Category: Fine Print

Washington Court of Appeals Emphasizes Distinction Between “Replacement Cost” and “Actual Cash Value” in Homeowners’ Insurance Coverage

Fine print is tedious, but it matters. That’s the takeaway from the Washington Court of Appeals July 30, 2024 ruling in McKay v. PEMCO Mutual Insurance Company.

We’ve blogged before about the distinction between “actual cash value” and “replacement cost” coverage. These are two types of coverage that basically decide when and how much you get reimbursed if your house is damaged.

The distinction has to do with how you define value. Let’s say your house burns down and your insurance policy says the insurance company will reimburse you for the home’s value. What was it worth? What does “value” mean? This is the kind of question generally pondered only by philosophy undergraduates and insurance lawyers.

One perspective is: “things are worth whatever someone would pay for them.” Under this theory, your house is worth whatever you could have sold it for on the open market the day before it burned down. This (basically) is “actual cash value.”

Here’s another way to look at it: “a thing is worth whatever you’d pay to get a new one.” Under this theory, your house is worth what it would cost to rebuild it. This (basically) is “replacement cost.”

The difference matters in a big way. As anyone who’s tried to hire a contractor in the last few years knows, building new is almost always going to cost more than what you could list the property for on the open market.

So, the difference between “replacement cost” and “actual cash value” becomes pretty relevant as soon as your house gets damaged and you need to make an insurance claim.

Back to McKay: Tina McKay’s house caught fire. Luckily, she had homeowner’s insurance. It would pay the full “replacement cost.”

But, like most homeowners’ insurance, the policy said McKay had to fix the damage from the fire before the insurance company was responsible for paying the replacement cost. (This makes sense, from a certain point of view, because how would we know what it cost to replace the home until the owner hires a contractor who completes the work and presents the final bill?).

Before the insured rebuilt the home, the insurance policy stated PEMCO would pay only the “actual cash value.” When PEMCO paid that amount, it did not reimburse McKay for the full amount of sales tax on the cost to restore the home and replace her belongings.

McKay sued. She alleged that sales tax should be included in the “actual cash value” even if she never collected the “replacement cost.” She relied on a Washington Supreme Court case from 2010 finding that insurers must pay the full cost of sales tax on the cost to repair a home after a loss.

The Court of Appeals saw it differently. It agreed with McKay that the 2010 Supreme Court case entitled her to be reimbursed for the full sales tax in the abstract.

But the court ruled that McKay couldn’t recover the full sales tax amount until she completed restoration and collected the “replacement cost.” The court reasoned that “actual cash value” is the equivalent of fair market value for used goods or property, and that, when you buy used goods, you pay sales tax on the secondhand price rather than the price you would have paid to buy new.

This case is a good example of how fine print and abstract ideas about the meaning of “value” can have a real-world impact for insurance coverage.

Ninth Circuit Helps Clarify Meaning of “Earnings” In Disability Insurance

Calculating earnings can be really important to disability insurance. Most disability insurance policies define “disability” in relation to how much the insured earned before they became disabled. For instance, a policy might say “we will pay you the insurance benefits if an injury keeps you from being able to earn 60% of what you earned while healthy.” And a person’s earnings often determine the amount of insurance benefits. Many disability policies will pay a person who becomes disabled a certain percentage of what they earned while working.

Calculating these amounts is simple where a person earns a basic salary. But where the insured earned things like bonuses, stock options, or fringe benefits, it can get complicated.

A recent Ninth Circuit Court of Appeals decision provides some guidance on this. In Neumiller v. Hartford Life and Accident Insurance Company, the Ninth Circuit addressed a dispute over how to calculate earnings in a case where the way earnings were calculated made the difference between the insured receiving ongoing disability benefits versus those benefits being terminated.

Neumiller had a disability insurance policy with Hartford. The policy paid benefits if she became disabled. The benefits ended if she earned more than 60% of what she made before becoming disabled.

Hartford decided Neumiller had earned more than that and terminated her benefits. Neumiller disagreed and filed a lawsuit under ERISA. The lower court agreed with Hartford. Neumiller appealed.

The Ninth Circuit focused on the insurance policy’s definition of “Current Monthly Earnings” to determine whether Neumiller had earned more than the 60% pre-disability earnings threshold that allowed Hartford to terminate her insurance benefits. The policy defined Current Monthly Earnings to mean money Neumiller received from any employment while disabled.

Neumiller argued that pre-tax deductions from her paycheck and certain bonuses fell outside this definition. The Ninth Circuit mostly disagreed.

The court looked to the dictionary definition of “earnings”, which meant any revenue gained from labor or services. It decided this definition was simple enough that it didn’t need to further consider what the term “earnings” might mean. Under this definition, the fact that bonuses weren’t explicitly listed in the insurance policy did not mean bonuses weren’t “earnings.”

And Neumiller’s pre-tax deductions were “earnings” too. Even though the deductions didn’t wind up in her paycheck, the Ninth Circuit reasoned that these funds went into her 401(k) because of her voluntary election. They were therefore “earned.”

But the Ninth Circuit did agree with Neumiller that bonuses paid out every four months were not “monthly” earnings under the insurance policy’s use of the term “Current Monthly Earnings.” These bonuses were paid for work performed over a four-month period. The lower court had nevertheless treated the entire amount of each bonus as earned in the month it was received.

The Ninth Circuit found that logic dictated the bonuses should be averaged over the four-month period in which they were earned for purposes of calculating Neumiller’s “monthly” earnings, especially given other parts of the insurance policy explicitly stated that bonuses would be averaged over the period in which they were earned.

This ruling is unpublished, meaning it can’t be relied on as binding precedent, but still provides helpful clarity on the calculation of earnings under disability insurance policies.

Ninth Circuit Ruling Elevates Hidden Fine Print to Reduce ERISA Plan Benefit

If you were to poll the public on why lawyers or the legal system get a bad rap, the experience of getting surprised by something sneaky the other party buried in the fine print might rank high on the list. That was the outcome in Haddad v. SMG Long Term Disability Plan, decided February 10, 2023. There, the Ninth Circuit ruled that an ERISA plan could reduce a former employee’s benefit payments based on inconspicuous language hidden in the benefit plan documents.

Mr. Haddad, like many folks, had long-term disability coverage through his employer’s benefit plan. He became disabled and the plan paid him the benefits.

But the plan reduced his benefits. The insurance company administering the plan decided Mr. Haddad’s settlement with a third party amounted to “lost wages.” The terms of the benefit plan allowed disability benefits to be reduced if the disabled employee had been compensated for lost wages.

Mr. Haddad sued. He argued that the “lost wages” reduction was hidden in the benefit plan documents’ fine print. He pointed to earlier Ninth Circuit rulings that any limitations should be conspicuous and that employees shouldn’t “have to hunt for exclusions or limitations in the policy.”

The Ninth Circuit said this rule didn’t apply to Mr. Haddad. It ruled that reductions in benefit payments on the basis of an “offset” were different from reduced payments due to an “exclusion” or “limitation.” The opinion does not elaborate on whether the average non-lawyer would find the distinction meaningful.

The ruling is “unpublished”, meaning it shouldn’t be relied on as binding precedent for lower courts.

Bicyclists Covered Under Insurance Policies That Cover “Pedestrians” Says Washington Supreme Court

Technical terms in the fine print of an insurance policy are often critical to understanding the insured’s rights. These terms often have definitions that differ from the normal dictionary definition. In one case, for instance, a court ruled that school busses are not automobiles under a particular insurance policy. The recent ruling in McLaughlin v. Travelers Commercial Insurance Company is such a case.

In McLaughlin, the Washington State Supreme Court ruled that a bicyclist was a “pedestrian” under McLaughlin’s insurance policy. McLaughlin was riding his bicycle in downtown Seattle when a motorist opened the door of a parked vehicle and hit McLaughlin. McLaughlin made a claim under his Travelers car insurance policy. The policy provided benefits if McLaughlin was struck by a vehicle “as a pedestrian.”

Travelers denied coverage. It argued that McLaughlin was not a “pedestrian” because he was riding his bike. The lower courts agreed with Travelers, relying on the dictionary definition of “pedestrian” as excluding bicyclists.

The Washington State Supreme Court held that McLaughlin had coverage. The court relied on an insurance statute in which the Washington legislature defined a “pedestrian” as any person “not occupying a motor vehicle…” Since McLaughlin was riding a bike and not a motor vehicle when he was injured, he was a “pedestrian”.

The court emphasized that the relevant statutes are read into insurance contracts automatically. Because the legislature has the power to regulate insurance, a valid statute becomes part of the insurance policy. The statutory definition of “pedestrian” therefore became a part of McLaughlin’s insurance policy just as if Travelers had copied the statute into the policy documents.

This conclusion was reinforced by traditional insurance law principles that insurance policy language should be read consistent with the expectations of the average insurance purchaser. The court had no trouble concluding that the average person buying this MedPay coverage would expect to be covered when injured by a car.

Another twist is that the Court applied Washington law even though McLaughlin bought the policy in California. Because he had moved to Washington, the Court determined that he was entitled to all the protections of Washington law. Washington courts have a long history of applying Washington law to any insurance policy protecting a Washington resident.

In sum, the McLaughlin case is a strong reminder that Washington State’s insurance laws and regulations will be enforced regardless of the insurance policy fine print.

Court Ruling Emphasizes Importance of Reading the Insurance Policy as a Whole

Insurance policies contain technical language that often varies from its everyday meaning. When a case depends on the meaning of the insurance policy fine print, how you interpret these technical terms can decide the outcome of a case.

One way to define insurance policy terms is to see how those terms are used elsewhere in the insurance policy. The Ninth Circuit Court of Appeals’ August 17, 2020 ruling in Engineered Structures, Inc. v. Travelers Property Casualty Company of America is a good illustration.

Engineered Structures, Inc. (ESI) was a construction firm that purchased a “builder’s risk policy” from Travelers insurance. The policy covered risks of damage when ESI was building a Fred Meyer gas station in Portland, Oregon.

ESI made a claim under the policy when an underground fuel storage tank ESI’s subcontractor was installing was improperly placed in the ground. The tank was loaded with inadequate ballast. After a rainstorm, the tank floated in the excavation hole, causing damages.

Travelers denied coverage under a policy exclusion for “faulty, inadequate or defective workmanship or construction”. ESI sued Travelers claiming the denial violated the policy and was made in bad faith. The issue depended on what the word “construction” in the exclusion meant. ESI said “construction” meant the finished product it was building, so the exclusion only applied for defects in the finished product.

Certain rules come into play when an insurance term of art is ambiguous, but the court determined those rules didn’t apply because it could understand the term “construction” by reading other language in the policy.  The court examined other language in the insurance policy that treated “construction” as referring to the process of building the gas station. The policy defined certain “construction activities” in terms of the actions taken in the course of constructing the gas station. The court interpreted the word “construction” in the exclusion as referring to the process of constructing the gas station, as opposed to the final product that was built.

This emphasizes the principle that insurance policy language must be read in the context of the entire insurance policy. Where the policy uses technical language in one place, it can often be understood only by reviewing similar language elsewhere in the policy. A few other references to a disputed term elsewhere in the policy can decide insurance coverage for a huge loss.