At SPECS, we always adapt to ensure that what we are delivering to our clients is clear and eliminates any ambiguity. One of the ways we do this is to make sure that the terminology we use cannot be interpreted in a variety of ways.
There exists some confusion around the term Actual Cash Value (ACV), which is commonly used in the insurance industry. It refers to the cost to replace damaged property with new property of similar kind and quality, less depreciation. However, there has been an occasion where home and business policy owners have contested this definition in court. Most of these cases have come up in instances where a property has been damaged, and there were issues with the amount offered to repair or rebuild. There are those who argue it should mean fair market value—or the amount a buyer would pay a seller if neither were under time constraints. Others think it should take into account the value of cash flow earned through the use of a building.
While many insurance companies still use ACV, SPECS knows repair cost is not the same as actual cash value. To be transparent, we changed the wording in our documentation from ACV to Depreciated Cost Value (DCV) and Depreciated Replacement Value (DRV). Our terminology clearly refers to the depreciated value of repairs reflective of condition and lifespan.
Probably the best way to illustrate why the term ACV can be so contentious is through a hypothetical example.
A fire occurred at a 100-year old home in rural Ontario. The house’s condition before the loss could be described as “original”—the owner had retained all the features typical of the period in which it was built, including custom millwork, plaster walls and ceilings, and double brick walls. At the time of the fire, he was renting the property and wanted the insurance estimate to return the house to its state before the damage. Of course, this would be a far more expensive route than if it was restored using readily available materials typically used today, like drywall.
This brings the idea of value into the conversation.
An appraiser looks at today’s value of the materials, labour, finishes, and structure required to rebuild a property to create an estimate. This repair amount is then reduced by depreciation to arrive at an Actual Cash Value. This final total could differ significantly from the owner’s perception of value, based on factors like how the property is used. For the homeowner, in this case, the real worth was not in the actual structure, but in the rental income stream generated, which he felt was tied to the home’s unique and historic charm.
Before the loss, this homeowner’s property was estimated at $180,000, of which $80,000 was land value. The repair quote to return the structure to its original condition came in at $350,000, minus $100,000 in depreciation, for a total ACV of $250,000. If the owner sold the property the day before the fire, he would have made $180,000. If he took the $250,000 instead of rebuilding and then sold land separately for $80,000, he would walk away with $330,000.
And now, the conversation turns to the concept of indemnity.
Indemnity, one of the basic principles of insurance, states that the insured should be put back to where they were prior to the loss. Seeing as many contribute to insurance policies that fund the few who actually make a claim, it is crucial that no one profits from a loss. Otherwise, it could encourage fraudulent claims.
Circling back to our hypothetical example, by adding the market value before the fire into the equation, if the homeowner pocketed the repair cost and then sold the land, he would benefit at the expense of the insurer—and, consequently, all those insured with the same company. In this case, we provided a valuation, and the adjuster applied the policy to that value. The homeowner ended up taking the depreciated cost value of $100,000 and then sold the land.
It is not our job to tell property owners or insurers what to do, but it is our job to provide a fair and accurate valuation to our clients. This is why it was so important for SPECS to use clearly worded terminology in all our documentation. By better defining value in an insurance context, we better serve our clients.