R & C Industries, Inc (R & C) conducted its warehouse operations from a large building. It was built in 1962 and was of concrete block construction. It was initially used as a manufacturing facility but was later converted to a warehouse. Over the years, several steel additions were added that doubled its capacity. On May 10, 2003, a hailstorm severely damaged the roof of the warehouse. R & C filed a claim with its insurer, Nationwide Mutual Insurance Company (Nationwide). The insured building value was $1,100,000 and included a coinsurance provision that imposed a penalty if the covered property was underinsured. Nationwide estimated the cost to replace the damaged roof at $295,674.75 but only paid R & C $160,011 after application of the coinsurance penalty. This was based on its conclusion that the replacement cost of a new warehouse built with materials of like kind and quality was approximately $2,500,000.

R & C tried to convince Nationwide that the true replacement cost was only $1,300,000 because a functionally equivalent and far superior facility could be built entirely of steel and without the need for the more expensive concrete block. When Nationwide refused to reduce the amount of the coinsurance penalty, R & C filed suit, claiming breach of contract and bad faith and stating that Nationwide used an inflated replacement cost estimate to reduce its insurance coverage. Nationwide filed a motion for a declaratory ruling asking the court to define the term "replacement cost" as requiring replacement of an insured structure with "materials of like kind and quality." The district court overruled Nationwide's motion and decided as a matter of law that the term "replacement cost" required a replacement value based on a functionally equivalent building instead of a building of materials of like kind and quality. A jury found Nationwide breached the contract and acted in bad faith. Nationwide filed a motion for judgment notwithstanding the verdict (JNOV) and a motion for a new trial. The court upheld the breach of contract verdict but granted the JNOV motion, concluding that Nationwide had a reasonable basis for its interpretation of the policy and also concluding that there was no evidence Nationwide knew or had reason to know of any lack of reasonable basis for its interpretation. R & C appealed and claimed the court was in error for not finding that Nationwide had acted in bad faith when defining replacement cost by materials of like kind and quality.

Since the policy was written on a replacement cost basis, the "actual cash value as of the time of the loss or damage" provision was replaced with the phrase "Replacement Cost (without deduction for depreciation)." The policy also contained an amendment that added the following paragraph to any provision using the term "actual cash value:" Actual cash value is calculated as the amount it would cost to repair or replace Covered Property, at the time of loss or damage, with material of like kind and quality, subject to a deduction for deterioration, depreciation and obsolescence. Actual cash value applies to valuation of Covered Property regardless of whether that property has sustained partial or total loss or damage.

Nationwide claimed that this amendment added this definition to the valuation section in the original policy. Since R & C selected replacement cost valuation, the phrase "Replacement Cost (without deduction for depreciation)" replaces "actual cash value," resulting in the following valuation provision: "We will determine the value of Covered Property in the event of loss or damage as follows: At Replacement Cost (without deduction for depreciation) at the time of loss or damage…Replacement Cost (without deduction for depreciation) is calculated as the amount it would cost to repair or replace Covered Property, at the time of loss or damage, with material of like kind and quality, subject to a deduction for deterioration, depreciation and obsolescence. Replacement Cost (without deduction for depreciation) applies to valuation of Covered Property, regardless of whether the property has sustained partial or total loss or damage.

The appellate court understood how Nationwide chose to value the covered property under this provision but, like the district court, determined that the resulting policy provision was ambiguous and did not define the relevant term. As a result, the court searched for the ordinary meaning of the otherwise undefined term. Black's Law Dictionary defines replacement cost as "the cost of a substitute asset that is equivalent to an asset currently held. The new asset has the same utility but may or may not be identical to the one replaced." The definition used by the district court, "the cost of acquiring an asset that is as equally useful or productive as an asset currently held; a functionally equivalent asset" conforms to this definition. Because the district court's definition complied with that in common usage and other Iowa case law, the appellate court found no error in the court's definition, denied Nationwide's cross-appeal on the issue and affirmed the district court's verdict.

R & C Industries, Inc., Plaintiff-Appellant/Cross-Appellee, v. Nationwide Mutual Insurance Company, Defendant-Appellee/Cross Appellant. No. 06-0437. 2007 WL 1484072 (Iowa App)