Successfully Appraising Commercial Insurance Losses

As published by Risk Insurance Magazine, August 2005


A few years ago, I testified as an expert witness in an insurance matter at the federal court in Toledo, Ohio. On my long drive home, as is always the case after these occasions, the thoughts of my testimony were pouring through my mind. Did I communicate the results of my analyses, findings, and opinions well? Did I properly serve the interests of economic justice? And what about the juror dressed in his finest Dale Earnhardt T-shirt?

The answers to these questions are tough to gauge. But testifying in these matters begs the question of whether or not the attainment of economic justice in U.S. judicial system is truly attainable. Is any given jury qualified to evaluate the merits of the computed economic damages? Which expert witness’ testimony should be relied on, and how is it possible that experts could have two entirely different opinions concerning the damages sustained?

Parties to litigation such as this might ask why there is not a better forum for complex matters such as these to be decided. Where the amount of losses sustained under insurance policies is disputed, the appraisal condition found in most commercial policies provides for such a forum.


The appraisal condition provides a mechanism through which valuation disputes can be resolved in a timely manner without litigation. An added benefit for insureds and insurers is that the costs of appraisal are typically a fraction of those incurred in litigation. In the appraisal process, valuation disputes can be resolved by those more qualified to sort through and evaluate the issues. (No offense intended to the guy in the Dale Earnhardt t-shirt.) Also, if the appointed appraisers select an impartial umpire, then there should be no reason for either party to the contract to dispute the fairness of the process. There will, however, always be a perceived winner and loser in these matters and for the loser, the downside is that there will likely be no appeal or any record upon which an appeal could be made. Appraisal results are enforced by most U.S. courts, barring any fraud, collusion or malfeasance, of course.

Appraising Losses

The next step is to determine how the parties to the insurance contract can successfully appraise their losses. First, what determines success in this process must be defined. Generally, it is the attainment of the measurement objectives of the relevant contracts. The underlying objective is to find the amount that would restore an insured to the financial condition that likely would have resulted or been achieved had the damage or destruction of property, or a resulting suspension of operations, not occurred. The amount of measured damages recoverable will normally depend on the provisions of the insurance policy.

The commercial insurance form is a contract of indemnity from which no one is expected to profit. This view and measurement objective is not only mine but one that is well established in our law. In its opinion in Travelers Indemnity v. Armstrong, 384 NE 2d 607 (Indiana 1979), the court stated, “Since it is well settled that the concept of indemnity underlies every fire insurance contract, it is clear that indemnity pervasively affects the interpretation and operation of the loss payable clauses in such contracts.”

The appraisal of economic losses under insurance contracts cannot be undertaken without the proper consideration of policy measurement provisions. Although the purpose of appraisal is to establish values, and not to resolve coverage issues, those of us who have performed loss evaluations and/or appraisals under these contracts recognize that there is virtually no measurement that could be undertaken that has not also been the source of a coverage dispute. If appraisers are not free to apply the policy measurement provisions in some reasonable way, there is nothing for them to do or any purpose served by the appraisal process. There may be coverage issues that are not directly related to measurement but that may, nevertheless, impact valuations determined by the appraisers.

For example, if a company is performing an appraisal under the business income form, coverage issues may arise such as calculating losses resulting from property damage, loss coverage and periods of indemnity.

Most regard coverage issues like these to be outside the scope of the appraisal process. Nevertheless, if ignored, these issues will most likely be resolved by the appraisers and the related loss measurements included in appraisal results.

When coverage issues are disputed by parties to the contract, it is important to provide appointed appraisers with written instructions concerning the scope of engagement. In most instances, appraisers and umpires approach these matters in a conscientious manner and will not attempt to exceed the authority granted to them.

With the aforementioned issues in mind, the following steps are provided for successful appraisal of commercial insurance losses.

Consider Motives and Positions

Before submitting to the process of appraisal, be certain that your valuations would be viewed as reasonable by others. If after a little soul searching you begin to see yourself as a steely insurance adjuster out to defeat a legitimate insurance claim with unreasonable assumptions, or with a policy that is too narrowly construed; reconsider your positions. You will likely find no benefit from the appraisal process. Just pay the appropriate amount of the claim. If you are an insured and after some re-evaluation of your positions you see yourself asking for a windfall that your business itself would not have produced, likewise you may also be disappointed if you invoke the appraisal clause. Make every attempt to resolve the claim with the adjuster. But if you are satisfied that your positions are sound and others are unreasonable, you are ready to enter the process.

Selecting an Appraiser

The first rule of engagement in the appraisal process is that there are no rules of engagement. The insurance contract is remarkably silent concerning what is to take place. All that the contract offers is that the appraisers perform their own valuations and then attempt to find agreement with the other appraiser concerning those valuations. If an agreement cannot be reached, submit differences to the umpire. A decision agreed to by the appraisers or agreed to by one appraiser and the umpire is binding.

The first course of action for insureds or insurers in the selection of an appraiser is to select an appraiser with experience. Although there are no hard and fast rules governing this process, there are often rules of procedure that are followed, particularly in complex matters of some magnitude. The appointed appraiser must also be competent and impartial.

Although the courts do not appear to require any special expertise in the subject of appraisal, take it up a notch. When appraising a business income loss or valuation of inventories, it would be helpful to have an accountant involved. Not just any accountant, however, but one familiar with the measurement objectives of the contract. If measurement positions in these matters are to be successfully argued by the appraiser (and there will be arguments), the appraiser must be sufficiently familiar with these contracts to advance the appropriate positions. One court has found that the impartiality requirement is not violated by appraisers acting as advocates for the respective selecting parties. [Central Life Ins. v. Aetna Casualty, 468 N.W. 2d 257 (Iowa 1991)].
Once the appraiser is selected, your involvement as a party to the appraisal is complete, with one exception. Though you should not interfere with this process, you must take steps to assure that the appraisal is moving along as it should. If your appraiser is not acting in good faith, you will likely suffer the consequences. Thus it behooves you to periodically contact your appraiser to see how the matter is proceeding.

To the Appraisers

You are an appointed appraiser. It was a condition of your appointment that you be impartial and act in that manner. Although you may act as an advocate for your client, in the spirit of this process you must also act in ways that will assure a fair and equitable result consistent with policy measurement objectives for which the appraisal condition was invoked. Formulate your positions and contract valuations. If you feel that additional information is necessary, you may request it. Make certain that any requested information is also provided to the other appraiser. Before discussing your valuations with the other appraiser, once again, re-evaluate your underlying assumptions and calculations. But be careful not to alienate a fellow appraiser by taking ridiculous or untenable positions. The appraisal process is a process of human interaction, and, as with all matters, perceived credibility and integrity are always important.

Once satisfied that your positions are reasonable, provide them to the other appraiser and arrange for the discussion of values. If you can find agreement with the other appraiser, the process is complete. Any findings should be recorded in writing with as much detail as is possible under the circumstances. Remember, appraisal is a process of valuation, and the appraisers should communicate their findings in a way that will resolve these disputes without confusion as to intent of the appraisers. In the event that you are unable to resolve the valuation with the other appraiser, then it is time to select an umpire.

Selecting an Umpire

When considering the selection of an umpire, it is critical that he or she is completely impartial. The impartiality of a selected umpire must be beyond reproach. If the topic of appraisal is commercial valuation, it is also suggested that an accountant be selected as the umpire. Although it is preferred that the accountant have some familiarity with the insurance contract, in practice, the nomination of any accountant with this experience is immediately suspect by one or the other appraiser. If for example, the selected accountant had experience dealing with these matters, he or she is likely to have gained that experience working either for insurers or insureds.

The selection of an umpire is often a point of contention between the appraisers. In order to get over this hurdle, request that the other appraiser nominate three accountants. Then interview the nominees to establish that there are no prior, current or anticipated future relationships with the participants in this process that would in any way affect their impartiality. In the same way that a juror may be interviewed, ask about prior experiences or other matters that could lead to any perceived predispositions in the current matter.

After selecting the umpire, ask that the umpire sign an affidavit swearing to the representations made to the appraisers and to his or her stated impartiality. If the appointed appraisers cannot agree on the umpire, however, under the contract the court will appoint one.

After the appointment of an umpire, however it occurs, the ground rules must be established with the umpire and other appraiser. The most important rule is one that involves the integrity of the process. There should be a clear understanding between appraisers concerning communication between each appraiser and the umpire. This understanding should prohibit communication with the umpire without the other appraiser’s knowledge. The integrity and fairness of this process should always be of utmost importance to the appraisal appointees. It is the only assurance that the parties to the contract have that disputes are being resolved in a fair and impartial manner.

Also in the interests of fairness, the appraisers and umpire should give the parties to the contract a fair hearing in matters, if requested. The process may be as formal or informal as the appraisers wish to make it. The presentation of witnesses, physical evidence or affidavits in support of positions is always permissible.

Once the appraisers and umpire reach agreement in any valuation matter, the process is complete. The participants should clearly communicate their findings with as much detail as possible to the parties to the contract.

The Appraisal Result

You now have an appraisal result. If there were other coverage issues involved such as defining the appropriate period of indemnity and you provided the appraisers with a clearly delineated scope of engagement, you likely will have, if requested, two appraisal results: one for perhaps a three-month loss period and another for a five-month period. Good luck to you in your continued litigation.

If, however, you were silent and are now unhappy, you now have a result that you will likely have to live with. In Indiana and in many other states, appraisal is the law, as was asserted by the United States Court of Appeals for the Seventh Circuit (FDL v. Cincinnati Ins. 135 F.3d 503, Seventh Cir. 1998). In this matter an appraiser determined the value of manufactured inventories under the valuation provisions of an insurance policy by including only the variable manufacturing costs actually incurred.

Although in practice, this is sometimes an unpopular view, it is a view that was consistent with the contract measurement objective. The umpire (nominated by the other appraiser) after thoughtful consideration, agreed and an appraisal result was achieved. Although a District Court had set aside the appraisal result, the United States Court of Appeals for the Seventh Circuit reversed the District Court’s entry of judgment. In its opinion the appellate court stated, “A party who voluntarily submits to determine the amount due under a fire insurance policy is bound by the appraisal award, absent exceptional circumstances,” citing Atlas 309 NE 2d at 814. “To hold otherwise would frustrate the very purpose of the appraisal clause in cases such as this. Exceptional circumstances include manifest injustice, fraud, collusion, misfeasance or the like.”

Steven J. Meils, CPA is a partner in the accounting firm of Buchanan Clarke Schlader, LLP, a national forensic accounting firm specializing in the measurement of financial damages. He has served as an appraiser in many commercial insurance disputes.