“Matching Regulations” Affecting Homeowners’ Insurance Claims

Homeowners Insurance PolicyIt remains one of the most difficult issues to deal within the world of property insurance. Homeowners’ insurance policies usually contain a provision obligating the carrier to repair or replace an insured’s damaged property with “material of like kind and quality” or with “similar material.” They cover property damage resulting from “sudden and accidental” losses. When damage caused by fire, smoke, water, hail, or other causes results in a small portion of a home or building being damaged (e.g., shingles, siding, carpet, cabinets, etc.), whether and when a carrier must replace non-damaged portions of a building in order for there to be a perfect match remains a point of contention. It is a matter of great importance to insurance companies because “matching” problems can turn a relatively small property damage claim into a big one. Replacing a slightly-damaged section of roof, siding, or flooring can lead to a domino effect of tearing out and replacing entire sections of property that are in perfect condition, functioning fine, and not damaged. The necessity of this expensive remedy often resides in the eye of the beholder.

Would the entire structure need to be re-sided or the entire roof re-shingled? Or is it sufficient to replace just one wall of siding or just a few shingles? Whether or not the insurance company must pay to replace entire sections of the structure in order to bring the property back to its previous uniformity and aesthetics can bring various state insurance laws and regulations into play. On the one hand, many pundits claim that the terms of the insurance policy require the carrier to pay the cost to “repair or replace with similar construction for the same use on the premises.” They argue that “similar” doesn’t mean matching exactly. Others argue that coverage for “matching” and “uniformity” under a homeowner’s policy doesn’t exist without a specific endorsement. The truth lies somewhere in between and can vary greatly from state to state.

Replacement Cost Value (RCV) vs. Actual Cash Value (ACV) Policy

There are two primary valuation methods for establishing the value of insured property for purposes of determining the amount the insurer will pay in the event of loss under a homeowner’s policy:

  • Replacement Cost Value (RCV): This method is usually defined in the policy as the cost to replace the damaged property with materials of like kind and quality, without any deduction for depreciation. It pays an insured for the value of replacing the damaged property without deduction for deterioration, obsolescence, or similar depreciation of the property’s value. The carrier assumes the cost of paying the full cost of repairing or replacing the damaged property.
  • Actual Cash Value (ACV): This method pays an insured for a similar item less depreciation. ACV is ordinarily determined in one of three ways: (1) the cost to repair or replace the damaged property, minus depreciation; (2) the damaged property’s “fair market value” (“FMV”); or (3) using the “broad evidence rule,” which calls for considering all relevant evidence of the value of the damaged property. The insured bears the difference between the depreciated value of the damaged property prior to loss and the higher cost of repairing or replacing it.

The issue of “matching” or “uniformity” in first-party homeowners insurance claims is one that lends itself to RCV policies. If property is only partially damaged, the carrier takes the position that it is only required to pay for repair or replacement of the limited portion of the property that is damaged. The insured argues that replacing only the damaged property restores the functionality of the roof but does not fully replace the damaged property because the replaced property does not match the existing property. For example, a roof had a uniform appearance, and uniformity has a significant effect on value. Therefore, the proper measure of RCV is the cost to replace the entire roof to restore the uniform appearance. This is known as the issue of “matching” or “uniformity.” The issue is whether the carrier has to “match” the damaged property to the undamaged property in order to return it to its previous “uniform” appearance and restore the entire home to its condition prior to loss.

Whether the policy is an RCV or ACV policy can make a big difference. ACV coverage pays an insured for a similar item less depreciation. RCV coverage compensates an insured for the value of replacing the damaged property without deduction for deterioration, obsolescence, or similar depreciation of the property’s value. An insurer with an ACV policy may be able to exercise the option to repair, restore, or replace the damaged property itself rather than having to pay for the cost to repair the property with property of like kind and quality. Moreover, some “matching” regulations only apply to RCV policies.

A good illustration of the matching/uniformity problem is found in a 2014 Minnesota federal district court case in which a manufacturer discontinued the shingles used on the insured’s roof, thus leading to a mismatch problem. The issue was whether the carrier was obligated to replace the damaged shingles with substantially similar shingles or to pay for new shingles for the entire roof. Trout Brook S. Condo. Ass’n v. Harleysville Worcester Ins. Co., 995 F. Supp.2d 1035 (D. Minn. 2014). The Harleysville RCV policy provided coverage which obligated it to pay for the property’s “replacement cost,” defined as:

(1) “the cost of repair or replacement with similar materials for the same use and purpose, on the same site” or

(2) “the cost to repair, replace, or rebuild the property with material of like kind and quality to the extent practicable.”

Harleysville claimed only partial damage to the roof and allocated $21,000 for roof repairs, but the insured’s construction expert believed the roof had to be entirely replaced at a cost of more than $800,000. In addition, the shingles were no longer being manufactured. The insured sued, arguing that the unavailability of matching shingles entitled it to full roof replacement. The court noted that the “covered property” under the policy was defined as the buildings (rather than the individual items on the property) and held there was a jury question as to whether the building suffered a loss on account of the unavailability of matching roof shingles. Whether Harleysville was able to replace shingles with shingles of a “like kind and quality” hinged on whether the unmatched shingles would provide an acceptable aesthetic result, and that had to be determined by a jury. The idea is that property that has not been physically damaged may become “damaged” where replacement of physically damaged property does not lead to an aesthetic result acceptable to the insured. It suggests that the carrier has an obligation beyond repairing the functionality of the damaged property, by paying to repair the aesthetics of the building.

Notwithstanding any insurance regulations that control the issue, a carrier’s obligation to pay for matching depends on the policy language and hinges on whether the loss payment and valuation terms of the policy can be read to obligate the carrier to match the replacement materials. The industry’s response is that allowing coverage for matching provides a windfall to the insured. To allow for full replacement of matching roofing and siding can be unduly burdensome on a carrier whose policy agrees only to repair damaged portions of the building.

Terms of Insurance Policy

The terms of insurance policies vary greatly and are extremely important to determining the carrier’s obligations in a claim which involves a “matching” concern. The current ISO HO-3 and HO-5 and company-specific policies contain “Loss Settlement” provisions which provide for payment of the “replacement cost of that part of the building damaged with material of like kind and quality and for like use.”

Individual insurance companies may have a variety of other standard terms included in their policies. Some policies may have other terms, conditions, and/or definitions which attempt to address the “matching” or “uniformity” issue and limit exposure in such situations. Some policies even contain “Roof Surfacing Loss Percentage Tables” which address the percentage of a roof the carrier will be obligated to replace as a function of the roof’s age and type of roofing surface material. Overshadowing all of the above are a patchwork of insurance statutes and regulations which attempt to govern claims which have a “matching” or “uniformity” component to them.

In response to a proliferation of “matching” claim issues, many insurers have begun inserting language in their policies that expressly precludes the coverage requirement of matching based upon color, a change in product specifications, or other factors, in an attempt to circumvent this clear precedent. Many states have statutes, insurance bulletins, or case law that directly address matching issues, but many do not.

Insurance Statutes, Regulations, and Case Decisions Governing Matching Claims

In an effort to provide uniformity and predictability in this area, many states have passed insurance statutes, rules, and regulations that govern the handling of matching claims. An Ohio regulation states that when “an interior or exterior loss requires replacement of an item and the replaced item does not match the quality, color, or size of the item suffering the loss, the insurer shall replace as much of the item as to result in a reasonably comparable appearance.” O.A.C. § 3901-1-54(I). In Kentucky, a regulation says that if “a loss requires replacement of items and the replaced items do not reasonably match in quality, color, or size, the insurer shall replace all items in the area so as to conform to a reasonably uniform appearance,” although the courts have not applied the regulation in private litigation. 906 Ky. Admin. Regs. § 12:095 § 9(b). Whether the statute or regulation applies, and whether the insured can bring a private right of action under the applicable statute or regulation, are also significant issues.

The National Association of Insurance Commissioners (NAIC) has drafted a model law called the “Unfair Claims Settlement Practices Act.” It is a consumer-protection law that prevents insureds from predatory and unfair claims settlement behavior on the part of insurance companies. Most states have enacted their own version of this model law, and the specifics of each such law vary from state to state. The NAIC Unfair Property/Casualty Claims Settlement Practices Model Regulation (MDL-902, 1997) has a section which reads as follows:

Section 9. Standards for Prompt, Fair and Equitable Settlements Applicable to Fire and Extended Coverage Type Policies with Replacement Cost Coverage.

A. When the policy provides for the adjustment and settlement of first party losses based on replacement cost, the following shall apply:

(1) When a loss requires repair or replacement of an item or part, any consequential physical damage incurred in making such repair or replacement not otherwise excluded by the policy shall be included in the loss. The insured shall not have to pay for betterment nor any other cost except for the applicable deductible.

(2) When a covered loss for real property requires the replacement of items and the replacement items do not match in quality, color or size, the insurer shall replace items in the area so as to conform to a reasonably uniform appearance. This applies to interior and exterior losses. The insured shall not bear any cost over the applicable deductible, if any.

On the other hand, subsection (B) governs ACV policies and reads as follows:

B. Actual Cash Value:

(1) When the insurance policy provides for the adjustment and settlement of losses on an actual cash value basis on residential fire and extended coverage, the insurer shall determine actual cash value as follows: replacement cost of property at time of loss less depreciation, if any. Upon the insured’s request, the insurer shall provide a copy of the claim file worksheets detailing any and all deductions for depreciation.

(2) In cases in which the insured’s interest is limited because the property has nominal or no economic value, or a value disproportionate to replacement cost less depreciation, the determination of actual cash value as set forth above is not required. In such cases, the insurer shall provide, upon the insured’s request, a written explanation of the basis for limiting the amount of recovery along with the amount payable under the policy.

While Section A of the above regulation establishes a guideline for the insurance company to follow with regard to the payment of claims involving “matching” or “uniformity” issues, it doesn’t necessarily mean that a carrier in any individual state must adhere to those guidelines or that the regulation works to the advantage of a property owner who has been wronged by a carrier who simply ignores the regulation.

Private Right of Action

Most states have case decisions that state that an individual homeowner/insured does not have a private right of action under a state’s statute or regulations governing unfair claims settlement practices and the handling of a “matching” or “uniformity” issue. As an example, in California, the case of Rattan v. United Services Automobile Association, 101 Cal.Rptr.2d 6 (Cal. App. 2000) involved a home damage by fire. United Services Automobile Association (“USAA”) allegedly breached the terms of policy in adjusting the loss, and the insureds claimed that it violated requirements imposed on carriers under regulations established by the Department of Insurance. The Court of Appeals disagreed, stating:

Even in first party insurance cases, neither the Insurance Code nor regulations adopted under its authority provide a private right of action. (Zephyr Park v. Superior Court (1989) 213 Cal.App.3d 833, 839 [262 Cal.Rptr. 106].) Thus, any particular violation of the regulations does not require a finding of unreasonable conduct. (See California Service Station, etc. Assn. v. American Home Assurance Co. (1998) 62 Cal.App.4th 1166, 1175-1176 [73 Cal.Rptr.2d 182].) Rather, as the trial court stated, at most the regulations, which were in evidence, may be used by a jury to infer a lack of reasonableness on USAA’s part. Because given as instructions the regulations would have suggested to the jury that any violation of the regulations was per se a breach of contract or an act bad faith, rather than only evidence of a breach or bad faith, the trial court was fully warranted in rejecting them.

Simply because a state requires carriers to follow a regulation such as the one above doesn’t mean that an individual homeowner (private citizen) has a “private right of action” under the statute or regulation.

Defenses to First-Party Matching Claims

The arguments most effectively used by carriers in combating matching claims include the following:

  • The property lacked uniformity prior to the covered loss, it would be impossible to “conform” any replacement items to an existing “reasonably uniform appearance” and, therefore, the obligation to match the replacement items under the regulation was not triggered;
  • The lack of a reasonably uniform appearance prior to the covered loss was the result of causes that were excluded under the policy so there was no obligation to replace all the existing items because it would represent an unjust windfall to the insured;
  • Even if a matching regulation or obligation applies to the insured’s loss, the evidence establishes that the repair can be performed such that a reasonably uniform appearance can be maintained;
  • The replacement items can be matched to conform to a reasonably uniform appearance because “reasonably uniform appearance” is analogous to “like kind and quality.” The area that must be replaced to conform to a reasonably uniform appearance is less than the entire property (immediate area, slope section, line of sight); and
  • The regulation is not enforceable because it does not create a private right of action.

Much will depend on the court’s and the parties’ understanding of terms such as “like construction and use” or “reasonably uniform appearance.” The “fine print” terms, conditions, and/or definitions of the policy will factor into the “matching” or “uniformity” issue and could limit exposure in such claims.

Cosmetic Damage

While the “matching” issue involves repairing truly “damaged” or “destroyed” property and the ensuing problems that result when the repaired section of a roof, siding, or cabinetry, for example, does not “match” the remainder of the roof, siding, or cabinetry in appearance. “Cosmetic” damage, on the other hand, is a related subject, but differs in that it involves dents, scratches, or other minor imperfections to property which result from a loss, that do not rise to the level of being truly “damaged.” In other words, it is a qualitative difference. The damage is so minor that it is only “cosmetic” and affects only the appearance of the property in a very minor way. Such cosmetic damage does not cause any punctures, leaks, or loss of functionality of a particular piece of property. An example would be dents in a metal roof resulting from a hail storm.

Insurance policies vary, and some include exclusions for “cosmetic damage” or “appearance damage” to property. While not every home or business policy currently includes these kinds of exclusions, a growing number of major insurers have started including them in their policies. One policy might cover cosmetic damage while another will exclude it, while technically covering direct physical loss from hail, even if the homeowner’s insurance policy doesn’t distinguish between cosmetic and other types of damage and such damages are usually covered. However, some homeowner’s insurance companies are introducing endorsements which may exclude cosmetic damages. The two organizations that standardize forms and policies for property/casualty insurers, the American Association of Insurance Services (AAIS) and the Insurance Services Office (ISO), have both filed cosmetic damage endorsements. The endorsement also enables the insurer to exclude one component – such as the roof – separately. These are becoming common with homes that have metal roofs.

In practice, what the insurance company considers cosmetic damage as opposed to functional damage is rarely straightforward. In the example of the dented metal roof, what happens if the dents have subtly affected drainage, runoff, or seals? For example, it is not easy to differentiate cosmetic from functional damage on traditional and architectural shingles. Insurers will argue that a few dings to the surface do not compromise the shingle structure, but the storm-chasing roof sales industry will argue that any localized loss of mineral will expedite the demise of the shingle. Profitability in homeowners’ coverage has become a multi-faceted, politicized, and elusive objective in many states. Regulators, politicians, and consumer advocacy groups with little understanding of how insurance works can present significant obstacles to obtaining appropriate rates for such policies and risks.

Recovery of RCV Matching Claim Payments in Subrogation Actions

Subrogation claims traditionally involve an insurance company stepping into the shoes of an insured and proceeding against the third-party tortfeasor who caused the loss in the first place to recover those claim payments. The subrogated insurance company (subrogee) assumes the same rights against the tortfeasor as the insured possessed – no greater, no less. The tortfeasor can usually employ any defenses against the subrogee that it could have employed against the insured. As a result, the measure of recovery (i.e., damages) for the subrogee is the same measure of damages as for the insured. This creates some unique and troubling issues when the law dictating third-party damages recoverable in tort are different from the measure of a first-party claim payment under a policy and/or applicable law or regulations. An insurance company that has paid additional damages in order to address “matching” problems in a first-party claim may or may not be able to recover those damages in its subrogation tort action against the tortfeasor/defendant. The law varies from state to state.

If a carrier pays for full replacement cost of a house or a portion of a structure, it might nonetheless be limited to recovering the “market value” or difference in market value before and after a loss, in a subsequent subrogation tort action. Whether a tort defendant is liable to a subrogated carrier for the additional claim payments necessary for the damaged property to match and be uniform after repair depends on the state. Reimbursement under an RCV policy is likely to lead to an economic betterment of the insured because it means that payment will be made to replace old, depreciated property with new property. Therefore, subrogated carriers cannot always count on recovering all of the claim dollars they have paid out. Liability carriers will argue they are only responsible for ACV or repair costs. Some states allow for recovery of the full cost of repairs without a reduction for depreciation or betterment, where the repairs do not materially increase the value of the property over its market value prior to the loss.

You can view a chart that summarizes the regulations or laws in all 50 states regarding the matching issue in the payment of first-party insurance claims HERE. This chart focuses on homeowners’ claims and only tangentially discusses commercial property policies/claims, although if law regarding a commercial policy is all that is available, it is included. It does not address whether damage alleged to be purely “cosmetic”, such as dents to a metal roof caused by hail, is covered “direct physical injury” or the issue of upgrades required by changes in modern zoning or building codes. It also does not address whether an individual private homeowner has a “private right of action” under the law of each state to mandate compliance with these regulations by an insurance company in a first-party RCV property damage claim or if a subrogated insurance carrier can recover the full RCV matching claim payments it has made in a civil subrogation tort action filed against a responsible tortfeasor.

For questions relating to insurance claims and/or subrogation of property damage claims, please contact Gary Wickert at gwickert@mwl-law.com.

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Gary L. Wickert
Partner

Gary L. Wickert is an insurance trial lawyer and partner with the law firm of Matthiesen, Wickert & Lehrer, S.C. Gary has 35 years of litigation experience and is regarded as one of the world’s leading experts on insurance subrogation. He is the author of several subrogation books and legal treatises and a national and international speaker and lecturer on subrogation and motivational topics.