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In a typical property loss situation the insured’s personal dwelling sustains damage. The insurance company may offer the insured to “cash out” the repair claim. When this occurs, the insurance company will typically pay the insured the difference between a contractor’s estimated cost of repair excluding the profit and overhead charges that are otherwise included in the estimate. Under the policy, the insurance company will typically advise its insured that if the insured decides to use a general contractor, upon the submission of a signed contract or a paid bill, the insurance company will reimburse the contractor profit and overhead.
The standard homeowner’s policy provides that, in the event of a loss, the insurance company has the option of electing either to repair, rebuild or replace the property itself or to pay the insured for the damaged property. If the insurance company chooses not to repair the property itself, the insurance company can pay to its insured the actual cash value for the property. If the insured chooses to repair, rebuild or replace the damaged property within 180 days of the actual cash value payment, the insurance company will make an additional payment to reimburse the insured for the cost of the repair, rebuild or replacement in excess of the actual cash value. The additional payment will include the reasonable and necessary expense required to complete the repair or replacement.
Against this claim loss backdrop, insureds will often argue that actual cash value should include contractor’s profit and overhead even though a contractor was not utilized. The claim for contractor’s profit and overhead is typically rejected by the insurance company in situations where the insured repairs the property himself because the insured has not employed a general contractor and, therefore, did not actually incur contractor’s profit and overhead fees.
The courts are split on whether the insured is entitled to profit and overhead fees when the insured does not retain the contractor. As an example, in Snellen v. State Farm Fire & Casualty Co., 675 F.Supp. 1064 (W.D. Ky. 1987), the court rejected the insured’s claim that contractor’s profit and overhead should be part of the ACV value. The Snellen case represents the old school approach to this issue. However, other courts are beginning to find that the insured is entitled to contractor’s profit and overhead as part of the ACV payment. As an example, in Gilderman v. State Farm Insurance Co., 437 Pa.Super. 217, 649 A.2d 941 (1994), the court noted that there are some types of property damage where a homeowner would use the services of a general contractor especially in those situations where there is extensive damage to the home requiring the use of more than one trade specialist. In those instances, the court found that the insurance company was not permitted to deduct contractor fees from the actual cash value when such fees were reasonably expected to be incurred. See also, Salesin v. State Farm Fire & Casualty Co., 229 Mich.App. 346, 581 N.W.2d 781, 783-84 (1998), where the court reasoned that because ACV is an estimate of all costs that will likely and reasonably be incurred in repairing or replacing the damaged property, the expense of a general contractor cannot be deducted from the estimate unless such services are not likely to be required.
Those courts which have required the payment of contractor’s profit and overhead fees as part of the ACV have focused on the future likelihood that a general contractor would be needed even though the insured did not actually incur the contractor fees. This is a forward-looking analysis which presumes potential utilization of a contractor under certain circumstances.
Those courts that favor payment of contractor’s profit and overhead fees focus on the language of the policy with the understanding that ACV is an estimate of the needed repairs; the determination of ACV is not based upon what the insured actually pays to repair or replace the damaged property. Therefore, the amount an insured ultimately spends to make needed repairs, if any, is irrelevant.
Claims professionals must familiarize themselves with the specific case law in the jurisdiction where the property loss occurred regarding whether a contractor’s profit and overhead fees must be paid as part of an ACV payment. While many jurisdictions require that the insured actually incur profit and overhead fees by retaining a contractor who actually performs the repair work, or by at least entering into a contract with a contractor to perform the repairs, some jurisdictions require the insurance company to reimburse for contractor’s profit and overhead even though a contractor has not been retained.
Where the nature of the repairs is extensive, requiring the use of more than one trade specialist to perform the repairs, then the adjuster needs to consider whether the jurisdiction in which the claim arose requires that repair or replacement costs include contractor’s fees.
The rationale behind this requirement is that the repair or replacement costs which are paid initially under the policy are to include any cost that the insured is reasonably likely to incur in repairing or replacing the loss, even though the insured may never ultimately make the repairs. This is so because the ACV is an estimate of all costs that will likely and reasonably be incurred in repairing or replacing the damaged property. In those situations where a contractor is unlikely to be required, then profit and overhead expenses can be withheld from the ACV payment. The key criteria is the extent of damage and whether there is a reasonable likelihood that more than one trade specialist would be required to perform the repairs.
If the insurance company wants to exclude contractor’s profit and overhead in situations where no contractor has been utilized, then it must do so in the wording of its insurance policy’s definition of actual cash value for dwelling coverage.