Academic journal article Journal of Risk and Insurance

Rainfall or Rainmaking? Lawyers, Courts, and the Price of Mold Insurance in Texas

Academic journal article Journal of Risk and Insurance

Rainfall or Rainmaking? Lawyers, Courts, and the Price of Mold Insurance in Texas

Article excerpt

ABSTRACT

In well-functioning property-liability insurance markets, the price of coverage reflects the impact of the legal environment on the frequency and severity of claims. This article presents a case study of the Texas mold insurance crisis of 2001-2002. We provide a narrative of the controversy in Texas over insurance coverage for household mold and use county-level data from a single Texas insurer to assess the determinants of postcrisis prices for supplemental mold, slab, and extended water loss coverages. We find that more attorneys per capita and more heavily Democratic courts were both associated with higher prices for mold and slab coverage.

INTRODUCTION

In well-functioning property-liability insurance markets, the price of coverage reflects, among other things, the impact of the legal environment on the frequency and severity of claims. This article presents a case study of the Texas mold insurance crisis of 2001-2002, showing that rapid changes in that state's legal environment were largely responsible for the crisis. Although regulatory reforms and market innovations resolved the immediate crisis, the legal environment subsequently continued to affect mold insurance prices. After providing a historical narrative of how the mold insurance crisis unfolded, we find that, other things being equal, postcrisis mold insurance prices were higher in Texas counties with more lawyers and more plaintiff-friendly courts.

In 2001, homeowners insurance claims for mold damage surged dramatically in Texas. For the three largest homeowners insurers in the state, the cost of mold-related claims increased from $9.1 million in the first quarter of 2000 to $79.5 million in the first quarter of 2001. (1) Similarly, the number of mold claims in Texas increased 548 percent between early 2000 and 2001. (2) This led to a showdown between insurers and the Texas Department of Insurance (TDI) over whether homeowners policies would continue to cover mold damage and even whether insurers would issue new policies.

Why was there such a sudden surge in the number of mold claims? Mold has been a constant companion of mankind throughout its existence, and it is extremely unlikely that there was a sudden surge in the amount of mold in Texas in 2001. We show instead that the Texas legal environment was an important contributing factor. In particular, in mold damage, entrepreneurial lawyers found a new legal area in which to file lawsuits, and courts friendly to homeowners' claims contributed to the surge in claims as well. To support our lawyer'/courts' explanation of the Texas mold crisis, we first provide a narrative of the Texas mold crisis that explains anecdotally the role of attorneys and courts. Next, we test the effects of attorneys and courts using data from a major insurer on postcrisis prices of mold insurance. We find that prices for mold coverage endorsements and slab coverage endorsements were significantly higher in Texas counties with more lawyers per capita and in counties within the geographic jurisdictions of courts of appeals with more Democratic Party judges. (3)

We are not the first to suggest that the presence of lawyers and friendly courts drives up insurance prices. Cummins and Tennyson (1992) showed how minor traffic accidents effectively gave motorists a lottery ticket with a high probability of recovering some amount of money as compensation for pain and suffering from a minor bodily injury. One element needed for these "lotteries" to work was "court systems that favor the plaintiff." They also found that in the city with the most successful insurance lottery, a "high proportion of the claims involved the same doctors and lawyers," who acted as managers of the lottery process. Derrig, Weisberg, and Chen (1994) emphasize that increased public awareness of the potential rewards from insurance lotteries played a major role in increased costs of auto accident bodily injury claims. …

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