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Mississippi Fails to Learn From History

Friday, February 16, 2007

The state’s malarial litigation climate may deprive its citizens of homeowner’s insurance.

In the 1840s, the state of Mississippi faced economic problems. Governor Alexander McNutt resorted to an easy out: he blamed the state’s troubles on foreign investors, and, invoking Judas and Shylock, closed a budget gap by repudiating Mississippi’s bonds and debts. Mississippi courts at first refused to recognize the repudiation, but investors who trusted the rule of law were ultimately out of luck: an 1853 referendum refused to raise taxes to pay the obligations, and an 1875 amendment to the state constitution prohibited the state from paying back the bonds. Mississippi had successfully bilked its creditors (including the family of William Wordsworth, who wrote a sonnet about the injustice) for short-term gain, but the victory was Pyrrhic: cut off from the credit markets, the state economy has languished behind the rest of the nation ever since.

The twenty-first century looked to be the dawn of a new era in Mississippi. Governor Haley Barbour and the Mississippi Supreme Court improved the legal environment. Judicially-created procedural rules that had unfairly tilted the litigation playing field toward plaintiffs were rectified by the Court. A special legislative session reformed the state’s law in the areas of joint and several liability, jury service, medical liability, and non-economic and punitive damages. Barbour’s reforms were hailed nationwide, and industry began considering Mississippi as a home in a way never seen before.

KatrinaBut then Hurricane Katrina hit. The storm did plenty of damage, but it was just a prelude for the litigation storm to follow.

Almost every home-owners insurance policy in the United States has a clause excluding coverage for flood damage. A government-subsidized flood insurance program makes it uneconomic for private insurance companies to include flood insurance in homeowners' policies. Insurers thus only offer the government policy. Every insurance holder in America benefits from these exclusions, since they make insurance for non-flood risks more affordable—because the price of the policy reflects the level of risk incurred by the insurer. When Hurricane Katrina hit, the storm surge destroyed thousands of homes on the Mississippi Gulf Coast; government flood insurance did not cover all of the losses, and some Mississippians had failed to purchase even the subsidized flood insurance. Historically, the government has tended to bail out flood victims (insured or not) after the fact, making the purchase of flood insurance a fools’ game.

State attorney general Jim Hood and trial lawyers led by Dickie Scruggs sought to retroactively rewrite the homeowner policies, suing insurers to force them to pay money for a risk they had not agreed to assume. A federal judge rejected the most egregious arguments for liability, but still annulled some important language in insurance policies. State Farm, which refused coverage for a plaintiff based on their pre-ruling interpretation of the policy, was held to have done so in bad faith, subjecting them not only to coverage not in the insurance contract, but also to a million dollars in punitive damages.

What has been especially appalling was to see Senator Trent Lott, mired in his own personal lawsuit against insurers over the flood exclusion, use the powers of his office to threaten Congressional investigations. Had any other Republican tried to resolve a personal contract dispute through the legislative subpoena power, one can only imagine the media bonfire over the abuse of office. In this case, however, the shrugging was audible—even though the prime beneficiary of Lott’s threats was his brother-in-law, Dickie Scruggs. (The Senate Republicans shrugged, too, and appointed Lott to the leadership role of minority whip, suggesting that they have learned nothing from the defeat of 2006.)

Without the rule of law enforcing contracts as written, legal risks rise so high as to make doing any business unjustifiable. This has been happening in Mississippi for months; insurers have quietly stopped writing new policies.

State Farm could have eventually withstood this litigation pressure with relief from appellate courts. In another case, the company stood on its rights when trial lawyers sought billions in an illegitimate Illinois class action, and it was eventually vindicated years later by an Illinois Supreme Court opinion in its favor. But with the abusive threat of criminal sanctions over these contract disputes added on top of the legal proceeding, the insurance company couldn’t take the risk. It had to capitulate to the extortion, or face the full power of the state.

Thus State Farm made the payoff: full compensation for Dickie Scruggs’s 640 clients, including Senator Lott, and the reopening of 35,000 insurance claims from people who hadn’t sued. Scruggs himself stands to collect between $26 and $46 million.

But this isn’t a free lunch for the people of Mississippi. The same sort of shortsightedness that led to Mississippi’s destructive decision to repudiate its debts is operating again today.

Jim Hood and Dickie Scruggs have obtained a few hundred million dollars from State Farm, and may muscle other insurers into paying up. But insurers have to price their insurance based on expected risk. Risks include not just the risk of hurricanes and storms and fires, but the legal risk that their contracts will be disregarded, that courts will demand payouts of $1.2 million on a $240,000 policy, and that a government official will use the power of the state to expropriate property.

Without the rule of law enforcing contracts as written, legal risks rise so high as to make doing any business unjustifiable. This has been happening in Mississippi for months; insurers have quietly stopped writing new policies. The announcement by State Farm this week that they would do the same is merely the first public recognition of what economists have been warning all along. As State Farm vice president of public affairs Mike Fernandez said, Mississippi's “current legal and political environment is simply untenable. We're just not in a position to accept any additional risk in this homeowners' market.” The expense of legal risk doesn’t just fall on insurers; businesses unable to get insurance or willing to risk that state officials will target them next have been closing down as well. Oreck, one of the first businesses to reopen after Katrina, moved a vacuum cleaner factory and 500 jobs from the Mississippi Gulf Coast to Tennessee. Others are sure to follow.

Image credit: Photo by Flickr user Daquella manera

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