Reasonable and Necessary is not unlike peanut butter and jelly–while they appear together as a concept, one does not confuse peanut butter for jelly and vice versa.
The Rule: Generally, a party seeking to recover remedial damages must prove that the damages sought are reasonable and necessary. McGinty v Hennen, 372 S.W.3d 625 (Tex. 2012) (citing Mustang Pipeline Co. v Driver Pipeline Co., 134 S.W.3d 195, 200 (Tex. 2004).
Don’t Confuse Proper Method of Repair (necessary) with Fair Market Value (reasonable).
Necessary, in this context, refers to the nature of the damage at issue and the need for the services rendered (proper method of repair).
Reasonable refers to evidence showing that the charges (policyholder’s costs) are ‘reasonable.’ (going rate in the market).
Too often, however, insurers attempt to apply a ‘necessary’ analysis to whether a charge is ‘reasonable.‘ One should not conflate the two as they are as different as peanut butter and jelly.
Necessary: Repair and Replacement, The Proper Method of Repair Rule
An example of the proper method of repair rule is found n State Farm Lloyds v Johnson, 290 S.W.3d 886, 891 (Tex. 2009),where the court notes the parties’ dispute might not be “solely about how much of the roof was damaged rather than how much needs to be replaced. Sometimes it may be unreasonable or even impossible to repair one part of a roof without replacing the whole. [citing Wausau Ins v H. Halperin, 664 F.Supp. at 987]. The policy provides that State Farm will pay reasonable and necessary costs to “repair or replace” damaged property, and repair or replacement is an “amount of loss” question for the appraisers. [citing Gulf Ins. Co. v Pappas, 73 S.W.2d 145, 146-47 (Tex.Civ.App.-San Antonio 1934, writ ref’d)].”
While Johnson references an insurer’s obligation to pay ‘reasonable and necessary’ costs, the two cases cited in Johnson only address the ‘necessary’ element of ‘reasonable and necessary.’ Both of these cases discuss “necessary” in terms of the physicality of required repairs — how much needs to be replaced to repair the identified damage (proper method of repair). In H. Halperin, the necessary repairs issue centered on whether it was structurally impossible to repair one part of the roof without repairing or replacing the entire roof. In Pappas, the necessary repairs issue centered on whether a sag in the floor and roof of the building required complete reconstruction or replacement of the whole interior of the building.
Determination of Reasonable Cost Does Not Have A “Necessary” Component
Many adjusters attempt to apply a “necessary” analysis to the determination of whether a cost is “reasonable.” This approach is not supported by Texas case law.
The Texas Supreme Court has consistently only applied a “reasonable” standard when reviewing the cost of necessary repairs. See McGinty v Hennen, 372 S.W.3d 625 (Tex. 2012) (citing Dall. Ry. & Terminal Co. v. Gossett, 156 Tex. 252, 294 S.W.2d 377, 383 (Tex.1956))
“The plaintiff must show more than simply the nature of the injuries, the character of and need for the services rendered. Instead, some other “evidence showing the charges are reasonable is required.” Id.
Overhead & Profit: Understanding Costs
“Texas courts have defined the term “actual cash value” as repair or replacement costs less depreciation.” Tolar v. Allstate Texas Lloyd’s Co., 772 F. Supp.2d 825, 831 (N.D. Tex. 2011). GCOP and sales tax are considered “replacement costs” because they are factored into policy limits and contractors’ bids. Id
Overhead and Profit are Indirect Costs–There is No “Necessary’ Component
“For individual trades, Overhead is any additional expense not charged (attributed) directly to the work being performed. Overhead is typically classified as an indirect cost. Profit is formally defined as “the excess of the selling price of goods over cost. When Xactware performs market research on unit prices, those surveyed are specifically asked to not include expenses that would be included in the General Overhead and Profit markup percentages.” See Xactware, White Paper, Overhead and Profit, 06/01/2011.
In estimating remedial damages, GCOP takes the form of an indirect and excess cost and the issue becomes is that cost reasonable (there is no necessary component).
What determines all cost an insured is reasonably likely to incur?
Short Answer: The insured’s geographic market for labor and materials.
It’s a Hypothetical Exercise
The sum of all actual costs incurred by a policyholder does not satisfy the ‘reasonableness requirement’ under Texas law. It is “well settled that proof of the amounts charged or paid does not raise an issue of reasonableness, and recovery of such expenses will be denied in the absence of evidence showing that the charges are reasonable.” See McGinty v Hennen, 372 S.W.3d 625 (Tex. 2012)
What if the policyholder will never incur some of these costs?
Admittedly, this issue has confused some courts. However, as the Ghoman court noted, “[insurer] points out that plaintiff did not actually incur some of these costs . . . While this may be true, it is legally irrelevant. [citation omitted] (“All repair and replacement costs are, in theory, ‘contingent’ prior to being incurred). Plaintiff contracted for the actual cash value of his loss. His recovery is not tied to the repair or replacement of his property.” Ghoman, at 934-5.
Does Xactimate determine the market value or reasonable cost of labor and materials?
Simply estimating costs of repair from a Xactimate program and further cross-referencing and double-checking pricing with subcontractors or historical data or jobs is not enough to establish the charges are reasonable. See McGinty v Hennen, 372 S.W.3d 625 (Tex. 2012)
Practice Pointer:
Evidence (expert opinion) is required to establish Xactimate measures the market rate and is able to determine the fair market value and thus reflects reasonable costs. An an expert might explain how he/she is familiar with the going rate in the market and believes the charges set forth in an estimate are reasonable.
The 3 Trades Rule: Where does it come from? Why is it wrong?
Short Answer: National Flood Insurance Program (NFIP) claims are unique and only authorize payment of general contractor overhead and profit when certain metrics are satisfied relating to the use of and need for a general contractor. These strict rules ONLY apply to NFIP claims and are not applicable to non-NFIP first-party property claims in Texas. While other jurisdictions have adopted variations of the NFIP approach, Texas has not.
Who Decides the Skill Level of Labor Involved?
Short Answer: The need for labor (in general) must be established by meeting the ‘necessary’ component of reasonable and necessary. The ‘market,’ however, sets the reasonable price (cost) for the labor regardless of who completes the task.
Discussion: Whether the adjuster believes unskilled labor is only required to remove the roofing materials (for example) is irrelevant. The market decides, for the specific tasks at issue, the going rate for the ‘task’ requested. If labor for a necessary task, removing the shingles for example, is required, the choice of who preforms that labor is up to the contractor while the cost associated with the requested task is set by the market.
The reasonable or going rate in the market (all costs reasonably likely to be incurred by the policyholder) is not determined by the whims of the insurer. If, for example, the market determines the going rate for the job at issue includes paying the skilled labor rate to remove the damaged roofing, then that is a cost the policyholder is reasonably likely to incur. Neither the policyholder nor the insurer can dictate to the contractor how the requested proper method of repair is achieved–such hubris would amount to the tail wagging the dog.
Practice Pointer:
It should not come as a surprise that component pricing, at the level practiced by adjusters and insurance carriers, does not accurately reflect how the real-world market functions. The market does not set prices based off a micro-level A la carte menu. Additionally, the going rate in the market is not limited to solely insurance restoration contractor pricing (which according to one source represents only about 25% of sales in the overall market for similar services).
Disclaimer
This article is for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem. Use of and access to this article or any of the e-mail links contained within the site do not create an attorney-client relationship between Thomas W. Hamrick and the user or browser. The opinions expressed in this article are the opinions of the individual author and may not reflect the opinions of other lawyers.
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