Expert Commentary

Post-Katrina Turmoil: Insurance Challenges

Legal battles continue in the wind-versus-water debate arising from Hurricane Katrina and Rita losses in 2005. In reviewing several lawsuits arising from these catastrophic events, the debate so often boils down to the following question: "What exactly is a flood?"

Personal Lines Insurance
May 2008

As one might guess, the typical policyholder's perspective on this is quite different from the insurer's perspective. These differing perspectives have led to a host of legal challenges heard in federal and state courts on the meaning of "flood."

Another key issue concerns the apportionment of damages caused by wind and the amount of damage caused by water. How have the courts sorted out how much the homeowners policy should pay and how much the flood policy should pay? This begs the question: What steps can be taken to mitigate this ongoing debate in the future, particularly since it is likely that hurricanes and floods will never go away and may, in fact, be increasing in a global warming environment?

This article will examine the definition of flood and the wind-versus-water debate. The next article in this series will address proactive steps that the United States can take to mitigate these concerns and challenges.

What Is a Flood?

In many of the Hurricane Katrina and Rita cases, the courts often become consumed with the definition of the word "flood." In one of the seminal cases heard by the U.S. Court of Appeals, In Re: Katrina Canal Breaches Litigation, 495 F.3d 191 (5th Cir. 2007), the plaintiffs contended that the various policies' flood exclusions did not clearly exclude losses arising from levee breaches allegedly caused by the negligent design, construction, or maintenance of these levees.

The district court had earlier determined that the policies' flood exclusions were ambiguous because the term "flood" was susceptible to two reasonable definitions: one that related to floods from natural causes only and one that related to floods resulting from both natural causes and negligent actions. Thus, the appellate court dived into the definition of "flood."

In more than one case, the plaintiffs had pointed out that "flood" was not defined by the homeowners policy, making the flood exclusion inherently ambiguous. But the appellate court in Katrina Canal Breaches [court case] stated that just because flood is not defined, does not make it ambiguous. To avoid this, the court said:

An insurer would have to define every word in its policy, the defining words would themselves then have to be defined, their defining words would have to be defined, and the process would continue to replicate itself until the result became so cumbersome as to create impenetrable ambiguity.

The court then looked at several standard dictionary, encyclopedia, law treatise, and law dictionary definitions of "flood," and it boiled and paraphrased the definitions down to a succinct one: "an overflowing of water onto land that is normally dry." This definition made no distinction between floods with natural causes and those with non-natural causes. In fact, the Columbia Encyclopedia stated that a flood may result from the bursting of a dam.

The appellate court then turned its attention to the issue of levees. It stated that, unlike water mains, levees are flood-control structures, meaning that they interact with floodwaters. Any time a flooded watercourse encounters a man-made levee, the court found, a non-natural component is injected into the flood, but that does not cause the floodwaters to cease being floodwaters. The court ruled that the distinction between natural and non-natural causes in this context would lead to absurd results and essentially eviscerate flood exclusions whenever a levee is even remotely involved. Every natural event could be recharacterized as non-natural, either because any preventive measures were inadequate or because no preventive actions were taken at all.

The plaintiffs also argued that the reasonable expectations consumers have of all-risk policies would cover losses from third-party negligence. But the court ruled that the clarity of the flood exclusion and the generally understood meaning of "flood" override this expectation. In addition, the court noted that flood insurance is widely available and sold for this purpose. The court thus ruled in favor of the insurers, upholding the exclusion.

An opposite conclusion was reached in Northrup Grumman Corp. v. Factory Mut. Ins. Co., No. 05-CV-8444 (C.D. Cal, August, 2007). This case involved a large commercial policyholder over whether wind-driven storm surge was covered under an excess property policy that excludes flood damage. In Northrup, the court found that the flood exclusion's language could be logically interpreted in more than one way. In addition, the flood exclusion lacked clarifying wording such as "whether driven by wind or not." The court noted that Factory Mutual could not prove that its interpretation was the only reasonable conclusion. It thus ruled for the commercial policyholder, finding that the exclusion failed to clearly exclude loss due to storm surge or wind driven water.

Wind-versus-Water Debate

A key argument arising from many of the Hurricane Katrina claims concerns the wind versus water debate. At the heart of the problem is the separation of the two perils onto two separate policies, the homeowners policy (covering wind losses) and the flood policy (covering flood losses).

In Broussard v. State Farm, 1:06-cv-00006-LTS-RHW (U.S. District Court, 2007), the plaintiff argued that high winds and possibly a tornado decimated his home (typically referred to as a slabbed house) before any flooding began. Judge J.T. Senter, in his opinion on State Farm's motion for summary judgment, ruled that the insurer had to establish, by a preponderance of the evidence, what portion is attributable to each peril. He noted that all of State Farm's evidence was directed to proving that 100 percent of the damage to the insured property was caused by rising water, but its own expert witness did not completely agree with this point. The expert said it was more probable that wind damaged the roof and he could not completely rule out the possibility of tornado damage.

The expert also said that based on the data available, he could not make a determination of the extent of the wind damage before the storm surge arrived. The jury concluded that State Farm failed to meet its burden of proof on the segregation of the total loss into wind damages and water damages. The jury awarded the Broussards $2.5 million, but the judge reduced this amount to the policy limits plus $1 million in punitive damages.

The case was then appealed to the appellate court, which reversed the judgment of the district court. It held that the insured has the burden of proof to show that the damages sustained were covered by the peril insured against, a burden that the Broussards failed to meet. The court ruled that State Farm's experts introduced sufficient evidence to permit a reasonable jury to find in its favor. It also reversed the punitive damages award and remanded for a new trial. On April 25, 2008, the two parties reached an out-of-court confidential settlement.

The case of Leonard v. Nationwide Mut. Ins. Co., 438 F. Supp. 2d 684, 690 (S.D. Miss. 2006) was also ruled in favor of the insurer. The Leonards' home was 515 feet from the beachfront of Pascagoula, Mississippi. It was a 2-story home situated 12 feet above sea level. Katrina battered the community with torrential rain and sustained winds over 100 mph, causing a tidal surge that flooded the home.

District Court Judge Senter initially heard this case and ruled in August 2006, granting the Leonards only a meager amount of money for losses caused by wind. But he also found that Nationwide's anti-concurrent causation exclusion (denying coverage whenever an excluded peril and a covered peril combine to do damage) ambiguous. The plaintiffs appealed the ruling to the U.S. Fifth Circuit appellate court in New Orleans.

The appellate court ruled that the policy's plain language only covers the peril of wind. It found that this leaves the district court no interpretive leeway to conclude that recovery can be obtained for wind damage occurring concurrently or in sequence with the excluded water damage. The appellate court rejected the district court's concern that the enforcement of the anti-concurrent causation (ACC) exclusion would render any recovery for hurricane damage illusory.

The appellate court ruled that federal and state courts have interpreted water damage exclusions to encompass wind-driven inundation by water or storm surge for ages. The Nationwide exclusion exempts "waves, tidal waves, and overflow of a body of water … whether or not driven by wind." The court found that the specific term "storm surge" is simply a synonym for "tidal wave" or wind driven flood, both of which are excluded. The court referred to the Katrina Canal Breaches case here as authority.

The court ruled that the policyholders could prevail only if they could demonstrate that the clause was prohibited by Mississippi case law, Mississippi statutes, or public policy. The court found that the clause was not prohibited by any of these.

In contrast, the case of Landry v. Louisiana Citizens Property Ins. Co., No. 07-247 (La, App., 3d Cir., Aug. 2007) was ruled in favor of the policyholder. This case, also dealing with the wind-versus-water issue, concerned Louisiana's 108-year-old valued policy law (VPL). The plaintiff contended that if a combination of forces causes the loss (including a force that is a covered peril under the policy), then the full value of the home must be paid. Thus, as long as one covered peril contributes to the loss, the VPL requires the loss be paid in full.

Louisiana Citizens contended that the VPL has nothing to do with causation. In its opinion, the VPL does not mandate full recovery in the event of a total loss caused in part by a covered peril and in part by a noncovered peril.

The Louisiana appellate court found in favor of the policyholder, stating that so long as the excluded cause of loss is not deemed the efficient or primary cause, the insurer is obligated to pay the full value per the VPL. It ruled that pro-rata provisions on causation do not contravene the VPL. This case has been appealed to the Louisiana Supreme Court; it has recently heard the case and its decision is pending.

See the next installment on this issue, Post-Katrina Turmoil: Insurance Solutions.

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