v.
State Farm Fire and Casualty Co.
2021 IL 126446
IN THE SUPREME COURT OF THE STATE OF ILLINOIS (Docket No. 126446) JARRET SPROULL, Appellee, v. STATE FARM FIRE AND CASUALTY COMPANY, Appellant. Opinion filed September 23, 2021. JUSTICE MICHAEL J. BURKE delivered the judgment of the court, with opinion. Chief Justice Anne M. Burke and Justices Garman, Neville, Overstreet, and Carter concurred in the judgment and opinion. Justice Theis took no part in the decision. OPINION ¶1 At issue is whether an insurer may depreciate labor costs in determining the “actual cash value” (ACV) of a covered loss when a homeowner’s policy does not define that term. Plaintiff Jarret Sproull filed a putative class action against defendant, State Farm Fire and Casualty Company (State Farm), in the circuit court of Madison County, seeking declaratory relief and damages for breach of contract. Plaintiff alleged that State Farm improperly depreciated labor costs in determining ACV and concealed this practice from its policyholders. State Farm moved to dismiss the complaint for failure to state a claim and argued that its method of calculating ACV complied with Illinois law. The trial court denied the motion but agreed to certify the following question for interlocutory review: “Where Illinois’ insurance regulations provide that the ‘actual cash value’ or ‘ACV’ of an insured, damaged structure is determined as ‘replacement cost of property at time of loss less depreciation, if any,’ and the policy does not itself define actual cash value, may the insurer depreciate all components of replacement cost (including labor) in calculating ACV?” The Appellate Court, Fifth District, reformulated the question to address solely labor costs, rather than all components of replacement cost, and answered the question in the negative. 2020 IL App (5th) 180577, ¶ 41. ¶2 BACKGROUND ¶3 Plaintiff was insured under a homeowner’s policy that provided replacement cost coverage for structural damage. Under the terms of the policy, covered losses were paid in two parts. The insured would initially receive an ACV payment but then could receive replacement cost value (RCV) if repairs or replacement were completed within two years and the insurer was timely notified: “COVERAGE A—DWELLING 1. A1—Replacement Cost Loss Settlement—Similar Construction. a. We will pay the cost to repair or replace with similar construction and for the same use on the premises shown in the Declarations, the damaged parts of the property covered ***, subject to the following: (1) until actual repair or replacement is completed, we will pay only the actual cash value at the time of the loss of the damaged part of the property, up to the applicable limit of liability shown in the
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Declarations, not to exceed the cost to repair or replace the damaged part of the property;
(2) when the repair or replacement is actually completed, we will pay the covered additional amount you actually and necessarily spend to repair or replace the damaged part of the property, or an amount up to the applicable limit of liability shown in the Declarations, whichever is less;
(3) to receive any additional payments on a replacement cost basis, you must complete the actual repair or replacement of the damaged part of the property within two years after the date of loss, and notify us within 30 days after the work has been completed ***.”
The policy did not define “actual cash value.”
¶4 According to plaintiff’s complaint, he suffered wind damage to his residence on or about December 28, 2015, and timely submitted a property damage claim to State Farm requesting payment for the loss. On or about January 23, 2015, State Farm sent an adjuster to inspect the damage to plaintiff’s property. State Farm determined that plaintiff had sustained a covered loss. The adjuster determined that the building sustained a loss with a replacement cost value (RCV) of $1711.54. In calculating ACV, State Farm began with the RCV and then subtracted plaintiff’s $1000 deductible and an additional $394.36, including taxes, for depreciation. Plaintiff thus received an ACV payment from State Farm for $317.18. Plaintiff claimed that he was underpaid on his ACV claim because State Farm depreciated labor, which is intangible and thus not subject to wear, tear, and obsolescence. Plaintiff cited Black’s Law Dictionary’s definition of “depreciation” as a “decline in an asset’s value because of use, wear, obsolescence, or age.” See Black’s Law Dictionary 506 (9th ed. 2009). According to plaintiff, labor may not be depreciated because it is not susceptible to aging or wearing and its value does not diminish over time.
¶5 Plaintiff alleged in the complaint that State Farm uses a program called “Xactimate” to calculate replacement and repair costs. The default setting is to apply depreciation to materials only when estimating structural repairs. However,
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State Farm’s adjuster set the program to also depreciate nontangible items such as labor. According to plaintiff, other property insurers within the State of Illinois do not depreciate intangibles such as labor when adjusting property claims, and State Farm did not used to do so either. The written estimate provided to plaintiff showed 26 line-item repairs. Depreciation for materials and labor was applied to seven of the line items—painting the walls in the dining room, kitchen, hallway, and living room; painting the ceilings in the dining room and kitchen; and removing and replacing fiberboard in the dining room. Depreciation was not applied to other items, such as sealing and priming the surfaces to be painted, drywall work, and removing and replacing insulation.
¶6 Plaintiff alleged that State Farm conceals its practice of depreciating labor from its policyholders in several different ways. First, State Farm does not state in its written estimates that the Xactimate software has been set to depreciate nontangible items such as labor. Second, State Farm does not separate labor and materials in the estimates provided to policyholders. Third, for obvious labor-only charges such as debris removal or roof tear-off charges, State Farm does not depreciate labor. Plaintiff alleged that State Farm does this to help avoid detection of labor depreciation in other line items.
¶7 Plaintiff alleged that State Farm was under an affirmative duty to disclose the manner in which it calculates ACV payments and that State Farm was fraudulently concealing breaches of contract from its policyholders. Plaintiff claimed that State Farm’s failure to pay the full cost of labor necessary to repair or replace plaintiff’s damaged property in the ACV payment left plaintiff underpaid for his losses. According to plaintiff, State Farm’s practice unlawfully discourages policyholders from repairing their property, as they may be left with insufficient funds to commence repairs if excessive depreciation is charged against their claims on top of their deductible obligations. Plaintiff argued that State Farm profits if the consumer fails to seek RCV for his or her claim. The more the ACV payment can be lowered, the less likely it is that the policyholder will be able to make up the difference between ACV and RCV and seek reimbursement later.
¶8 Plaintiff proposed a class action on behalf of “All Illinois resident persons and Illinois resident legal entities that received ‘actual cash value’ payments, directly or indirectly, from State Farm for loss or damage to a dwelling or other structure
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located in the State of Illinois, where the cost of labor as defined herein was depreciated.” Plaintiff alleged that common questions of law and fact existed as to all putative class members and predominated over any questions affecting only individual class members. According to plaintiff, his claims are typical of the claims of all putative class members.
¶9 Count I of the complaint alleged breach of contract. Plaintiff claimed that State Farm breached its contractual duty to pay plaintiff and other putative class members the ACV of their claims by unlawfully depreciating labor costs. Count II sought declaratory relief. Plaintiff sought a declaration that the consumer property insurance contracts of the class members prohibit the deduction of depreciation for labor.
¶ 10 State Farm moved to dismiss the complaint pursuant to section 2-615 of the Code of Civil Procedure (735 ILCS 5/2-615 (West 2016)). State Farm argued that plaintiff’s allegations did not suggest a breach of contract because State Farm’s method of calculating ACV fully complied with Illinois insurance regulations and the terms of the policy. For the same reason, State Farm contended that plaintiff was not entitled to declaratory relief. In a supporting memorandum, State Farm explained that the Illinois Department of Insurance (DOI) has promulgated a regulation mandating the “replacement cost less depreciation” method of determining ACV:
“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 company shall determine actual cash value *** as follows: replacement cost of property at time of loss less depreciation, if any.” 50 Ill. Adm. Code 919.80(d)(8)(A) (2002).
State Farm argued that its method of calculating ACV fully complied with the regulation and that plaintiff was improperly trying to add language to the regulation. According to State Farm, plaintiff was reading the regulation not as “depreciation, if any,” but as “depreciation only of the material component of replacement cost.” State Farm further contended that, even if plaintiff’s reading of the regulation were reasonable, it would have to yield to the DOI’s interpretation of it. According to State Farm, the DOI’s approval of policy forms that specifically set forth that labor
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¶ 11 State Farm further argued that plaintiff’s construction of the policy was unreasonable. State Farm contended that the term “actual cash value” in the policy was not ambiguous because its meaning was supplied by the regulation. [1] Moreover, State Farm contended that, even if the regulation were considered ambiguous, plaintiff’s construction was unreasonable. State Farm used the example of a homeowner who sustained damage to a roof that had 20-year shingles on it after the shingles had been on the roof for 19 years. If a new roof would cost $10,000 ($4000 for materials and $6000 for labor), plaintiff’s theory would mean that the ACV of the roof was $6000 plus the depreciated value of the shingles, even though the shingles had only one year of their expected life remaining. By contrast, if a depreciation factor of 80% were applied to the entire replacement cost of the roof, this would lead to an ACV payment of $2000, which State Farm contended would better represent the value of the roof.
¶ 12 Finally, State Farm argued that case law supported its calculation. State Farm relied on Gee v. State Farm Fire & Casualty Co., No. 11-cv-250, 2013 WL 8284483 (N.D. Ill. Sept. 23, 2013), in which the court held that sales tax could be depreciated in determining the replacement value of damaged personal property. State Farm also relied on state and federal decisions that held that labor could be depreciated in determining ACV. State Farm acknowledged that there was also state and federal authority supporting plaintiff’s position but argued that the cases State Farm relied on had rejected the premises of plaintiff’s theory as unreasonable.
¶ 13 The trial court denied the motion to dismiss. In a written order, the trial court explained that it found the policy ambiguous because it did not define the term “actual cash value.” The court believed that both sides had put forth reasonable explanations of the term, and therefore it was required to construe the term in favor
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of the insured. The court found plaintiff’s interpretation reasonable because an insured “armed only with policy language and everyday meaning of words used could reasonably have understood depreciation in its everyday sense applies only to physical deterioration because labor does not sustain physical deterioration since *** it is not a physical component.” The trial court agreed with State Farm that, because the term was undefined in the policy, the regulation promulgated by the DOI supplied the definition. Nevertheless, the court did not believe that the regulation answered the question before the court. The regulation does not address whether labor may be depreciated, and the court noted that DOI, unlike other state departments of insurance, has not given any guidance on how to interpret the regulation. The trial court found persuasive the state and federal decisions that held that labor may not be depreciated in determining ACV. The court agreed with those decisions that, when an insurer fails to define ACV, that term should be construed in favor of the insured. The court stated that it would not assume the responsibility of defining a term that State Farm had an opportunity to draft more specifically to align with its depreciation practices. The court also found that State Farm’s definition was inconsistent with indemnity principles, as it would leave the insured with a significant out-of-pocket loss. The court noted that the purpose of indemnity is to place the insured in the position he was in before the loss. The court found that proper indemnification requires paying the cost of materials depreciated for wear and tear, plus the cost of their installation.
¶ 14 State Farm later moved to certify a question of law pursuant to Rule 308(a) (Ill. S. Ct. R. 308(a) (eff. July 1, 2017)). The trial court granted the motion, determining that its order denying the motion to dismiss involved a question of law over which there was a substantial ground for difference of opinion and that an immediate appeal would materially advance the ultimate termination of the litigation. The parties proposed different wording for the certified question, and the trial court chose to certify the question as proposed by State Farm. The appellate court initially denied leave to appeal, but this court entered a supervisory order directing the court to hear the appeal.
¶ 15 The appellate court issued an opinion affirming the trial court. 2020 IL App (5th) 180577. The appellate court determined that the question certified by the trial court was too broad, as it asked whether all components of replacement cost could be depreciated. Because the parties limited their arguments to whether labor could
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be depreciated when a policy does not define ACV, the court reformulated the question and answered only that question. Id. ¶ 41.
¶ 16 Based on case law and dictionary definitions, the appellate court determined that the plain and ordinary meaning of depreciation in an insurance context is “a reduction in value of a property because of aging and wear and tear to the physical structure of that property.” Id. ¶ 35. The court held that State Farm had not demonstrated that it had incorporated the DOI’s ACV regulation into its policy. Id. ¶ 36. Nevertheless, the court held that the regulation did not support State Farm’s position because it referred to the “ ‘replacement cost of property at time of loss less depreciation, if any.’ ” (Emphasis in original.) Id. Because property is something tangible, the court held that “actual cash value” referred to an asset that can lose value over time due to wear and deterioration and did not refer to services such as labor. The court held that this interpretation was consistent with State Farm’s policy language that defined “property damage” as “ ‘physical damage to or destruction of tangible property, including loss of use.’ ” (Emphasis in original.) Id. The court determined that a reasonable insured would understand “depreciation, if any” to describe the depreciation of physical, tangible materials, particularly where the language follows the word “property.” Id. The court believed that State Farm was applying a “technical definition of depreciation that is not evident in the language of the policy or in the regulation upon which it relies.” Id. ¶ 39. Finally, the court stated that its resolution of the question was “in keeping with the primary purpose of an indemnity clause in an insurance contract.” Id. Accordingly, the appellate court answered the certified question in the negative and concluded:
“Where Illinois’s insurance regulations provide that the ‘actual cash value’ of an insured, damaged structure is determined as ‘replacement cost of property at time of loss less depreciation, if any,’ and the policy does not itself define actual cash value, only the property structure and materials are subject to a reasonable deduction for depreciation, and depreciation may not be applied to the intangible labor component.” Id. ¶ 41.
¶ 17 We allowed State Farm’s petition for leave to appeal. Ill. S. Ct. R. 315 (eff. Oct. [1], 2020). Additionally, we allowed United Policyholders to file an amicus brief in support of plaintiff’s position, and we allowed a joint amicus brief in support of defendant’s position by the American Property Casualty Insurance Association, the
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National Association of Mutual Insurance Companies, and Allstate Insurance Company. Ill. S. Ct. R. 345 (eff. Sept. 20, 2010).
¶ 18 ANALYSIS
¶ 19 This appeal arises on a certified question and requires us to construe common insurance policy language. When this court accepts an appeal under Rule 308, the scope of our review is broad and not limited to determining how the circuit court’s question should be decided. Crim v. Dietrich, 2020 IL 124318, ¶ 18; Schrock v. Shoemaker, 159 Ill. 2d 533, 537 (1994). The rules applicable to contract interpretation govern the interpretation of an insurance policy. State Farm Mutual Automobile Insurance Co. v. Elmore, 2020 IL 125441, ¶ 21. Our primary objective when construing an insurance policy is to ascertain and give effect to the intention of the parties, as expressed in the policy language. Hobbs v. Hartford Insurance Co. of the Midwest, 214 Ill. 2d 11, 17 (2005). The construction should be a natural and reasonable one. De Los Reyes v. Travelers Insurance Cos., 135 Ill. 2d 353, 358 (1990). Undefined terms will be given their plain, ordinary, and popular meaning; i.e., they will be construed with reference to the average, ordinary, normal, reasonable person. Outboard Marine Corp. v. Liberty Mutual Insurance Co., 154 Ill. 2d 90, 115 (1992). The court will not adopt an interpretation that “rests on ‘gossamer distinctions’ that the average person, for whom the policy is written, cannot be expected to understand.” Founders Insurance Co. v. Munoz, 237 Ill. 2d 424, 433 (2010) (quoting Canadian Radium & Uranium Corp. v. Indemnity Insurance Co. of North America, 411 Ill. 325, 334 (1952)). If the policy language is susceptible to more than one reasonable meaning, it is considered ambiguous and will be construed strictly against the insurer. Travelers Insurance Co. v. Eljer Manufacturing, Inc., 197 Ill. 2d 278, 293 (2001). Indeed, “[w]here competing reasonable interpretations of a policy exist, a court is not permitted to choose which interpretation it will follow. [Citation.] Rather, in such circumstances, the court must construe the policy in favor of the insured and against the insurer that drafted the policy.” Employers Insurance of Wausau v. Ehlco Liquidating Trust, 186 Ill. 2d 127, 141 (1999). Our review is de novo. See Addison Insurance Co. v. Fay, 232 Ill. 2d 446, 451 (2009) (“The construction of a provision of an insurance policy is a question of law, subject to de novo review.”); Rozsavolgyi v. City of Aurora, 2017
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IL 121048, ¶ 21 (“certified questions are questions of law subject to de novo review”).
¶ 20 The question before us has been the subject of much litigation, and it has divided the state and federal courts. Before we proceed to an analysis of the issue, we address two preliminary matters. First, we consider here only whether labor may be depreciated under a policy that does not define ACV to expressly include labor depreciation. Second, the appropriate method of calculating ACV is that set forth in the ACV regulation. The appellate court held that State Farm had not demonstrated that it had incorporated the regulation into its policy. 2020 IL App (5th) 180577, ¶ 36. However, as State Farm points out, a “basic rule of the construction of contracts and a material part of every contract is that all laws in existence when the contract is made necessarily enter into and form a part of it as fully as if they were expressly referred to or incorporated into its terms.” Illinois Bankers Life Ass’n v. Collins, 341 Ill. 548, 552 (1930). Moreover, plaintiff concedes that replacement cost less depreciation is the proper method for determining ACV in Illinois.
¶ 21 Redcorn
¶ 22 The first case to address this issue was the Oklahoma Supreme Court’s decision in Redcorn v. State Farm Fire & Casualty Co., 2002 OK 15, 55 P.3d 1017 (2002). In that case, the plaintiff suffered damage to his roof in a storm. He was insured under an ACV policy with State Farm. [2] Id. ¶ 3. He received an ACV payment that included a deduction for depreciation for both materials and labor. Id. Redcorn brought an action in federal court alleging that only the materials component of a roof replacement should be subject to depreciation. The district court certified the question to the Oklahoma Supreme Court. Id. ¶ 1. The court ruled in favor of State Farm in a 5 to 3 decision. Id. ¶¶ 15-18.
¶ 23 The majority noted that, in Oklahoma, “actual cash value” is determined by the “broad evidence rule.” Id. ¶ 7. Under this rule, all relevant factors are considered in