Market value should be used to determine property coverage under an industry standard policy – not replacement cost – according to a recent decision from the 8th U.S. Circuit Court of Appeals.

The case involved the theft of electrical wiring from Buddy Bean Lumber Co. lumberyard in Hot Springs, Arkansas. Buddy Bean filed a claim seeking the actual cash value of the wire, about $725,000.

But Buddy Bean’s insurer, Axis Surplus Insurance Co., refused coverage. Axis pointed to the coinsurance provision in Buddy Bean’s policy that required the lumberyard to take out coverage equivalent to 90% of the value of its mills. If the policy limit fell below that percentage of value, Buddy Bean would be penalized on its claims in proportion to the shortfall.

Axis valued Buddy Bean’s property using replacement cost for a total of $21,024,000. Because the policy limit was $3,837,500, it fell far below the required 90%, Axis argued. The coinsurance penalty therefore limited the claim to just $98,000.

Buddy Bean filed suit, arguing that the term “value” in its coinsurance policy meant actual cash value and not replacement cost. The industry standard form at issue defined the term “value of Covered Property” as “actual cash value as of the time of loss or damage.” But Axis contended that Buddy Bean opted to purchase expanded coverage that changed that definition. Specifically, the lumberyard selected optional replacement cost coverage.

In response, Buddy Bean said the purchase of optional coverage did not dictate the type of valuation. Instead, the “value of Covered Property” depended on the type of claim filed by the insured – in this case, actual cash value. If the insured was penalized on claims made on basic coverage, there would be no point in purchasing replacement cost coverage, the lumberyard argued.

Noting similar decisions from a Washington state court and a North Carolina federal court, the 8th Circuit agreed with Buddy Bean. “[T]he proper interpretation of the coinsurance provision depends on whether the insured has filed an actual cash value claim or a replacement cost claim,” the panel held. “In order to calculate whether Buddy Bean is subject to a coinsurance penalty on that claim, then, the term ‘value’ in the coinsurance provision should be read as the actual cash value of Buddy Bean’s saw and planning mills.”

This reading of the coinsurance provision “makes sense of the ‘whole policy,’ as Arkansas law directs. Buddy Bean’s choice to purchase a type of expanded coverage was not intended to vitiate its basic coverage,” the court wrote. “If Buddy Bean’s decision to buy replacement cost coverage would automatically change how to calculate the coinsurance provision, the insured would always suffer a substantial coinsurance penalty even on actual cash value claims.”

As the property values were undisputed, the court determined that Buddy Bean was not subject to a coinsurance penalty and was therefore entitled to receive its claim of $725,000 for the stolen wire, less undisputed deductibles and an interim payment made by Axis, for a total of $575,000.

To read the decision in Buddy Bean Lumber Co. v. Axis Surplus Insurance Co., click here.

Why it matters: To determine whether market value or replacement cost should be used to value the insured’s claim, the court looked to the meaning of “value” in the policy as a whole. The purchase of additional coverage for replacement cost claims did not dictate the 8th Circuit’s outcome. The panel noted that when read together, the additional coverage and the coinsurance provision would result in policyholders facing a stiff penalty on most claims – an unlikely outcome that would “vitiate” the policyholder’s basic coverage. Reading the policy as a whole, the court found that basing the definition of “value” on the type of claim filed by the policyholder made the most sense.