Like a shot to the gut, insurers had the wind knocked out of them last month by a potentially monumental decision that many insurer flood exclusions did not, in fact, preclude payment of claims resulting from the failure of levees to protect New Orleans during Hurricane Katrina.

U.S. District Court Judge Stanwood R. Duval Jr. in New Orleans ruled that flood 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 plaintiffs in the consolidated case successfully argued that water damage to their properties was caused not by your standard catastrophic flood, but because the man-made levee failed to keep water out as it was designed to do. Therefore, the cause of loss is third-party negligence in the building and maintenance of the levees, not Mother Nature.

State Farm--the biggest insurer in Louisiana last year, with a 35 percent share of the private marketcaught a break, as the judge ruled that its policy was unequivocally clear in excluding flood losses regardless of the cause. The problem with the other policies was their emphasis on natural disasters--which this loss was not, the judge determined.

Will the decision stand? Many in the industry are doubtful (although that may be wishful thinking). Some pointed out that even the judge himself might have doubts. After all, after conceding that the rulings impact on individuals as well as the insurance industry might be considered overwhelming, he cleared the case for immediate appeal to the 5th Circuit.

To add to the industry's woes, earlier this month a state court judge--Edward D. Rubin with the 15th Judicial District Court in Lafayette, La.--threw out the flood exclusion in a 2005 Hurricane Rita claim against the states residual insurer, Citizens Property Insurance Corp. Judge Rubin issued a summary judgment for the plaintiffs, suggesting that the exclusion in their homeowners policy should only apply in cases where properties were completely and clearly destroyed by flooding, not wind. Citizens plans an appeal.

Meanwhile, over the summer, insurers celebrated a key victory when U.S. District Judge L.T. Senter upheld the flood exclusion in an individual case involving Nationwide and a Mississippi homeowner.

However, another angry Mississippi policyholderU.S. Senator Trent Lott, a Republicancould cause the industry a lot of grief before this debate is over.

The incoming minority whip is pursuing his own suit against State Farm for denying his Katrina claim. Hes represented by his brother-in-law--the high-powered class-action attorney Richard Scruggs. (Hows that for politics making strange bedfellows, when one considers Sen. Lotts usual support for tort reform?)

As if that wasn't enough, Sen. Lott slipped a provision into an appropriations bill requiring the U.S. Department of Homeland Security to investigate insurer handling of Hurricane Katrina claims. The agencys report, due next April 1, could provide fodder for industry bashing at high-profile Congressional hearings next spring.

And just to show theres no hard feelings, Sen. Lott has also vowed to introduce a bill next year to repeal the industrys federal antitrust exemption under the McCarran-Ferguson Act.

In related news, a bill to reform the underfunded and little-understood National Flood Insurance Program passed the House but stalled in the Senate. A different version of the legislation cleared the Senate Banking Committee in July, but never made it to the full body.

The Senate isnt thrilled with House calls for increases in maximum coverage limits and business interruption paymentsprovisions not included in the Senate billbut it's hard to say where this will end up when the Democrats take control next year.

In the meantime, most people claim to remain clueless about their flood coverage. On the first anniversary of Hurricane Katrina this summer, a survey of homeowners found more than one in four are not clear if they even have flood coverage, while over one-third are uncertain what their insurance covered in terms of hurricane damage.

In any case, the majority of exposed homeowners still do not buy the additional, federally-provided protection. Can anyone out there guess as to why, and what can be done to change this culture of either ignorance or indifference?

Special Reports /

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