Gerald Walker v. Auto-Owners Insurance Comp

IN THE

SUPREME COURT OF THE STATE OF ARIZONA

GERALD WALKER, III, AND ADA WALKER,
Plaintiffs,

v.

AUTO-OWNERS INSURANCE COMPANY, A FOREIGN COMPANY,
Defendant.

No. CV-21-0236-CQ
Filed: September 27, 2022

Certified Questions from the
United States District Court for the District of Arizona
The Honorable Cindy K. Jorgenson, Judge
No. CIV 20-449-TUC-CKJ
QUESTIONS ANSWERED

COUNSEL:

Thomas Joseph Snodgrass (argued), Snodgrass Law LLC, Minneapolis,
MN; Robert D. Ryan, Law Offices of Robert D. Ryan, PLC, Phoenix,
Attorneys for Gerald and Ada Walker

Todd A. Noteboom (argued), Stinson LLP, Minneapolis, MN; Sharon W.
Ng, Stinson LLP, Phoenix, Attorneys for Auto-Owners Insurance Company

Thomas B. Dixon, Dixon Law Offices, P.L.C., Phoenix, Attorney for Amicus
Curiae United Policyholders

Gena L. Sluga and Katharine A. Myers, Christian, Dichter & Sluga, P.C.,
Phoenix, Attorneys for Amici Curiae American Property Casualty
Insurance Association and National Association of Mutual Insurance
Companies
GERALD WALKER ET AL. V AUTO-OWNERS INSURANCE COMPANY
Opinion of the Court

JUSTICE KING authored the Opinion of the Court, in which CHIEF
JUSTICE BRUTINEL, VICE CHIEF JUSTICE TIMMER, and JUSTICES
BOLICK, LOPEZ, BEENE, and MONTGOMERY joined.

JUSTICE KING, Opinion of the Court:

¶1 The United States District Court for the District of Arizona
certified two questions to this Court: (1) When a homeowner’s insurance
policy does not define the terms “actual cash value” or “depreciation,” may
an insurer depreciate the costs of both materials and labor in determining
the actual cash value of a covered loss?; and (2) Is the broad evidence rule
applicable in Arizona such that an insurer and/or fact finder may consider
labor depreciation as a pertinent factor in determining actual cash value? 1

¶2 The answer to each question is no, pursuant to the terms of
the homeowner’s insurance policy before us. However, we do not
categorically preclude application of the broad evidence rule with respect
to other homeowners’ insurance policies where appropriate.

I. BACKGROUND

¶3 Gerald and Ada Walker (the “Walkers”) purchased the
Homeowners Insurance Policy (the “Policy”) from Auto-Owners Insurance
Company (“Auto-Owners”), covering a house the Walkers owned in
Tucson from December 15, 2018, through December 15, 2019. Section 1 of
the Policy, entitled “PROPERTY PROTECTION,” described “HOW
LOSSES ARE SETTLED.” Therein, the Policy provided, in relevant part:

Loss to covered property will be settled as follows:

...

1 “Actual cash value” is also referred to as “ACV.”

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Opinion of the Court

(2) If the damaged covered property is insured under
Coverage A – Dwelling or Coverage B – Other Structures . . . ,
we will pay as follows:

(a) If at the time of loss, the limit of insurance applying
to the damaged covered property is 80% or more of the
full replacement cost of that covered property, we will
pay the full cost to repair or replace the damaged part
of such covered property. No deduction will be made
for depreciation. In no event shall we pay more than
the smallest of:

1) the limit of insurance applying to the
damaged covered property;

2) the cost to replace the damaged covered
property with equivalent construction for
equivalent use at the residence premises; or

3) the amount actually spent to repair or replace
the damaged covered property.

(b) If at the time of loss, the limit of insurance applying
to the damaged covered property is less than 80% of
the full replacement cost of that covered property, we
will pay the greater of either:

1) the actual cash value of the damaged covered
property; or

2) the cost to repair or replace the covered
property, less the deductible amount,
multiplied by the ratio of the limit of insurance
applying to the damaged covered property to
80% of its full replacement cost. No deduction
will be made for depreciation.

...

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Opinion of the Court

If you do not repair or replace the damaged
covered property, we shall pay the actual cash
value of the property at the time of loss. Actual
cash value includes a deduction for
depreciation.

(Emphasis in original). The Policy does not define the terms “actual cash
value” or “depreciation.”

¶4 Although Auto-Owners endorses some of its homeowners’
insurance policies with Form 57911, it did not do so with the Walkers’
Policy. Form 57911 defines “actual cash value” and “depreciation” as
follows:

1. Actual cash value means the cost to repair or replace lost
or damaged covered property with new property of
similar quality and features reduced by the amount of
depreciation applicable to the lost or damaged covered
property immediately prior to the loss.

2. Depreciation means a decrease in value because of age,
wear, obsolescence or market value and includes . . . the
cost of materials, labor and services . . . necessary to repair
or replace lost or damaged covered property.

(Emphasis added).

¶5 On May 28, 2019, an accidental water discharge from an
appliance damaged walls and floors in several rooms in the Walkers’ house.
The Walkers submitted a claim under the Policy. Auto-Owners accepted
coverage for the loss.

¶6 The Walkers’ Policy contained replacement cost coverage
(also known as “replacement cost value” or “RCV”), which Auto-Owners
would pay if the insured chose to “repair or replace the damaged covered
property.” The Policy also provided an actual cash value option, which is
the provision that applied to the Walkers’ covered loss here: “If you do not
repair or replace the damaged covered property, we shall pay the actual
cash value of the property at the time of loss. Actual cash value includes a
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Opinion of the Court

deduction for depreciation.” (Emphasis in original). Auto-Owners
depreciated both materials and labor when calculating the actual cash value
of the Walkers’ covered loss.

¶7 The Walkers filed a complaint in the United States District
Court for the District of Arizona, on behalf of themselves and similarly
situated class members, alleging breach of contract and asking for
declaratory and injunctive relief. The Walkers alleged Auto-Owners
underpaid them and other similarly situated insureds by depreciating both
materials and labor when calculating property damage claims under their
homeowners’ insurance policies.

¶8 Auto-Owners filed a motion to dismiss, claiming the Policy
allows it to deduct “‘depreciation’ when estimating the value of ‘the
property,’ and never distinguishes between materials and labor,” and thus
Auto-Owners may deduct both materials and labor when determining
actual cash value. Auto-Owners also argued that “although Arizona case
law regarding [actual cash value] is sparse,” it believed “the Arizona
Supreme Court would likely adopt the ‘broad evidence rule’ for
determining” actual cash value. To resolve the motion, the district court
certified the above-stated questions to us. Observing that no prior
decision of this Court had addressed these questions and that clarification
is warranted, we agreed to answer them. See A.R.S. § 12-1861; Ariz. R.
Sup. Ct. 27.

II. DISCUSSION

A. Depreciation of both Materials and Labor when Determining
Actual Cash Value under the Policy

¶9 We must determine whether Arizona law permits Auto-
Owners, consistent with the terms of the Policy, to depreciate the costs of
both materials and labor when determining the actual cash value of the
Walkers’ covered loss. 2 We begin with an explanation of the difference

2 When discussing the depreciation of labor, we are referring to future
labor—for example, the cost of labor to remove and replace a floor installed

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Opinion of the Court

between a policy that permits depreciation of both materials and labor and
a policy that permits depreciation of materials only. A hypothetical
recently discussed in Mitchell v. State Farm Fire & Casualty Co., 954 F.3d 700,
706 (5th Cir. 2020), aptly summarizes the difference:

[The insured’s] interpretation of “Actual Cash Value”
includes depreciation of only the material components of the
roof. Suppose the hypothetical roof can be replaced for a cost
of $5,000 in materials and $5,000 in labor—a $10,000 roof.
Suppose that the destroyed roof was 10 years old and
expected to last 20 years. Under [the insured’s] interpretation,
the Actual Cash Value would be $7,500, because $2,500 would
be deducted in depreciation (half of the cost of the materials).

By contrast, [the insurer’s] interpretation of “Actual Cash
Value” includes depreciation of both the materials and the
labor in constructing the roof. Using the same example, [the
insurer’s] interpretation would yield an Actual Cash Value of
$5,000, because $5,000 would be deducted in depreciation
(half of the total cost of replacing the roof).

¶10 Here, we are charged with stating the law governing the
interpretation of the Walkers’ Policy. “We accord words used in
[insurance] policies their plain and ordinary meaning, examining the policy
‘from the viewpoint of an individual untrained in law or business.’” Teufel
v. Am. Fam. Mut. Ins. Co., 244 Ariz. 383, 385 ¶ 10 (2018) (quoting Desert
Mountain Props. Ltd. v. Liberty Mut. Fire Ins. Co., 225 Ariz. 194, 200 ¶ 14 (App.
2010)). “If a policy is subject to ‘conflicting reasonable interpretations,’ it
is ambiguous, and we interpret it by examining, as pertinent here, the
‘transaction as a whole.’” Id. (internal citation omitted) (first quoting State
Farm Mut. Auto. Ins. Co. v. Wilson, 162 Ariz. 251, 258 (1989); and then quoting
First Am. Title Ins. Co. v. Action Acquisitions, LLC, 218 Ariz. 394, 397 ¶ 8

in 2010 that was damaged in 2022. We are not referring to the labor
performed in 2010, which was included in the value of the floor before the
loss. The parties do not dispute that valuation of the property pre-loss
includes depreciation of both labor and materials because those two
components cannot be separated once the floor has been constructed.
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Opinion of the Court

(2008)). “If an ambiguity remains, we construe it against the insurer.”
Id.; see also Sec. Ins. Co. of Hartford v. Andersen, 158 Ariz. 426, 428 (1988)
(“Where ambiguity in an insurance contract exists, the policy will be
construed against the insurer.”); Sparks v. Republic Nat’l Life Ins. Co.,
132 Ariz. 529, 534 (1982) (“Where the language employed is unclear and can
be reasonably construed in more than one sense, an ambiguity is said to
exist and such ambiguity will be construed against the insurer.”).

1. Methodologies for Determining Actual Cash Value

¶11 “Insurance contracts often fail to define ‘actual cash value,’
leaving that task to the courts.” Dickler v. CIGNA Prop. & Cas. Co., 957 F.2d
1088, 1097 (3d Cir. 1992). To that end, the “discussion about the
depreciation of labor costs [when determining actual cash value] is not
occurring in a vacuum.” Lammert v. Auto-Owners (Mut.) Ins. Co.,
572 S.W.3d 170, 175–78 (Tenn. 2019) (collecting cases from multiple
jurisdictions). Here, as in Lammert, “both sides have presented many cases
supporting their divergent positions.” Id. at 175. It is clear that the
“question before us has been the subject of much litigation, and it has
divided the state and federal courts.” Sproull v. State Farm Fire & Cas. Co.,
184 N.E.3d 203, 210–16 ¶¶ 20–42 (Ill. 2021) (collecting cases from multiple
jurisdictions regarding the depreciation of labor when determining actual
cash value). As “state and federal courts have split on this issue,” some
“have adopted the view that labor can be depreciated” when determining
actual cash value, id. at 211–12 ¶ 28, while others “have held that labor may
not be depreciated” for varying reasons. Id. at 213 ¶ 33.

¶12 As the Dickler court observed, “[c]ourts confronting such
contracts have defined the term ‘actual cash value’ in essentially three ways:
1) as fair market value[,] 2) as replacement cost less depreciation, and 3)
according to the ‘broad evidence’ rule.” 957 F.2d at 1097–99 (collecting
cases from various jurisdictions with different methodologies of
determining actual cash value in an insurance policy); see also Lammert,
572 S.W.3d at 174 (“[T]here are multiple methods for determining actual

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Opinion of the Court

cash value, including market value, replacement cost less depreciation, and
the broad evidence rule.”). 3

¶13 The relevant language in the Walkers’ Policy states, “If you
do not repair or replace the damaged covered property, we shall pay the
actual cash value of the property at the time of loss. Actual cash value
includes a deduction for depreciation.” (Emphasis in original).
Although the first sentence, standing alone, could arguably support a
market-based valuation, we must read these two sentences together. See
Apollo Educ. Grp., Inc. v. Nat’l Union Fire Ins. Co., 250 Ariz. 408, 411 ¶ 11
(2021) (noting that an “insurance policy is a contract” and we “interpret the
terms in the broader context of the overall contract” (citation omitted)
(internal quotation marks omitted)). The second sentence—“Actual cash
value includes a deduction for depreciation”—modifies the meaning of the
first sentence providing that Auto-Owners “shall pay the actual cash value
of the property at the time of loss.” When the two sentences are read
together, we conclude the Policy adopts the replacement cost less
depreciation (“RCLD”) method for determining actual cash value.

¶14 Courts have applied the RCLD methodology to homeowners’
insurance policies containing language similar to the Policy here. In
Coppins v. Allstate Indem. Co., 857 N.W.2d 896, 899 ¶ 4 (Wis. Ct. App. 2014),
the insurance policy “did not define ‘actual cash value,’” but the policy “did
provide some clues as to how ‘actual cash value’ would be calculated in the
event of a covered loss.” There, the policy provided that the insurer
would “pay for a loss to [the] covered property on an actual cash value
basis, meaning there may be a deduction for depreciation.” Id. A
separate endorsement similarly stated, “Loss to property insured by this
policy . . . will be settled on an actual cash value basis. This means there
may be a deduction for depreciation.” Id. at 899 ¶ 5 (alteration in original).

3 Auto-Owners acknowledges these differing methodologies, noting that
“[c]ourts have created several approaches to resolving disputes about ACV,
including the market-value method, the replacement-cost-less-depreciation
method, and, most recently, the broad-evidence rule.”
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Opinion of the Court

¶15 The Coppins court determined the policy’s language that
“there may be a deduction for depreciation” mandated use of the RCLD
methodology:

The policy language, the commonly-accepted definitions of
“actual cash value” . . . and our directive to interpret the
policy from the standpoint of a reasonable insured, all
support a conclusion that actual cash value should have been
calculated primarily by subtracting depreciation from the cost
to replace the damaged materials.

Id. at 905 ¶ 30 (internal citation omitted). Here, as in Coppins, “nothing in
this policy would tip off an insured to the fact that ‘broad evidence’” or
“market value[] would be used to calculate the loss. If [the insurer]
planned to [use a different method] to determine coverage, the policy
should have clearly said so.” Id. at 906 ¶ 31; see also Lammert, 572 S.W.3d
at 171–73, 178–79 (analyzing a homeowner’s insurance policy under the
RCLD methodology where the policy stated “actual cash value includes a
deduction for depreciation” and the parties agreed “the method used to
calculate the actual cash value is replacement cost less depreciation”); see
also Dickler, 957 F.2d at 1091, 1098 (concluding that an actual cash value
definition that contained “less depreciation” language contemplated use of
the RCLD methodology).

¶16 We further note that an Arizona Department of Insurance
homeowner’s insurance publication (“Homeowners Insurance Check-Up”)
defines “Actual Cash Value (ACV)” as “the cost to repair or replace the
damaged property with materials of like kind and quality, less depreciation
of the damaged property.” Ariz. Dep’t of Ins., Homeowners Insurance
Check-Up 2 (2015), https://difi.az.gov/sites/default/files/documents
/files/Homeowners_Check_Up_04%202015.pdf. This publication further
supports an understanding, “from the viewpoint of an individual
untrained in law or business,” Teufel, 244 Ariz. at 385 ¶ 10 (quoting Desert
Mountain Props., 225 Ariz. at 200 ¶ 14), and “in light of the objective,
reasonable expectations of the average insured,” Gordinier v. Aetna Cas. &
Sur. Co., 154 Ariz. 266, 272 (1987), that the RCLD methodology would be
used to determine actual cash value.

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Opinion of the Court

¶17 We conclude the Walkers’ Policy, which fails to prescribe any
other methodology for determining actual cash value, adopts the RCLD
methodology.

2. Does the RCLD Methodology Permit Depreciation of
Labor?

¶18 We must next determine whether the RCLD methodology
permits a deduction for depreciation of labor when determining actual cash
value. Several other courts of last resort have already concluded that labor
is not depreciable when actual cash value is determined through the RCLD
methodology.

¶19 In Sproull, the Illinois Supreme Court explained that
“[s]everal state and federal courts have held that the language ‘replacement
cost less depreciation’ would not necessarily indicate to a reasonable
insured that labor would be depreciated in determining ACV.”
184 N.E.3d at 219 ¶ 49. Thus, when the method of determining actual cash
value is replacement cost less depreciation, “depreciation may not be
applied to the intangible labor component.” Id. at 221 ¶ 54 (quoting
Sproull v. State Farm Fire & Cas. Co., 172 N.E.3d 1186, 1198 ¶ 41 (Ill. App. Ct.
2020)).

¶20 In Lammert, the Tennessee Supreme Court held that “labor
may not be depreciated when the insurance company calculates the actual
cash value of a property using the replacement cost less depreciation
method.” 572 S.W.3d at 179. Instead, “depreciation can only be applied
to the cost of materials, not to labor costs.” Id.

¶21 Further, in Adams v. Cameron Mutual Insurance Co., 430 S.W.3d
675, 676 (Ark. 2013), the policy provided that “[c]overed property losses are
settled at actual cash value at the time of loss but not more than the amount
required to repair or replace the damaged property,” and the insurer
calculated “the depreciation of the items requiring repair” in determining
“actual cash value.” There, the Arkansas Supreme Court concluded it
“simply cannot say that labor falls within that which can be depreciable.”
Id. at 679.

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Opinion of the Court

¶22 And in Bellefonte Insurance Co. v. Griffin, 358 So. 2d 387, 389
(Miss. 1978), the Mississippi Supreme Court reviewed a policy that
provided an insurer’s liability was “what it would then cost to repair or
replace the automobile or such part thereof with other of like kind and
quality, with deduction for depreciation.” The court concluded “the trial
court was correct in disallowing proof of depreciation on repairs” (i.e., labor
depreciation). Id. at 391; see also Mitchell, 954 F.3d at 706–07 (concluding
an insurer may not depreciate labor where “Actual Cash Value” in policy
means “cost of replacement less depreciation”).

¶23 In Arizona, “[i]f an insurer desires to limit its liability under a
policy, it should employ language which clearly and distinctly
communicates to the insured the nature of the limitation.” Sparks,
132 Ariz. at 535. Auto-Owners failed to draft its homeowner’s insurance
policy to expressly include depreciation of labor in the calculation of actual
cash value. It chose not to define the terms “actual cash value” and
“depreciation.” We construe any resulting ambiguity against Auto-
Owners. See id. at 536–37 (construing ambiguity against insurer where
“the policy language . . . fall[s] far short of clearly and distinctly
communicating to the insured the nature of the limitation asserted by
defendants”). 4

¶24 We are charged with interpreting insurance provisions “in
light of the objective, reasonable expectations of the average insured.”
Gordinier, 154 Ariz. at 272 (“Where the contract terms . . . cannot be

4 We further observe that, since at least 2002, insurers have known of the
disagreement about whether labor may be depreciated when determining
actual cash value. See Redcorn v. State Farm Fire & Cas. Co., 55 P.3d 1017,
1023 ¶ 10 (Okla. 2002) (Boudreau, J., dissenting) (“I would respond to the
certifying court that in determining actual cash value of a residential roof
using the replacement cost less depreciation method, labor costs may not
be depreciated.”); see also Arnold v. State Farm Fire & Cas. Co., 268 F. Supp.
3d 1297, 1310 n.18 (S.D. Ala. 2017) (“[T]he defendant has not explained why
it should be judicially protected from this foreseeable consequence of its
own imprecise drafting regarding an issue of which it has been actually
aware (as the defendant in Redcorn) since at least 2002. That the defendant
scraped by with a 5-3 decision might well have prompted a reasonable
insurer to consider defining ACV so as to eliminate any controversy.”).
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Opinion of the Court

understood by the reasonably intelligent consumer who might check on his
or her rights, the court will interpret them in light of the objective,
reasonable expectations of the average insured.”); see also Apollo Educ. Grp.,
250 Ariz. at 412 (noting the rule of construing ambiguous terms against the
insurer “exists to protect ordinary consumer insurance purchasers”).
Accordingly, we conclude that if a policy adopts the RCLD methodology
for determining actual cash value, as the Walkers’ Policy did here, the
insurer is precluded from depreciating labor when determining the actual
cash value of the covered loss.

B. Applicability of the Broad Evidence Rule

¶25 We have also been asked whether the broad evidence rule is
applicable in Arizona for the purpose of determining actual cash value.

¶26 As previously noted, courts charged with determining the
meaning of actual cash value have defined that term in three ways: (1) as
fair market value; (2) as RCLD; and (3) according to the “broad evidence”
rule. See Dickler, 957 F.2d at 1097; Lammert, 572 S.W.3d at 174. The
second certified question is now moot given our conclusion that the
Walkers’ Policy adopts the RCLD methodology, rather than the broad
evidence rule. See Lammert, 572 S.W.3d at 178 (“[W]hether Tennessee is a
broad evidence state is not at issue because in this case, as the homeowners
point out, the parties agreed that the actual cash value was to be calculated
based on the replacement cost [less depreciation] method.”); see also Dickler,
957 F.2d at 1100 (explaining the broad evidence rule “should not be
considered by a factfinder where, as here, the parties have precluded
application of the ‘broad evidence’ rule by defining actual cash value as
replacement cost less depreciation”).

¶27 Nonetheless, because the second certified question asked
more generally whether “the broad evidence rule [is] applicable in
Arizona,” we clarify that our conclusion with respect to the Walkers’ Policy
does not bar application of the broad evidence rule under other
homeowners’ insurance policies in Arizona, and we provide guidance for
when it may be applied. First and foremost, the parties’ policy terms will
dictate the methodology for determining actual cash value where, as here,
a court is able to discern which methodology the policy adopts. See Apollo
Educ. Grp., 250 Ariz. at 411 ¶ 11 (“An insurance policy is a contract, and in
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Opinion of the Court

an action based thereon the terms of the policy must govern.” (quoting
Dairyland Mut. Ins. Co. v. Andersen, 102 Ariz. 515, 517 (1967))).

¶28 But where the terms of a homeowner’s insurance policy do
not define actual cash value or the methodology to be used for determining
it, we adopt the following approach. First, “[w]here market value is easily
determined [for a covered loss], actual cash value is market value.” Henn
v. Am. Fam. Mut. Ins. Co., 894 N.W.2d 179, 184 (Neb. 2017) (quoting Olson v.
Le Mars Mut. Ins. Co. of Iowa, 696 N.W.2d 453, 458 (Neb. 2005)). Second, “if
there is no market value, replacement or reproduction cost may be used.”
Id. Third, “failing the other two tests, any evidence tending to formulate
a correct estimate of value may be used,” which is the broad evidence rule.
Id. at 184–85. The broad evidence rule provides that actual cash value may
be determined by

consider[ing] every fact and circumstance which would
logically tend to the formation of a correct estimate of the
building’s value, including the original cost, the economic
value of the building, the income derived from the building’s
use, the age and condition of the building, its obsolescence,
both structural and functional, its market value, and the
depreciation and deterioration to which it has been subjected.

Id. at 185 (quoting Erin Rancho Motels v. U.S. Fid. & Guar. Co., 352 N.W.2d
561, 564–65 (Neb. 1984)). In sum, while the broad evidence rule is not
applicable to the Walkers’ Policy, it may apply where the terms of the policy
do not dictate otherwise in the context of other homeowners’ insurance
policies in Arizona.

III. CONCLUSION

¶29 We answer the questions presented by the District Court as
follows. Under the terms of the homeowner’s insurance policy before us,
an insurer may not depreciate the cost of labor when determining actual
cash value and the broad evidence rule does not apply. However, we do
not bar application of the broad evidence rule where the terms of the policy
do not dictate otherwise in the context of other homeowners’ insurance
policies in Arizona.

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