A state grand jury was impaneled in Pascagoula, Miss., last weekto hear evidence in an investigation of State Farm's handling ofHurricane Katrina claims, a week after the carrier was hammeredwith a $2.5 million punitive damage award.

The attorney general's inquiry is looking into allegations thatengineering reports may have been altered to minimize winddamage.

The probe, being conducted by State Attorney General Jim Hood,began months ago when subpoenas were issued, and was the subjectlast year of an unsuccessful court challenge by the insurer and aHouston engineering firm.

Last April, Circuit Judge Stephen B. Simpson in Gulfport, Miss.,ruled against the insurer and Rimkus Consulting group, after theysought to limit Mr. Hood's investigation.

Phil Supple, a representative for Bloomington, Ill.-based StateFarm, said he could "confirm State Farm is cooperating fully withthe attorney general's investigation." He said because grand juryactivities "are by nature confidential, there will be no furthercomment." Mr. Hood's office had no immediate comment.

Mr. Hood has also brought a civil suit against State Farm andother insurers, seeking to compel the carriers to cover damagecreated by wind-driven storm surge.

Settlement talks are underway between State Farm, Mr. Hood andplaintiffs' attorney Richard Scruggs in an effort to resolve morethan 600 suits involving Gulf Coast homes with storm-surge damage,which the insurer says is noncompensable under flood exclusionlanguage.

Mr. Supple said it would be in the best interests of all partiesin Mississippi if a settlement could be reached. Last week, thecompany lost a flood damage case in which Biloxi, Miss., homeownerswere awarded $2.74 million--a figure that included $2.5 million inpunitive damages.

In the April court action, Mr. Hood's office sought allengineering reports prepared for all insurance companies as aresult of Hurricane Katrina in Hancock, Harrison and JacksonCounties. Judge Simpson ruled that request was too broad-based, andordered that the attorney general should limit his demand forinformation to specific insurers and adjusters.

Meanwhile, the punitive damage verdict by a Mississippi federaljury is still sending shock waves throughout the industry. Thejury's Jan. 10 finding came hours after U.S. District Court JudgeL.T. Senter Jr., in Gulfport, Miss., ruled that the homeownerswhose claim had been denied by the insurer were entitled to$223,292 for damages to their house.

At that time he also rejected arguments from the Bloomfield,Ill.-based insurer's attorneys and ruled the jury could considerpunitive damages against State Farm.

Judge Senter--whose earlier rulings on the issue of insurancepolicy flood exclusion language negatively impacted carriers--madehis latest finding in a case brought by Norman and GenevieveBroussard of Biloxi, Miss., who sought $5 million in punitivedamages.

One legal expert said the ruling could impede State Farm'songoing efforts to reach a global settlement for similar Katrinacases (see last week's edition for details).

The company said it was disappointed with the punitive damagefinding and will evaluate its next steps, "which will likelyinclude an appeal."

The carrier had not expected the jury's decision, Kim Brunner,State Farm's executive vice president, secretary and generalcounsel, said in a statement. "Testimony of expert witnesses showedthat damage to the Broussard home was overwhelmingly caused bywater and not wind," he said.

However, Judge Senter ruled that the company did not presentsufficient evidence to prove how much damage to the home was causedby water and how much by wind, saying that plaintiffs only neededto prove a direct physical loss.

Mr. Brunner said State Farm believes the ruling "is inconsistentwith the insurance contract and Mississippi law."

State Farm--in denying the Broussard claim that the winds fromHurricane Katrina destroyed their home--attributed the loss tostorm surge, which the company said was noncompensable damage underflood exclusion language of their policy.

Judge Senter, in a case involving Nationwide in August of lastyear, ruled that insurers cannot totally exclude a claim becausethere has been flooding, and must pay for any wind damage.

The judge ruled in the Broussard case that State Farm had notdisproved the Broussard claim that their Gulf Coast home was blownoff its foundation by hurricane winds.

Attorney General Hood released a statement saying the latestcourt action did not surprise him. "Our learned Judge Senter readthe law and applied it. His ruling reflects what we have beensaying all along." The attorney general in his own action hasargued that disputed insurance policy language is ambiguous.

Mr. Hood added that the strongest part of Judge Senter's latestfindings "was that the insurance company did NOT meet its burden ofproof to show that water caused the damage. Judge Senter held thatthey had no reasonable basis on which to deny the claim. Thereforethe court gave a bad-faith jury instruction, and the jury returnedthe maximum punitive damage verdict available."

He added, "I hope the insurance companies will come to theirsenses and reach a settlement agreement. I will continue to workwith them toward a speedy settlement."

However, Mr. Hood concluded by raising the threat ofCongressional action, and warned that if insurers don't settle andif they "continue with their 'robber baron' mentality," hepredicted U.S. Rep. Gene Taylor, D-Miss., Rep. Bennie Thompson,D-Miss., and Sen. Trent Lott, R-Miss., would "see to it that wehave national insurance reform."

Sen. Lott--who is suing State Farm Fire & Casualty in aclaim dispute over damage to his home from Hurricane Katrina--lastOctober inserted language in legislation requiring the U.S.Department of Homeland Security to investigate insurer handling ofhurricane claims. Rep. Taylor is also suing State Farm over apersonal claim.

Randy Maniloff--a Philadelphia commercial litigation attorneywho defends insurers, and who has made a close study of JudgeSenter's rulings--said the most recent ruling could stymie StateFarm's wider settlement efforts.

The latest decision "justifies State Farm's decision to try andreach a global settlement. The question now is will thepolicyholders want to settle. If you are a policyholder, you arenow looking at this case and you'll say you want full value underthe policy as these people got."

There is less incentive for plaintiffs to settle, he added,because, "they will look at this decision and have visions ofgrandeur."