Dec. 21 (Bloomberg) -- The home of Richard Scruggs, or what's left of it, is less than 150 feet from the seawall where the state of Mississippi meets the Gulf of Mexico. Scruggs was home in Pascagoula to arrange a memorial for his mother, Helen, who died at the age of 95, as Hurricane Katrina approached the Gulf Coast.

As the water rose against the seawall, Scruggs and his family fled northward, flying in one of his two private jets to Oxford, forgoing the service until the following week. On the morning of Aug. 29, Scruggs's 7,000-square-foot, $1.2 million home, his neighbors' houses and even that of his late mother were inundated or destroyed when the Category 4 storm came ashore, pushing a monstrous storm surge inland.

In the days following the hurricane, which killed more than 1,300 and laid waste to New Orleans, President George W. Bush told Mississippians that he hoped to sit on the rebuilt porch of Scruggs's Pascagoula neighbor and brother-in-law, U.S. Senator Trent Lott. Scruggs saw another storm coming -- this one over who was going to pay for his brother-in-law's porch.

A trial lawyer who in 1998 wrested a $206 billion settlement and $1 billion in fees from the tobacco industry, Scruggs, 59, warned that homeowners along the Gulf Coast in Mississippi, Louisiana and Alabama would face an insurance industry unwilling to pay them for the havoc Katrina had wrought on their homes.

Insurers such as Metropolitan Property & Casualty Insurance Co., Nationwide Mutual Insurance Co., State Farm Fire & Casualty Co. and United Services Automobile Association contend that the standard homeowners' insurance policy in Mississippi and other states doesn't cover flood damage and that the storm surge that resulted from Katrina coming off the gulf was just that -- a flood.

National Insurance

They point to the federal government's sponsorship of its own flood insurance program as evidence of this fact. Scruggs, along with Mississippi Attorney General Jim Hood, says the policies are vague and that many specify hurricane deductibles, which suggests water damage. The insurers point to exclusions of water damage also contained within the policies.

Since October, Scruggs and Hood have filed lawsuits on behalf of homeowners and the state in an effort to obtain a judicial ruling that storm surge should be covered by homeowners' insurance, either because policyholders expected coverage or because it's good public policy.

At stake, says Paul Newsome, an analyst at A.G. Edwards & Sons Inc. in St. Louis, are additional insurer losses that could match those reported in the third quarter. In the longer term, Scruggs says, the upending of catastrophic storm coverage in the U.S. could result. A plaintiff victory would be a powerful precedent supporting similar claims, he says, adding that a few wins could force a massive settlement.

`Bad Faith'

``It would almost make it bad faith for them to continue to deny coverage,'' he says. A federal judge in the first Scruggs case has scheduled a tentative trial date of Oct. 2.

Katrina may end up being the most costly U.S. disaster for insurers. Risk Management Solutions Inc. estimates there will be $40 billion to $60 billion in claims, as much as three times the $20.9 billion produced by Hurricane Andrew in 1992. Total losses from Katrina, including flood losses, may reach $125 billion. Mississippi had about $9.8 billion in losses and 490,000 claims from Katrina as of Oct. 4, according to the Insurance Information Institute.

The 2005 hurricane season was the busiest since records were kept beginning in 1851. Though most insurers themselves hold reinsurance policies to protect against catastrophic payouts, the Katrina litigation poses longer-term risks.

`Significantly Higher Losses'

``I think it is safe to say the industry would be facing significantly higher losses should it be forced to cover flood damage, and I would not be surprised if the industry's losses from the third-quarter hurricanes could double in size,'' Newsome says.

Matthew Steffey, a professor at the Mississippi College School of Law in Jackson, agrees with Scruggs's strategy of seeking to win a few cases to force a settlement.

``A victory or two will raise the settlement value of many claims,'' Steffey says. ``Adverse precedent would surely seem to prompt some number of settlements.''

Scruggs and Hood are asking for an expedited ruling on the merits of the cases they have filed. Scott Stolley, an insurance litigator at Thompson & Knight LLP in Dallas, says a victory in Mississippi would set off a campaign by state attorneys general and plaintiffs' lawyers across the country to reform homeowners' policies.

Domino Effect

``Success breeds imitation,'' he says, adding that other state courts will look to Mississippi rulings as guidance given the novelty of the legal issue, possibly creating a domino effect.

For Mississippi residents, Stolley warns, a victory for Hood or Scruggs may also have unforeseen negative consequences. ``A lot of insurers will pull out of Mississippi, and homeowners' and other types of property insurance will become exorbitant and difficult to obtain, if available at all,'' he says. ``People in Mississippi will not be able to get mortgages to buy homes if there are no insurers willing to write coverage.''

Hood, 43, a Democrat and fifth-generation Mississippian elected in 2003, says the exclusion invoked as a result of Katrina violates good public policy since homeowners expected to be covered. He says his primary motive now is to get a court order stopping insurers from denying coverage based on the exclusion. Coastal residents may abandon the state if they aren't compensated, he says, and he wants to give them some hope.

`Win-Win'

Scruggs has selected a few plaintiffs with different backgrounds to ask the courts whether the insurance companies have been playing a game of sleight of hand. Scruggs claims in six separate lawsuits in Mississippi federal court, including one his firm filed on Dec. 15 on behalf of Lott, that insurers have been defrauding consumers by charging premiums on the expectation that hurricane losses would be covered and then rejecting payouts based on flood exclusion clauses.

Insurance companies have reported estimated pretax losses of as much as $30.8 billion as of Nov. 10, according to data compiled by A.G. Edwards Inc. Scruggs describes his strategy as a ``win-win'' because the precedential value of one court victory could force insurers to settle for billions of dollars more than they expected.

Insurers counter that such a victory would do irreparable damage to homeowners in low-lying regions and destroy their incentive to participate in a federal flood insurance program aimed at encouraging communities to adopt flood plain management.

Industry Warning

``What's really happening here is an attempt by trial lawyers and the state's highest law enforcement officer to retroactively rewrite contract terms,'' says Robert Hartwig, chief economist at the Insurance Information Institute, an industry group. ``It would create a situation where it would be impossible to sell insurance in these states.''

The cases Scruggs has filed target each of the major homeowner policy insurers in Mississippi. He calls them ``pathfinder'' cases in which, like class actions, each client represents a type of claim among the almost 3,000 policyholders who he says have retained his law firm. All of his lead clients have agreed, in exchange for free representation, to adhere to his strategy of using their cases to find out how receptive the courts are to his arguments and not to settle unless the companies agree to pay everyone's full claim, Scruggs says.

While he's representing the lead plaintiffs for free, Scruggs will ask for 20 percent of any settlement obtained by the remainder of his clients. Scruggs says he hasn't sued on his own behalf, despite having much of his home gutted by floodwaters and almost $300,000 in losses uncovered by insurance.

Concrete Slab

Among his clients are Tina Lee, 41, a respiratory therapist who, with her husband, David, 47, occupied a house directly behind the lawyer's until the storm surge destroyed it, dropping portions of Scruggs's guesthouse in their yard and leaving them a concrete slab. They now live in a trailer on their home's foundation.

Scruggs also represents retired U.S. Navy Rear Admiral James Lisanby, 77, who, like Scruggs, has national flood insurance as well as a homeowners' policy. Together, the two policies covered only a fraction of his losses, Scruggs says.

Less than a month after the storm hit, Hood sued Allstate Property & Casualty Insurance Co., Mississippi Farm Bureau Insurance, Nationwide, State Farm and USAA. In his complaint, Hood accuses the insurers of violating public policy and entering into unconscionable contracts with consumers under state law. Contracts deemed to be unfair and oppressive because their terms violate the reasonable expectations of one of the parties may be thrown out by a court. Policyholders, Hood argues, expected flood damage to be covered.

Assumptions

``People were buying a homeowners' and a hurricane policy, so they naturally assumed that the policy would cover what causes 90 percent of the damage of a hurricane: storm surge,'' he says, adding that 20,000 families on the Mississippi coast who had their homes destroyed had no flood coverage.

The lack of insurance coverage has created a mass exodus from coastal Mississippi, Hood says, as well as a spike in bankruptcy filings by individual homeowners, businesses and banks. He says the insurance industry is pursuing a stalling strategy because it knows that many claimants will simply give up, which will save the industry billions. He says the industry would need to pay out only an additional $2 billion to $4 billion in Mississippi to cover the claims.

``You can't sell somebody something and then take it all away in the fine print,'' he says.

According to A.M. Best Co., insurers with homeowners' policies in Mississippi include State Farm, which has 30.4 percent of policies; Southern Farm Bureau Group, with 21 percent; Allstate, with 9.9 percent; Nationwide, with 7 percent; and Farmers Insurance Group, with 5.7 percent.

Undermine Industry

Dick Luedke, a State Farm spokesman, says the litigation will undermine the insurance industry's financial stability. In October, Allstate Chief Executive Edward Liddy said his company plans to raise prices and reduce sales to homeowners in Gulf Coast states. Northbrook, Illinois-based Allstate, the biggest publicly traded insurer operating in Alabama, Florida, Louisiana and Texas, reported more than $4.7 billion in storm claims in the quarter.

For Mississippi native Scruggs, this litigation is just the latest fight in a career spent as a thorn in the side of corporate America. Born in Brookhaven and raised in Pascagoula, Scruggs served in the U.S. Navy as a fighter pilot, reaching the rank of lieutenant before leaving to attend the University of Mississippi School of Law, from which he graduated in 1976.

Most-Feared Lawyers

In the past three decades, he has joined the ranks of the nation's most-feared plaintiffs' lawyers, facing down health maintenance organizations and asbestos manufacturers and earning more than $1 billion in fees from settlements with tobacco companies. Scruggs is now leading the charge against nonprofit hospitals, coordinating lawsuits in 25 states that accuse them of overcharging uninsured patients.

In the Katrina cases, Scruggs claims that 60,000 to 100,000 families in Mississippi alone may benefit from a settlement. He says he's seeking only to have his clients compensated for their losses, not additional money damages.

``This is kind of a safety net where a highly technical application would result in injustice,'' Scruggs says of his lawsuits. ``We're focusing on people with homes right now who have no job and a mortgage on rubble.''

The insurers say the legal interpretation is simple. ``Losses that result from rising water are covered by the flood policy and losses that result from wind and from wind-driven rain are covered by the homeowners' policy,'' Luedke says.

Ambiguity

Todd Rossi, a Baton Rouge, Louisiana-based insurance lawyer, warns that what seems to insurers like a straightforward interpretation of homeowners' policies could go awry in Scruggs's lawsuits. If there is any ambiguity in such policies, he says, the legal standard is that the decision favor the policyholder.

``If the court finds ambiguities, the policy terms are construed against the insurer and in favor of coverage,'' Rossi says. ``The court will look at the policy language and will construe the policy terms in favor of coverage if there is at least one reasonable interpretation that results in coverage.''

Pascagoula police officer Paul Leonard, 47, and his wife, Julie, 39, who live on the same street as Scruggs, have a homeowners' policy issued by Nationwide for more than $300,000, covering their home, other structures, personal belongings and loss of use and additional living expenses, according to their lawsuit. Since 1999, their policy contained a ``hurricane deductible'' of 2 percent of their coverage limit. Their expectation, Scruggs says, was that the policy would cover all damages ``proximately caused'' by a hurricane such as Katrina.

On Duty

Leonard was on duty as the storm hit Pascagoula. Following the destruction of what the lawsuit says was the ``entire bottom portion of their house,'' the Leonards were forced to cook in a makeshift kitchen in their upstairs hallway and wash dishes in an upstairs bathtub. They were denied coverage by Nationwide, Scruggs says, which attributed the damage to water excluded under the policy.

On Sept. 7, the insurance company sent the Leonards a Hurricane Coverage and Deductible Provision Endorsement, which, for the first time, attempted to unequivocally exclude storm surge from the policy, the suit says. Since storm surge is driven by wind, damage from which is covered under such policies, Scruggs argued, the flood exclusion shouldn't apply. The insurer's follow-up form shows the insurance company knew the policy was ambiguous, he claims.

Leonards' Losses

The suit, originally filed on Oct. 4 in Mississippi Chancery Court, seeks a declaration that storm surge be covered, that the company pay for all of the Leonards' losses and that they be indemnified for their expenses since the storm and have all of their $2,000 annual premiums paid over the past 10 years placed in trust. ``Defendant Nationwide fraudulently and intentionally failed to provide full and comprehensive coverage,'' Scruggs wrote in his complaint.

The so-called hurricane deductible covers losses caused by windstorm or objects driven by it, according to a copy of the Leonards' policy endorsement supplied by Scruggs. Whether storm surge would qualify as an object under the policy would be up to the judge.

``There is a legitimate reason to have a hurricane deductible in a policy even when the policy excludes hurricane- caused water damage,'' says Stolley, who has represented both insurance companies and policyholders. ``I don't think it is legally justified or sound public policy to make insurers retroactively pick up a multibillion-dollar tab.''

Nationwide, in moving the Leonards' case from Mississippi state court to federal court, warned that a ruling in favor of the Leonards would defeat the purpose of the National Flood

Insurance Program.

Risk to Flood Program

``A ruling that flood insurance coverage is being provided broadly through a homeowners policy would eliminate, among other things, one of the incentives communities have to adopt flood plain management,'' wrote H. Mitchell Cowan, a Jackson, Mississippi- based lawyer for the insurer. If homeowners believe they can recover for such damages by suing for coverage under their homeowners' insurance policies, the program will fail, insurers say.

``We are gravely concerned with any efforts that seek to throw out well-established flood exclusions contained in policy language,'' Joe Case, a spokesman for Columbus, Ohio-based Nationwide, says. ``If these long-recognized and relied-upon exclusions were to be deemed null and void, it would have a significant negative impact on insurance policyholders across the country.''

Insufficient Coverage

Pascagoula resident Lisanby, like Scruggs, has a national flood insurance policy in addition to his USAA homeowners policy. In his Nov. 2 lawsuit on Lisanby's behalf, Scruggs said his client's gulf-front home should have been covered for flood damage under both policies. For wealthier homeowners, the federally funded policy's $250,000 limit isn't sufficient to cover the damage to their homes, he argued.

The lawsuit claims that USAA's ``wind and hail'' deductible, 1 percent of the value of the home, or $5,050, guaranteed coverage for ``any and all damage to the insured residence caused by a hurricane, including damage caused by hurricane wind and `storm surge.'''

The exclusion in the Lisanby policy states that ``flood, surface water, waves, tidal water, overflow of a body of water, or spray from any of these, whether or not driven by wind'' aren't covered. In an Oct. 20 letter, a USAA insurance adjuster attributed damage to his guesthouse, garage and carport to ``the flood event.''

Home Condemned

Lisanby's home was condemned due to damage from the storm, Scruggs says. USAA, which insured his home and property for more than $1.2 million in exchange for an annual premium of more than $4,000, offered $21,808 in coverage for wind damage.

``We are very sympathetic to the citizens of Mississippi, Alabama, Louisiana, Florida, etc. who did not purchase flood insurance,'' USAA spokesman David Snowden says. ``However, we cannot compromise the interests of our members who have covered losses by being forced to pay for uncovered losses. And the courts cannot rewrite the contract after the fact.''

USAA says it has lost $380 million due to Katrina-related costs, the most of any hurricane for the Texas company. Hurricane Wilma, which followed Katrina, was the second most expensive for the company, costing it $211 million as of Nov. 30, according to data supplied by the company.

Insurance companies sell national flood insurance policies, earning commissions on them and leaving payouts to the federal government. As a result, Scruggs says, the companies have an added incentive to ascribe storm losses to flooding. In Mississippi, there were 42,473 such policies in force for a total of $5.2 billion in coverage in 2004, according to the Insurance Information Institute.

Private Insurance

On Nov. 16, insurance regulators in four states called for the private insurance market to replace the government plan. The commissioners want to end the 37-year-old program in favor of commercial policies that cover flood damage.

Mississippi Insurance Commissioner George Dale is seeking to straddle the line between the industry and policyholders, saying the companies will be unfairly damaged by a court ruling that flood damage is included in homeowners' policies, and simultaneously saying that he has urged insurers to provide each policyholder with an in-person survey of damage and to pay as much as they can under the policies.

Dale says his office is assembling a mediation program for policyholders with complaints to take the burden off the court system. He says he has asked insurance companies to pay so-called slab losses, where all that remains of a house is its foundation.

Key to the Debate

The key to the entire debate is whether there's any distinction between wind and water damage in hurricanes. Insurance lawyer Jay Brown of Houston's Beirne, Maynard & Parsons LLP says Mississippians need only look west to Texas for a vision of the future should the Katrina cases succeed.

``Primarily through state court decisions and consumer- biased regulation, Texas consumers now enjoy some of the highest insurance premiums of any state for typical homeowners' coverage,'' Brown says. ``It costs considerably more to insure identical properties with identical houses in Texas as compared to most other states.''

Scruggs remains undeterred, saying that nothing else in his career has driven him harder than trying to force these insurers to pay up. ``This is where my life was formed, and the people who shaped it have been devastated by this and are being ignored completely by the insurance companies,'' he says. ``It's quite personal.''

Given the opponents he has already beaten, that's a stance that has to unsettle his adversaries this time around.