A federal judge's ruling last week that insurer flood exclusionsdo not apply to the 2005 levee breaks in New Orleans after theywere ruptured by Hurricane Katrina could cost carriers more than $2billion, according to some estimates. But to insurers, who areappealing the ruling, the legal precedent set if the decision isupheld would be more problematic than the immediate financialimplications, observers warn.

The decision by U.S. District Court Judge Stanwood R. Duval Jr.in New Orleans is “inconsistent with many other rulings that held aflood is a flood, whether or not man-made factors are involved,”said Jennifer Wislocki, speaking for St. Paul-Travelers,which–along with Allstate and other carriers–is taking the case tothe U.S 5th Circuit Court of Appeals.

John Ellison, representing Anderson Kill & Olick, whose lawfirm has filed a prospective class action in the case, said lawyershave estimated the ruling's potential cost to insurers at between$1 billion and $2 billion.

Robert P. Hartwig, executive vice president and chief economistat the Insurance Information Institute in New York, said that inassessing the ruling's potential impact, “you're looking at severalbillion dollars, but that's not even the greatest threat.”

The bigger damage, he said, would be “a determination in afederal court–a precedent that could spread to otherjurisdictions.”

Mr. Hartwig said he believed the judge had overreached and hadreservations on his own ruling, because he had cleared it forimmediate appeal to the 5th Circuit.

The National Flood Insurance Program has paid millions in floodclaims from the levee break, and “it cannot be the federalgovernment and this judge are both right,” according to Mr.Hartwig.

Judge Duval in his ruling conceded that the impact of hisdecision “on individuals as well as the insurance industry might beconsidered overwhelming.”

The judge found that flood damage exclusion language in policiesissued by Allstate and other carriers does not “exclude waterdamage caused by negligent or intentional acts of man. It does notaddress the ambiguity of the term 'flood' and the fact that all ofthe listed 'causes' appear to be the result of natural occurrences,not the monumental civil engineering debacle that is alleged byplaintiffs.”

The judge's ruling did not extend to more detailed exclusionarylanguage in policies issued by State Farm, the largest writer inLouisiana in 2005 with a 35 percent share of the market (excludingLouisiana Citizens, the state's residual market), or by TheHartford, which wrote only 1 percent of the premiums (according toinformation from Highline Data).

With respect to State Farm, the judge wrote: “The State Farmpolicy does precisely what the [Insurance Services Office] WaterExclusion Policy fails to do,” referring to less precise languagein Allstate's coverage and other policies.

The judge said State Farm's policy “makes it clear thatregardless of the cause of the flooding, there is no coverageprovided for any flooding 'regardless of the cause.' Such languageis clear to the court and as such, the court must find that theState Farm policy as written excludes coverage for allflooding.”

Plaintiffs in the consolidated case, which involved fiveseparate policies, argued that the water damage was not the resultof flood, but was instead water intrusion, caused simply from abroken levee wall–the result of third-party negligence in thebuilding of the levees.

Their suits, in addition to insurers, named the Board ofCommissioners for the Orleans Levee District. Judge Duval severedthe OLD from the cases before him and remanded those claims toCivil District Court.

Judge Duval, finding it was his duty to interpret the commonintent of the parties to the contract, wrote that all risk“generally allows recovery for all fortuitous losses” not resultingfrom misconduct or fraud, unless the policy contains a specificprovision expressly excluding the loss from coverage.

Under Louisiana law, according to Judge Duval, “unless there isa specific exclusion for the type of water damage that an insuredhas incurred, coverage is presumed under these policies.”

The insurers, in an argument noted by the judge, maintained that“flood” is not limited to natural events. Mike Siemienas, anAllstate representative, said the company intends to appeal,contending that Judge Duval erred in finding “that the floodexclusions are ambiguous.”

Mr. Ellison said it was possible the 5th Circuit could send thematter to the Louisiana State Supreme Court to decide the issues oflaw involved, and plaintiff lawyers intend to ask the 5th Circuitto send the entire case to the Louisiana Supreme Court. He said hebelieved the 5th Circuit probably will make rulings in the case inJanuary.

Bear Stearns analysts examining the case said that using a $1billion loss figure, “if we take Allstate's market share of theLouisiana homeowners market of roughly 20 percent and apply it tothis loss, then Allstate's share of the total loss would be about$200 million.”

The decision, while only a first step, “could be a near-termnegative for [Allstate] shares as concerns resurface regardingfurther potential Katrina payments,” according to Bear Stearns.“Mitigating factors are that this is only the beginning of theprocess and will likely take years to play out, and secondly thismay not be a significant dollar amount for Allstate.”

The analysts added they “believe at the end of the day, thelikelihood that Allstate is forced to pay is limited,” noting that“the fact that the judge sent the ruling immediately to the Courtof Appeals may suggest he was less than certain in his decision, inour view.”