How To Deal With A Div Claim In Insurance Coverage

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1 Troubling Trends in Diminution in Value and Small-Loss Appraisals Thomas D. Martin Partner Swift Currie McGhee & Hiers LLP 1

2 Introduction In 2012, the Supreme Court of Georgia concluded that a building owner could potentially recover for a loss in the value of a building, even after repairs had been made, based upon the stigma that the building had occasioned a loss. Such diminution in value (DIV) claims in Georgia previously were recognized only in the automobile context. In 2012, the Georgia Supreme Court extended such claims to real property losses as well. Because interest in auto DIV claims nationwide increased after the 2001 ruling, the industry may see similar interest in DIV claims following the 2012 opinion on structural losses. In 2012, another area of the insurance law small-loss appraisals remained challenging for insurance companies, particularly those doing business in Georgia. Difficulties in small-loss appraisals seemed to become more frequent after the crisis in the housing market in late 2008 and the resulting economic fallout. In 2012, policyholders, often with the aid of public adjusters, increasingly tried to use the appraisal clause found in many homeowner policies as a tool to gain leverage for larger settlements in modest damage claims. Such trends appear likely to continue into This article will discuss these developments, the challenges they present and what insurers in Georgia and other jurisdictions might expect as a result. DIV Issues in Insurance Litigation In 2012, the Georgia Supreme Court, in a case called Royal Capital Dev. LLC v. Maryland Cas. Co., 1 authorized an insured to seek Diminution in Value (DIV) damages where the loss involved damage to real property. This decision by the Georgia Supreme Court followed a previous decision by the court in State Farm Mut. Auto. Ins. Co. v. Mabry, 2 an earlier decision authorizing DIV in automobile property damage claims. In these cases, the court authorized the recovery of both repair costs and the post-repair loss in value resulting from the incident. The post-repair loss in value of the property, or stigma damage, was the DIV claim. In my opinion, this change in the law in Georgia is negative. Following the decision in Mabry, there was a great deal of litigation in other jurisdictions, as many attempted to jump on that gravy train. A quick survey of those decisions found that the plaintiffs had only limited success. Some efforts failed because the plaintiffs sought class actions in which they overreached, seeking class certification involving claims in a number of states. In other instances, the efforts failed because local state law did not recognize DIV as a component of the insurance contract damages. Notwithstanding the legal effects, the practical implications of the Mabry decision for the industry were troubling. The decision required new adjustment practices and supplemental payments that were not previously contemplated by insurers. In the past, insurers adjusted claims by assessing the cost of repairs and then making payment based upon the repair estimate and the payment options under the policy. The Mabry decision required an additional assessment an evaluation of any loss in market value and a supplemental payment based upon the loss in market value. 3 The loss in market value seemed dubious because it would require a good deal of speculation and because the loss in market value presumably would itself diminish or disappear altogether over time. Nevertheless, 1 Royal Capital Dev. LLC v. Maryland Cas. Co., 291 Ga. 262, 728 S.E.2d 234 (2012). 2 State Farm Mut. Auto. Ins. Co. v. Mabry, 274 Ga. 498, 556 S.E.2d 114 (2001). 3 Mabry, 274 Ga. 498, 556 S.E.2d 114 (2001).

3 insurers were required to make payment based both on the repair cost and the DIV. In the long term, I suspect that these additional costs will be passed on to consumers, raising the long-term rates for auto insurance. As was the case in Mabry, the industry may see lawsuits following Royal Capital seeking to extend DIV to real property losses in other jurisdictions. To the extent that there is some litigation success in that area, insurers in those states, like insurers in Georgia, will have to assess their adjustment practices and payment obligations. An increase in adjusting costs or claim payments will probably increase insurance costs over the long term. Essentially, the decisions set out the notion that insurance is supposed to place an injured party, as nearly as possible, in the same position as he or she would have been if the injury had never occurred. In the absence of any provision in a policy to the contrary, compensating the insured for the loss should include both the cost to fix or repair the property as well as any loss in value associated with the stigma of having been physically damaged. The court in both Mabry and Royal Capital seemed to rely, in part, on the industry s use of undefined terms such as loss and actual cash value to justify its decision. However, policies already contain language of the type that should have limited or proscribed DIV (e.g., the requirement of direct physical loss to property or the exclusion of consequential damages). Other jurisdictions have recognized these limits, criticizing the DIV decisions. Further, the application of DIV to a real property case is even more tenuous. Even the court in Royal Capital seemed to acknowledge that such damages would be unusual. 4 Value, in the real property context, will include the unique qualities of the land on which the building is located and the market conditions unique to that property. Unlike automobiles, there are not thousands (or perhaps tens of thousands) of identical properties, at a similar location, with similar features, under similar market conditions. Therefore, the ability to evaluate a loss in market value due to the stigma of damage is much less certain. Still, companies will have to try to adjust these additional damages. Disputes with policyholders will inevitably follow. Costs will go up on the front end and on the back end of these claims. Consumers will be the losers in this scenario. The trend of seeking DIV damages will likely continue. As noted, this trend started with automobiles, drifted into the real property context, and it will probably find its way into personal property claims as well. Again, the notion here is not to compensate the insured for any tangible loss. Instead, the notion is to compensate the insured for an intangible, speculative loss in market value after repairs have been effected. The assessment is made at a moment in time when the repairs are completed even though such loss in market value could vanish over time depending upon how long the property is held and changes in market conditions. The recent DIV decisions do not require that the insured actually sell the property to establish an actual loss. It is not even clear that repairs have to be effected. It is only clear that insurance policies are being interpreted to compensate a policyholder for the possibility of a loss in market value at a moment in time. As long as such speculation can find support in the courts, plaintiffs are going to seek similar opportunities with other types of insurance. In those jurisdictions that recognize DIV, legal strategies in 2013 will have to account for the possibility that insureds will seek DIV damages. This situation could apply to existing litigation, and it 4 Royal Capital, 291 Ga. 262, 728 S.E.2d 234 (2012).

4 could apply to existing claims. In either case, the possibility is that damages will increase; additional witnesses, such as expert appraisers, may be needed; litigation costs will probably go up; and there will be greater uncertainty about the outcome of such disputes. In those jurisdictions that do not recognize DIV, recent decisions will probably embolden those who tried before, without success, to obtain such damages to try once again. Impact of DIV Decisions on Insurance Law Strategies The changes in the area of DIV damages are creating a lot of uncertainty for carriers. The changes are affecting adjustment, settlement negotiations, and litigation strategies. DIV is another potential source for disagreement between an insured and their carrier, and thus, another condition that could result in litigation. As a result, carriers may be retaining counsel in cases that would have typically been resolved. Strategies for clients have also been affected: For one thing, not everyone is seeking DIV claims. Therefore, it is difficult to recommend or develop a uniform approach to these claims. Further, different policyholders interpret the effect of the recent DIV decisions differently. For some, replacement cost provisions (that compensate an insured for actual cash value ACV up front but hold back depreciation until actual replacement is completed) were nullified by the DIV ruling. Others acknowledge the right of the carrier to withhold replacement benefits and DIV until actual repairs are completed. The use of expert witnesses (appraisers) will likely increase with the advent of DIV claims. Depending upon the policy terms, such experts may be needed to make two separate evaluations: first, the actual cash value of the loss (the value of the property immediately before the loss less the value after the loss); and second, the long-term loss in value (DIV) once repairs are made. For the insurance industry, these developments are, again, negative: they create uncertainty, additional costs, and additional conflicts. There is also an increased likelihood that public adjusters will become involved in an effort to offset their fees by the DIV claim. Attorneys practicing in this area will be affected by a likely increase in disputed claims involving DIV, and a likely increase in litigation involving disputed DIV claims. Small-Loss Appraisal Disputes Another type of dispute that has been increasing in recent times involves disputes over small-loss appraisals. This scenario involves the recent trend of policyholders or their public adjusters to demand appraisal in losses where only a small part of the loss appears to be caused by a covered loss but the balance of the claim involves excluded or limited coverage. In these cases, some policyholders appear to be misusing the appraisal clause as leverage either to obtain a favorable settlement or to get an appraisal award on excluded losses.

5 The theory is that some insureds are demanding appraisals in situations where part of a loss may be covered but most of it is excluded (such as hail damage to a few shingles on a roof where most of the roof was already worn out from age, wear and tear, etc.). The insured will demand appraisal of the entire loss, asserting the entire loss must be part of the appraisal. Any attempt to limit or narrow the scope of the appraisal is opposed as a violation of the appraisal clause. If the appraisal goes forward, the appraisal may result in a compromise verdict between the umpire and the insured s appraiser. Such an appraisal award could be difficult to challenge after its entry. The insurance company may have to institute litigation to challenge the appraisal award, thus driving up costs. Conversely, the carrier may simply pay the appraisal award, effectively covering an excluded loss. The approach some carriers are taking is to challenge the appraisal at the front end. If an insured demands appraisal in situations where there are excluded damages, the carriers are agreeing to appraise only those portions of the loss where coverage is not an issue. The insured typically rejects this offer, in which case the company simply refuses the appraisal demand and pays what it calculated as its liability for the loss. This effectively shifts the burden back to the insured to determine whether it will bring suit on the policy. Some may view this approach as risky, because the standard appraisal clause contains terms like demand and shall when referring to the obligations under the appraisal clause. Indeed, based upon this compulsory-sounding language, some might conclude that an appraisal demand by either the insured or the insurance company must be followed, and that a failure to do so would be a breach of the policy. However, others recognize that the appraisal clause typically appears in the policy conditions. As such, it is up to the insurer to decide whether and to what extent it will enforce the conditions of coverage. Thus, only if the insurance company agrees to the appraisal can the compulsory obligations of the clause take effect. If the company decides not to enforce the appraisal condition, then the company is not obligated to follow the mandatory appraisal terms. For many, this approach makes a lot of sense. First, it adheres to traditional rules of contract construction by recognizing that policy conditions are different from other terms of the policy. Policy conditions are a condition of coverage when and only when the insurance company requires their performance. Thus, policy conditions are enforceable only at the insurance company s behest. In addition, this approach has the effect of keeping coverage issues out of the appraisal process. In many jurisdictions, appraisal is seen as a remedy for damage disputes, not a remedy for liability disputes. Indeed, liability disputes necessarily can result in a disagreement over the amount of a loss. However, in a liability dispute, the reason for the disagreement over the amount of loss is the dispute over coverage. Many jurisdictions have concluded that such coverage disputes are not a matter for appraisal. Thus, the insurance company s ability to reject the appraisal demand allows it to keep such coverage disputes out of the appraisal arena. Changing Negotiation and Settlement Strategies

6 Given the change in the law concerning DIV (i.e., the Royal Capital case 5 ), the industry s analysis and, ultimately, its settlement strategy, could be dramatically affected. At first, settlement strategy will likely depend upon the particular facts of the claim and the policy language at issue. Long term, carriers will have to weigh various factors in determining what changes in the policy are made or the risk of inaction: Inaction will probably result in greater disagreement over interpretations of the DIV rulings: the proper way to adjust claims; the enforceability of payment provisions in property policies; the duty of the carrier to determine and adjust DIV upfront; and the factors appraisers should consider in evaluating fair market value, to name a few. Greater disputes will raise the specter of prolonged litigation. This creates the risk of higher litigation expenses, adverse case law, and a greater risk of bad-faith verdicts. A passive approach risks higher adjustment costs, increasing premiums, and dilution of policy terms. Either way, settlement strategy is affected. A snapshot of these issues recently came up in two cases. Immediately following the decision in one of these cases, one claimant alleged that the insurance company could not employ its usual method for adjusting claims (prepare a replacement estimate, depreciate the estimate, pay the depreciated cost upfront and hold back the replacement benefit pending actual replacement). Further, an appraisal of the property resulted in a post-loss evaluation that was simply the pre-loss value less the full amount of the replacement estimate. This effectively nullified the replacement provisions of the policy, contrary to traditional rules of contract construction. In another case, the insured cited the DIV decisions as authority for the proposition that DIV was automatic, always resulting in a permanent reduction in the fair market value (FMV) of the property. The insured contended that the company s obligation is to calculate that amount and issue payment, subject to the insured s right to dispute the amount of the payment. Since DIV is based on the perceived long-term effect of a loss on fair market value, the potential for claims down the road may have to be addressed. This will mean addressing DIV in settlement documents. Right now, until policies are changed or courts give further guidance, real estate appraisals are going to become a common occurrence in real property damage claims. Further, appraisers are going to have to become familiar with industry methods for calculating repair costs. The industry is currently evaluating several options for dealing with the changes in DIV. Those options include looking at exclusions, limits, and defining policy terms in order to avoid some of the alleged uncertainty in evaluating an insured s loss. Regarding small-loss appraisals, company strategy will have to include giving careful consideration to the law in the jurisdiction applicable to the policy. A refusal to participate in the appraisal may depend upon whether the jurisdiction treats the appraisal clause as strictly a policy condition or whether the clause is used as a means of alternative dispute resolution. If the clause is seen as the 5 Royal Capital, 291 Ga. 262, 728 S.E.2d 234 (2012).

7 latter, then the ability to refuse the demand may be limited absent an outright denial of the claim. In that case, the insurance company may be obligated to either participate in the appraisal (if the facts do not otherwise support a denial) or seek judicial relief (in the form of a declaratory judgment action) in order to safely address what it may consider an improper appraisal demand. Conclusion While these developments may not give rise to any new practice areas, defense counsel can expect more disputes and increased litigation over issues such as DIV and the appropriate scope of an appraisal. Typically, a difficult economy can result in an increase in the number of suspicious or fraudulent insurance claims. However, there also may be a connection between the economy and the cases described in this chapter. The number of appraisal demands on small claims have increased, perhaps because some policyholders are more desperate than ever to turn a small claim into a significant windfall. DIV claims could also be motivated by economic considerations, as some insureds may contend that loss in market value is attributable to a particular insurance event rather than to broader market conditions. As long as the economy continues to suffer, such economic incentives, if they exist, will continue to drive these claims. A much higher percentage of cases in litigation (or where litigation is threatened) involve not only fraud but the other kinds of cases discussed (DIV claims and small appraisal disputes). Some of these trends may suggest the need for a more comprehensive response, such as through legislation or regulatory authority. Ultimately, I would think that few areas of insurance law are invulnerable to economic conditions. Key Takeaways Legal strategies in 2013 likely will have to account for the possibility that insureds will seek DIV damages, and this situation could apply to existing litigation and claims. It is possible that damages will increase; additional witnesses, such as expert appraisers, may be needed; litigation costs will probably go up; and there will be greater uncertainty about the outcome of such disputes. Advise clients that the use of expert witnesses (appraisers) likely will increase because of DIV claims. Such experts may be needed to make two separate evaluations: the actual cash value of the loss and the long-term loss in value once repairs are made. Advise clients that the use of real estate appraisals may become common practice in real property damage claims and that appraisers are going to have to become familiar with industry methods for calculating repair costs. Assist clients in evaluating several options for dealing with DIV, including looking at exclusions, limits, and defining policy terms. Inform carriers that they may wish to challenge an appraisal at the front end. If an insured demands appraisal in situations where there are excluded damages, agree to appraise only those portions of the loss where coverage is not an issue.

8 If an insured refuses a company s effort to narrow the scope of the appraisal, then consider advising the company about a strategy of refusing the appraisal demand: paying the amount admittedly owed but otherwise rejecting the insured s appraisal demand. Where refusing an appraisal demand is contemplated, careful consideration should be given to the law applicable to the policy, the loss, and the claim. Some jurisdictions treat appraisal as a form of arbitration and permit the appraisal process to resolve coverage issues. Other jurisdictions take a contrary view. The ability to refuse an appraisal demand may depend upon the law in the jurisdiction. Thomas D. Martin, a partner at Swift Currie McGhee & Hiers LLP, practices civil litigation emphasizing firstparty insurance defense, casualty coverage and coverage litigation. His insurance practice includes arson and fraud insurance defense where he has extensive experience assisting carriers in claims involving suspected fraud in homeowners, auto, life, disability, and health insurance claims. His insurance practice also includes insurance coverage defense in the context of both first- and third-party property losses. He joined Swift, Currie in A member of the American Bar Association and the State and Federal Bars of Georgia, Mr. Martin is a frequent guest speaker on topics relating to insurance fraud defense and insurance coverage issues. He has been an instructor for industry personnel. Mr. Martin graduated summa cum laude from the University of Georgia in He then attended the University of Georgia School of Law where he received his JD cum laude in 1987.