This previous post explored the role of federally-subsidized flood insurance in attracting capital investment in New Orleans that probably would not have occurred had the owners of the capital been faced with paying the cost of private flood insurance. Until Hurricane Rita developments took us a bit off track, I had been meaning to pass along this NY Times article about a batch of lawsuits by plaintiff’s lawyers and Mississippi Attorney General Jim Hood that seek to eviscerate flood exclusion provisions in homeowner’s liability insurance constracts and make the insurers responsible for damages caused by flooding from Hurricane Katrina For those of us who prefer to pay less rather than more for such insurance, these lawsuits are a real bad idea, as the following and this OpinionJournal piece explain.

Insurers have long had flood exclusions in their insurance contracts, which is one of the primary reasons why the federal government got into the business of subsidizing flood insurance in the first place. The reason for this is that floods are not a typical insurable risk, which insurers normally spread among a large pool of insureds who are subject to the risk through collecting premiums from that pool. Insurers then use the premium funds from that pool to compensate the relatively few who actually suffer accidents from the risk. Floods are also not a typical insurable risk because the only people who buy flood insurance are those who are likely to be flooded, which makes it impossible to spread risk over a large enough pool of insureds. Finally, floods tend to be widespread and recurring, so they cause huge losses that require equally huge pools to cover the losses. That’s why private flood insurance is very expensive.
However, Attorney General Hood is now attempting to set aside these flood exclusions in private insurance contracts in the wake of Katrina as being “unconscionable.” Similarly, well-known Mississippi plaintiff’s lawyer Dickie Scruggs is following up with other lawsuits in which he contends that the insurers engaged in deceptive trade practices by excluding flood coverage arising from storm surge from their contracts. Messrs. Hood and Scruggs are taking these positions despite the fact that federally-subsidized flood insurance has been promoted in the region for about 40 years and relatively few Mississippi coastal residents have bothered to buy it, presumably because either they did not want to pay extra for it or they assumed that the feds would bail them out in the event of a Katrina-like catastrophe, anyway.
So, Messrs. Hood and Scrugges are demanding that private insurers pay for Katrina flood damages even though the insurers never collected any flood premiums over the years and thus, have no such reserves dedicated for that risk. Inasmuch as insurers are already liable for an estimated $50-70 billion in insured losses, adding another $15-20 billion in uninsured flood losses would ensure that at least a few insurers would end up in chapter 11.
But there would be even a more draconian result if Messrs. Hood and Scruggs are successful in their lawsuits. Insurance companies would have to assume that flood risk is a part of the insured risk, regardless of the exclusions in the insurance contracts. Consequently, the insurers would either charge you and me higher premiums — certainly at least hundreds of dollars annually — to cover this risk, or they could simply stop writing policies at all in the Gulf Coast region. That would reduce the competition among insurers to provide policies to all of us, which would also ratchet up the cost of such insurance.
Finally, one has to ponder how Mr. Hood — a governmental official who has at least an indirect responsibility to encourage reconstruction of the battered regions of his state — rationalizes taking actions that will increase the cost of liability insurance and thus, make it more expensive for Mississippi citizens to rebuild. Hopefully, a common sense opponent to Mr. Hood will appear in the campaign for the next election who will point that out to Mississippi voters.
Update: Professor Ribstein notes the even wider impact of the Mississippi insurance lawsuits on respect for the rule of law:

[N]obody’s safe if courts don’t enforce contracts. How could the insurance industry ever be sure it was excluding a risk if can’t enforce this clearest exclusion of all? How could any company ever be sure it was limiting the scope of any promise?

Doug Simpson over at Unexpected Consequences also reviews the effects of the Mississippi insurance lawsuits.