Minn. 449, 465, 117 N.W.Zd 224, 234 (1962) ("If, for instance, a building has a usable life of 10 years, a deduction of 10 percent of the cost price of the building annually may be fair."). C. Real Estate Appraisals The cost approach to valuation of real property (i.e., replacement cost less depreciation) is also used by real estate appraisers as one of several methods of valuing real property for various purposes. The leading appraisal treatise, entitled THE APPRA[sAL of REAL EsTAT~, is published by the Appraisal Institute. Here is an example from that treatise regarding calculation of depreciation when using the cost approach to determine the value of property that includes land and an 18-yearold structure that has a total life expectancy of 50 years: The total percentage of depreciation (36%) is determined by dividing the estimated effective age of 18 years by the total economic life expectancy of 50 years (Step 2). Thus, the economic age-life formula indicates total depreciation of 36%. When this rate is applied to the ~~

23 cost of $668,175, the total depreciation is $240,543 (Step 3). The cost approach is applied as follows: Total [replacement] cost $668,175 Less total depreciation - 240,543 Depreciated cost $427,632 Plus land value +180,000 Indicated value by the cost approach $607,632 THE APPRAISAL OF REAL ESTATE 386 (Appraisal Institute, 13th ed. 2008). This example further demonstrates that, when using the cost approach to calculate market value, depreciation is applied to the entire replacement cost value of the structure. Applying depreciation only to the materials portion of replacement cost value would be contrary to how depreciation is applied in the context of property tax assessments, eminent domain valuations, and standard principles of real estate appraisal.3 This would mean that the same court, when applying the cost approach to valuation (i.e., replacement cost less depreciation), would value the same property in inconsistent ways, depending on whether the valuation is for purposes Plaintiffs' proposed rule regarding application of depreciation also is contrary to the approach of the Internal Revenue Service. If a taxpayer builds a structure, the cost of the labor and materials is included in the taxpayer's basis, and an appropriate rate of depreciation (depending on the category of property) is applied to the taxpayer's full basis. (IRS Publication No (rev. May 2002), at 3; IRS Publication No. 946 (Feb. 15, 2U 13 version), at 44.) 17

24 of a property tax assessment, eminent domain valuation, real estate appraisal, or "actual cash value" insurance purposes. Such substantial inconsistency in property valuations is unwarranted and can undermine public confidence in the courts. III. CONTRACT CERTAINTY IS ESSENTIAL TO A VIABLI+: INSURANCE MARKETPLACE Since at least the late 1800s, insurers calculating "actual cash value" under property insurance policies in Minnesota and throughout the United States have applied depreciation to the entire replacement cost value, and have priced their premiums accordingly. Parties to insurance contracts expect that they will be applied consistent with the manner in which they have been applied by insurers and courts for many years. As this Court has noted, policyholders "pay a premium commensurate with the risk involved," and when courts expand insurers' liabilities beyond what is contemplated by the policy, this "would tend only to increase the premium therefor and put a burden on the insurer which does not in reason or principle belong to him." Wendt v. Wallace, 185 Minn. 189, 191, 240 N.W.2d 470, 471 (1932); see also Garvey v. State Farm Fire ~ Cas. Co., 770 P.2d 704, 711 (Cal. 1989) (stating that, when courts expand insurers' liabilities, this can leave "ordinary insureds to bear the expense of increased premiums necessitated by the erroneous expansion of their insurers' potential liabilities")

25 CONCLUSION AIA respectfully urges the Court to answer the certified question in the affirmative, and rule that an insurer may apply depreciation, where applicable, to the full replacement cost of damaged property, including both the cost of materials and embedded labor components. Respectfully submitted, Dated: July 22, 2015 B ~ /~ William M. Hart, No Meagher &Geer, P.L.L.P. 33 South Sixth Street, Suite 4400 Minneapolis, MN Tel. (612) Fax (612) whart@meagher.com Stephen E. Goldman (pro hac vzce motion pending) Wystan M. Ackerman (pro hac vzce motion pending) Robinson &Cole LLP 280 Trumbull Street Hartford, CT Tel. (860) Fax (860) sgoldman@rc.com wackerman@rc.com Attorneys for Amicus Curiae American Insurance Association 19