Property Insurance By: Michael S. Sherman Chuhak & Tecson P.C. Chicago Illinois Association of Defense Trial Counsel Appraisers Use of Actual Cash Value v. Fair Market Value in First Party Property Claims As the costs and expenses related to litigation continue to rise, the interest in appraisal as an alternative dispute resolution has become increasingly desirable to both plaintiffs and defendants. This is particularly true in the area of first-party property claims where there exist a specific avenue, under most policies, to avoid litigation when the insured and insurer cannot reach an agreement with regard to the amount of a loss. One of the issues which arises when an insured or insurer seeks to demand appraisal concerns what means the selected appraisers will use to arrive at the appropriate amount of damages since generally damages are the only question the appraisers are allowed to answer. Applicable Policy Provision The applicable policy provision which relates to the right to demand appraisal typically provides as follows: Appraisal. If we and you disagree on the value of the property or the amount of loss, either may make written demand for an appraisal of the loss. In this event, each party will select a competent and impartial appraiser. Each party will notify the other of the selected appraiser s identity within 20 days after receipt of the written demand for an appraisal. The two appraisers will select an umpire. If the appraisers cannot agree upon an umpire within 15 days, either may request that selection be made by a judge of a court having jurisdiction. The appraisers will state separately the value of the property and amount of loss. If they fail to agree, they will submit their differences to the umpire. A decision agreed to by any two will be binding. Each party will: a. pay its chosen appraiser; and b. bear the other expenses of the appraisal and umpire equally. Contrary to the above policy language, the Illinois Insurance Code requires that the insurer accept liability for the umpire and the insured s appraiser s fee in certain instances. Standard fire policy; Appraisal When an insured requests an appraisal under a policy of fire and extended coverage insurance, as defined in subsection (b) of Section 143.13, and the insured s full amount of appraised loss is upheld by agreement of the appraisers or the umpire, then the insured s appraisal fee and umpire s appraisal fee shall be paid by the insurer. 215 ILCS 5/397.05 (1991). The Demand for Appraisal The purpose of the appraisal process is generally to resolve the sole issue of the value or amount of a loss. It is not intended to address issues related to the effect of policy conditions, exclusions or other Page 1 of 5
direct coverage issues. As a result of this limitation, certain issues arise with regard to the means by which damages should be determined. Most property policies which contain an appraisal provision do not impose an absolute duty on either party to cause the amount of loss to be determined by appraisal. However, both insured and insurer have the right under the terms and conditions of the policy to demand appraisal unilaterally. As a general rule, either party s demand for appraisal must be made within a reasonable time from when the necessity of appraisal arises, or when it appears that the parties cannot agree. Reilley v. Agricultural Ins.Co. 311 Ill.App. 561, 37 N.E.2d 352 (4th Dist. 1941). An insured s demand will generally be considered timely, unless an insurer can show prejudice or when appraisal has become impractical because of the delay. As for an insurer s demand, it will generally be considered timely as long as good faith negotiations toward settlement have been proceeding. Hanby v. Maryland Casualty Co. 265 A.2d 28 (Del. 1970). Fair Market Value v. Actual Cash Value Although there is not a tremendous amount of case law concerning appraisal in Illinois, there is a recent case which has apparently caused some degree of controversy. In General Casualty Co. v. Tracer Indus., 285 Ill.App.3d 418, 674 N.E.2d 473 (4th Dist. 1996), the court examined a serious discrepancy between the actual cash value of a certain property and its fair market value. In Tracer, General Casualty insured a commercial building located in Havana, Illinois, against loss by, among other things, fire. The building in question had been purchased approximately one week prior to the time of the fire for $67,000. Shortly before the purchase of the property, two real estate appraisers appraised the premises at a market value of between $69,900 and $71,000, with the value of the land alone placed at $52,500. As such, the building itself was worth no more than $18,500. General Casualty and the insureds were able to reach an agreement with regard to the contents portion of this loss but were unable to reach an agreement as to the value or amount of loss for the building portion of this claim. Therefore, a demand for appraisal was made by General Casualty. The policy in this particular case called for any loss to be determined at an amount equivalent to actual cash value. The controversy arose when after proceeding through the appraisal process, with an umpire named by the court, the appraisers award placed the actual cash value of the building at approximately five (5) times higher than the market value. Although it is not uncommon for disputes to arise regarding the value of a loss in matters concerning property insurance, a difference of almost five times between the actual cash value and market value, at a minimum, raised questions of impropriety. Nevertheless, the Tracer court specifically held that there was no indication of fraud or collusion. Tracer, 285 Ill.App.3d at 426, 674 N.E.2d at 477. There is no question that actual cash value and market value are very different concepts. Fair market value is the amount of money which a purchaser willing but not obliged to buy a certain property would pay to an owner willing but not obliged to sell that property. American Reliance Ins. Co. v. Perez, 689 So.2d 290 (Fla. 3rd Dist., 1997). In most states, including Illinois, actual cash value means replacement cost less depreciation for age. Smith v. Allemannia Fire Ins. Co., 219 Ill.App.3d 506, 513 (3rd Dist. 1920); See also C.L. Maddox v. Royal Ins. Co., 208 Ill.App.3d 1042, 567 N.E.2d 749 (5th Dist. 1991). Common Law Basis for Actual Cash Value Since the early 1900 s, the rule in Illinois has been that if the property destroyed is a building the measure of damages is actual cash value not market value. The Smith court set forth as follows: If the property destroyed is a building, the measure of damage is not the market value of the building at the time of the loss, nor what someone would have paid for the building, but the Page 2 of 5
actual value of the property at the time of the loss, as the insured is entitled to be indemnified for the loss sustained. The market value cannot be used as the test in determining the amount of recovery for the destruction of a building for various reasons. If there was no market demand for the property so it could be sold, it would have no value, and consequently there would be no loss. Id. at 512. Accordingly, when applying the Smith rule, as set forth above, to the facts in Tracer it seems somewhat odd that there was such a major discrepancy between the actual cash value amounts arrived at by the appraisers in Tracer. However, the appellate court in Tracer relied heavily on the fact that when a contract provides for a determination of an amount by an appraiser, substantial deference is given to that appraiser. Bailey v. Timpone, 75 Ill.2d 539,545, 389 N.E.2d 1193,1196 (1979). The Broad Evidence Rule Many jurisdictions employ the broad evidence rule to determine the value of damaged property, including but not limited to, buildings. The broad evidence rule has been used in certain jurisdictions in an effort to reach a more realistic value of the property in question. Thus, the broad evidence rule allows the trier of fact, whether a court or an appraiser, to consider all evidence relevant to the value of the property at the time of the loss in order to properly determine the value of the loss. or example, in Chicago Title & Trust Co. v. United F States Fidelity & Guaranty Co., 511 F.2d 241, 245 (7th Cir. 1975) the Seventh Circuit appears to have adopted the broad evidence rule. In relying on the broad evidence rule, the Seventh Circuit held that in determining actual cash value, the trier of fact is entitled to consider all evidence relevant to the value of the property at the time of the loss, including both market value and reproduction value of the property in question. In addition, certain out of state jurisdictions have adopted the broad evidence rule or some form thereof. For example, the Florida courts have actually found that when a policy of insurance uses the term actual cash value it means fair market value. Perez, 689 So.2d at 291. Moreover, the court in Perez determined that all relevant evidence should be allowed to be used in order to make a determination of the property value at the time of loss, including the property s actual cash value, fair market value, depreciation and other related factors. However, it must be noted again that, currently, most Illinois courts do not follow the broad evidence rule and usually do not allow courts or appraisers to consider evidence other than replacement cost less depreciation to determine damages in a loss which requires valuation at actual cash value. Enforceability of Appraisal Clause Illinois courts have consistently held that appraisal clauses in first party property policies are enforceable. Thus, an appraisal clause in an insurance policy is considered to be similar to an arbitration clause and as such, is enforceable in a court of law. Beard v. Mount Carroll Mutual Fire Ins., 203 Ill.App.3d 724, 726, 561 N.E.2d 116,118 (5th Dist. 1990). It has further been held that the appraisal clause applies even in the case of a total loss of the insured property, despite the fact that the appraisal process might be made more difficult because there is no property left to view. In Beard, the insured filed suit based upon the fact that the insured and the insurance company were unable to agree on the amount of his loss. Thereafter, the insurer filed a motion to dismiss alleging that it had made a demand for appraisal and that the insured had refused to submit the matter to Page 3 of 5
appraisal. The insurer further alleged that the plaintiff s suit was barred based upon the policy provision which states that no suit is sustainable in any court unless all the requirements of this policy shall have been complied with. Accordingly, the appellate court reversed the order of the trial court which denied the insurer s motion to compel appraisal and stayed the court proceedings. Further, the appellate court remanded the matter to the trial court to enter an order compelling appraisal. Similarities Between Appraisal and Arbitration Clauses The similarities between appraisal clauses in first party property policies and arbitration clauses have caused some courts to look to the Uniform Arbitration Act for guidance on the applicability of the appraisal clause. As such, it must be noted that some Illinois courts have begun to question whether arbitration clauses are enforceable in certain insurance situations. This is worthy of discussion in the context of appraisal clauses based upon the fact that they have been so closely linked with arbitration clauses. Prior to the adoption of the Uniform Arbitration Act, agreements to submit future or anticipated disputes to arbitration were deemed void as depriving the individual citizen of his right to resort to the courts for the redress of grievances. ILL REV STAT. ch. 10, par. 101 et seq. (1989); Horwath v. Parker, 72 Ill.App.3d 128, 132, 390 N.E.2d 72, 76 (1979). However the Uniform Arbitration Act now provides that parties may agree to submit a future controversy to arbitration, and that such an agreement is valid and enforceable in a court of law. 710 ILCS 5/1 (1996) The limited case law relating to unenforceable arbitration clauses is primarily based upon the construction of uninsured and underinsured motorist type policies and claims. Although there is clearly a difference between an appraisal clause in a first party property policy and the arbitration provision in an uninsured or underinsured clause, the court s rationale for its decisions in these early uninsured and underinsured arbitration clause cases may ultimately become applicable to litigation arising out of a first party property appraisal clause. The only two Illinois cases which seem to address the issue of the validity of arbitration clauses in an automobile policy are Firemans Fund Ins. Co. v. Bugailiskis, 278 Ill.App.3d 19, 662 N.E.2d 555 (2nd Dist.1996), app. denied, 167 Ill.2d 552, 667 N.E.2d 1057 (1996) and Reed v. Farmers Ins. Group, 226 Ill.Dec. 282, 685 N.E.2d 385 (3rd Dist. 1997). In the first such case, Bugailiskis, the defendant alleged that the arbitration clause was void as against public policy because it allowed the award to be appealed only if it exceeded the minimum liability amount set forth under the Illinois Safety Responsibility Act. Bugailiskis, 662 N.E.2d at 555. Similarly, the issue which has fueled the debate on the enforceability of the uninsured and underinsured arbitration clauses have been the existence of alleged escape hatch language in the arbitration clause. Thus, many of the underinsured and uninsured provisions contain certain language which provides that if the arbitration award is below the minimum policy limit required under Illinois Safety Responsibility ($20,000) then it is binding. However, if the award exceeds the statutory amount, it is appealable by either party. As the Illinois Supreme Court had yet to determine the validity of an arbitration clause containing this alleged escape hatch language, the court in Bugailiskis apparently looked to the courts of several other states which had addressed the validity of arbitration clauses which included similar language. The court noted that a majority of the other jurisdictions which have examined this issue have held that the clause itself was void as against public policy. See Mendes v. Automobile Ins. Co., 212 Conn. 652, 563 A.2d 695 (1989); Worldwide Ins. Group v. Klopp, 603 A.2d 788 (Del.1992); Schmidt v. Midwest Family Mutual Insurance Co., 426 N.W.2d 870 (Minn.1988); Hanover Ins. Co. v. Losquadro, 157 Misc.2d 1014, 600 N.Y.S.2d 419 (1993); O Neill v. Berkshire Mutual Ins. Co., 786 F.Supp. 397 (D.Vt. 1992). However, courts in other jurisdictions, including Florida and New Jersey, have held that arbitration clauses which include the alleged escape hatch provision do not violate Page 4 of 5
public policy and are enforceable. See; Roe v. Amica Mutual Ins. Co., 533 So.2d 279 (Fla. 1988); Cohen v. Allstate Ins. Co., 231 N.J.Super. 97, 555 A.2d 21 (1989). Ultimately, in Bugailiskis, the court in reviewing the validity of an uninsured motorist arbitration clause, held that the arbitration clause, because of its provision for a trial de novo, violated public policy and was unenforceable. Bugailiskis, 662 N.E.2d at 558. The court reasoned that although both parties had the opportunity to appeal an award in excess of the statutory minimum, in reality, only the insurer would want this opportunity. The Illinois Supreme Court denied petition for leave to appeal with regard to this alleged escape hatch language as it relates to uninsured and underinsured arbitration clauses. See Bugailiskis, 278 Ill.App.3d at 19, 662 N.E.2d at 555. The second case which reviewed the issue of alleged escape hatch language in uninsured and underinsured arbitration clauses was Reed v. Farmers Ins.Group, 226 Ill.Dec. 282, 685 N.E.2d 385 (3rd Dist. 1997). In Reed, the Plaintiff filed a complaint seeking to have the uninsured motorist arbitration clause of her policy declared void as against public policy. Her claim was based upon the alleged escape hatch language contained within that clause. Upon review, the court declined to find that the alleged escape hatch provision was void as against public policy but did find that the clause was oppressive and therefore unenforceable. Reed, 226 Ill.Dec. at 287, 685 N.E.2d at 390. However, the court specifically stated that in the context of a voluntary arbitration, the escape hatch would seemingly be less oppressive to an insured. Similarly, as the appraisal clause in a first party property insurance policy is basically voluntary to the demanding party, the Reed court s analysis may assist in any argument that suggests that the appraisal clause should be held to be unenforceable. Where the court s construction of uninsured and underinsured arbitration clauses may apply to appraisal is in cases where property policies allow the insurer to retain the right to deny an insured s claim even after the matter has been submitted to appraisal. However, any argument concerning alleged escape hatch type language in an appraisal clause returns to the previously stated purpose of the appraisal process, i.e., that the appraisal process is intended to resolve issues concerning the value or amount of a loss. It is not intended to address issues related to the effect of policy conditions, exclusions or other direct coverage issues. As such, even if an insurer, by the terms of the policy s appraisal clause, retains the right to deny coverage to the insured, it should not be based upon the appraisers damage award but on a potential coverage defense. Thus, a denial based upon a potential coverage defense would be applicable whether or not the matter ever goes to appraisal. Conclusion As both insureds and insurers continue to attempt to keep costs to a minimum and the use of appraisal becomes more popular, it must be remembered that appraisal should only be used to determine the amount or value of a loss where there is a disagreement. Appraisal should not be used to interpret policy conditions, exclusions or other coverage issues. Appraisers must make sure that they comply with the terms and conditions of the policy under which appraisal is demanded when arriving at the damages in each particular case. This includes causing appraisers to apply the appropriate measure of loss especially in the case of an appraisal of actual cash value. About the Author Michael S. Sherman is with the Chicago firm of Chuhak & Tecson, P.C. He concentrates his practice on property insurance coverage and on first and third-party insurance defense litigation matters. Mr. Sherman specializes in the investigation and litigation of property and casualty insurance fraud cases, including first-party and third-party losses, fraudulent bodily injury claims, auto theft, arson and theft losses. Page 5 of 5