A federal judge's ruling last week that insurer flood exclusions do not apply to the 2005 levee breaks in New Orleans after they were ruptured by Hurricane Katrina could cost carriers more than $2 billion, according to some estimates. But to insurers, who are appealing the ruling, the legal precedent set if the decision is upheld would be more problematic than the immediate financial implications, 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 a flood 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 to the U.S 5th Circuit Court of Appeals.

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

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

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

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

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

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

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

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

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

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

Plaintiffs in the consolidated case, which involved five separate policies, argued that the water damage was not the result of flood, but was instead water intrusion, caused simply from a broken levee wall–the result of third-party negligence in the building of the levees.

Their suits, in addition to insurers, named the Board of Commissioners for the Orleans Levee District. Judge Duval severed the OLD from the cases before him and remanded those claims to Civil District Court.

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

Under Louisiana law, according to Judge Duval, “unless there is a specific exclusion for the type of water damage that an insured has 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, an Allstate representative, said the company intends to appeal, contending that Judge Duval erred in finding “that the flood exclusions are ambiguous.”

Mr. Ellison said it was possible the 5th Circuit could send the matter to the Louisiana State Supreme Court to decide the issues of law involved, and plaintiff lawyers intend to ask the 5th Circuit to send the entire case to the Louisiana Supreme Court. He said he believed the 5th Circuit probably will make rulings in the case in January.

Bear Stearns analysts examining the case said that using a $1 billion loss figure, “if we take Allstate's market share of the Louisiana homeowners market of roughly 20 percent and apply it to this 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-term negative for [Allstate] shares as concerns resurface regarding further potential Katrina payments,” according to Bear Stearns. “Mitigating factors are that this is only the beginning of the process and will likely take years to play out, and secondly this may not be a significant dollar amount for Allstate.”

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

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