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Recent Hurricanes will Spawn Diverse Disputes over Insurance Coverage

October 11, 2005

The natural disaster caused by Hurricanes Katrina and Rita has caused unprecedented devastation to our nation’s gulf coast, particularly in Alabama, Louisiana and Mississippi. As the region and nation recover from the horrific stories and scenes that followed, attention has turned to the long clean up and recovery effort now underway. In addition, as families and property owners begin to assess the damage caused by the hurricanes and resulting flooding, a great deal of attention has turned to the insurance industry and how it will respond to claims arising from the disaster. Indeed, the disaster that hit the gulf coast region has spawned a variety of insurance issues and disputes that will likely take years to resolve.

Floods, Windstorm and "Storm Surge"
The issue that has received the greatest amount of attention following the recent hurricanes is whether policyholders are covered for their property loss under standard homeowners and commercial insurance policies. Practically all such policies exclude coverage for losses caused by flood, which is typically not thought to be an insurable risk due to the inability to spread the risk of loss. A typical flood exclusion excludes coverage for damage caused "directly or indirectly" by "flood, surface water, waves, tidal water, overflow of a body of water or spray from any of these, all whether driven by wind or not." Policies typically provide that the flood exclusion will apply "regardless of any other cause or event that contributes concurrently or in any sequence to the loss."

However, most such policies will cover property damage caused by windstorm, such as when winds remove shingles or entire roofs, allowing water to infiltrate a building. While in many instances whether a loss was caused by flood, or by windstorm, can be readily determined, the events that unfolded after Katrina cloud the picture. This is particularly true within the city of New Orleans, where several days of rain were followed by the failure of the city’s levee system, causing massive flooding from Lake Pontchartrain. Even in some inland areas, the rain brought by Katrina, which was blown inward by sustained winds reaching 145 mph, was followed shortly by a period of flooding that lasted up to several days.

Whether coverage exists for affected homeowners and most commercial insureds will depend upon whether a policyholder’s loss was caused by windstorm, or, instead, by the excluded cause of flood. Flood insurance is provided almost exclusively by the federally-sponsored National Flood Insurance Program. That program provides coverage for residential properties up to $250,000, with an additional $100,000 for personal property. The program provides coverage for commercial properties up to $500,000, with an additional $500,000 for contents. It is believed that only 30% to 50% of New Orleans’ property owners purchased such coverage, with coverage rates in other affected areas significantly lower.

The insurance industry has for years used the "water from below is a flood, water from above is from rain and wind" test to allocate a loss. However, the meteorological facts and timing issues related to Katrina and Rita make this test difficult to apply. Moreover, the insurance industry will be under intense pressure and scrutiny to pay claims to help victims recover and to assist an entire region of the country rebuild. Ultimately, of course, some disputes will reach the courts, which will have the final word on which losses are covered and which are excluded.

Indeed, pressure on insurers to cover hurricane-related claims has already begun, with news stories focusing on devastated homeowners who have been told their policies do not apply. In addition, political and regulatory pressure has begun to mount. On September 15, 2005, just seventeen days after Katrina made landfall, Mississippi Attorney General Jim Hood filed a lawsuit in state court seeking to have flood exclusions invalidated and insurers ordered to pay affected homeowners. In his suit, Hood refers to the cause of loss as a "storm surge," rather than a flood, for which he asserts coverage exists. In addition, Mr. Hood alleges that insurers misled policyholders into believing they were purchasing hurricane insurance and that the denial of those claims violates an insured’s "reasonable expectations of coverage." Several high-profile plaintiff lawyers have also filed suits against the insurance industry seeking class-action status.

Even policyholders demonstrating a covered loss may find themselves significantly out of pocket as they attempt to rebuild their homes. Insureds agreeing to quick final settlements may find that the amount paid is not sufficient to rebuild their home as labor and material costs rise throughout the region. In addition, most insureds will likely shoulder the cost of moisture-related mold damage, because in recent years insurers have issued policies with mold exclusion endorsements. Shoreline homeowners also likely have wind storm deductibles that may be two or three percent of the amount for which the home is insured.

Adjusters Make Case-By-Case Determinations
Most experienced adjusters beginning the task of assessing Katrina-related losses are trained in distinguishing flood damage from wind-related losses. Adjusters look for tell-tale signs of flood, such as water lines on drywall or uniformly water damaged neighborhoods, as they begin the adjustment process along the gulf coast. Especially in New Orleans, insurers may also make use of the graphic pictures of flooded out neighborhoods near the failed levees to determine that those losses were caused by flood.

In contrast, adjusters finding structures with water damage resulting from infiltration through lost roof shingles, or blown out windows, may determine that the loss was caused by windstorm. In addition, houses and other structures essentially blown away or apart in the hurricane’s winds, such as those found in Biloxi or inland areas less prone to flood, are more likely to be covered losses. Complicating the adjustment process is the inability of adjusters to reach affected areas even weeks after the hurricane, as well as the use of inexperienced adjusters to whom some carriers have turned out of necessity.

Valued-Policy Laws
Determining that a loss was at least partially caused by flood may not ultimately prevent carriers from paying 100% of a loss, however, at least for claimants in Louisiana and Mississippi. Those states’ "valued policy" laws may require insurers to pay 100% of a total loss, without deduction or offset for a portion of the loss caused by an uncovered cause, if the insurer used a property valuation to calculate its premiums. However, under those laws, if the insurer provides clear notice in its policy of a different method of calculating the loss, the insurer would not be required to pay the full value of the loss and can instead apportion the loss between covered and uncovered causes.

Valued policy laws apply only to claims involving a total loss and only to claims involving a loss caused at least in part by a covered cause. Losses, even total losses, caused solely by flood would remain excluded.

Business Interruption Claims
Perhaps the largest claims to follow Katrina will be business interruption claims filed under standard commercial policies. Indeed, Katrina’s devastation was historical in the sense that it caused the near-complete evacuation of New Orleans, a major American city and commercial center, and essentially destroyed the resort and gambling mecca located in Biloxi, Mississippi. In addition, Katrina laid waste to large portions of this country’s oil refining infrastructure, which was located along that part of the gulf coast.

Business interruption coverage is typically triggered only by losses from covered perils. Accordingly, many of the business interruption claims will be subject to the same disputes involved in the underlying property claim, regarding whether the loss was caused by rising floodwaters or by windstorm. However, some business interruption policies also cover losses caused by acts of civil authority, such as government-mandated evacuation orders, regardless of the reason for the order. Accordingly, under those policies, if a business interruption loss is caused by a government-ordered evacuation, it may be covered.

Whether such claims based on acts by civil authority will prevail, however, depends on how individual municipalities and local governments handled the impending and continuing disaster. In New Orleans in particular, the city’s handling of the hurricane came under intense criticism when it failed to issue a mandatory evacuation order until after the hurricane had made landfall.

Affects on Reinsurers and the Retrocessional Market
Industry experts believe that primary property and casualty insurers learned from their near-catastrophic losses following 1992’s Hurricane Andrew and increased premiums and retention rates in areas prone to hurricanes. Accordingly, primary carriers may emerge from their post-Katrina losses in far better position than they did following Andrew. Reinsurers, however, are likely to experience a greater share of the loss than they did post-Andrew, as primary carriers increased their reinsurance coverage for such claims. Moreover, because most loss estimates exceed $20 billion, industry experts expect to see an effect on the retrocessional market, which covers reinsurers at very high levels. In addition, industry sources are reporting that some "catastrophe bonds" – private investments used by some insurers as an alternative to the reinsurance market – were triggered as the result of the losses caused by hurricane Katrina.

Post-Hurricane Accident, Health and Environmental Claims
The devastation that has followed Katrina and Rita will likely lead to a sharp increase in accident and health claims, as unsafe and unhealthy conditions continue to exist in affected areas. While martial law was declared in New Orleans, local law enforcement and emergency services have strained to meet the needs of those affected by the storms all along the gulf coast. Moreover, toxic waters, unclean food supplies and a lack of effective health care and medicine distribution will likely cause health insurers and health care plans to experience higher-than-normal claims.

Moreover, Katrina caused significant damage to the gulf coast oil and fuel industry, as well as to off-shore oil drilling platforms. Coupled with the contaminated water invading New Orleans and other inland areas, Katrina has the potential to spur environmental claims unlike those insurers have traditionally faced.

Public Safety Legal Claims
The New Orleans tragedy may also spur a wave of litigation related to flood protection and levee failures. It has long been suspected that New Orleans, and its levee system, were vulnerable to a Category 4 or 5 hurricane. Indeed, many flood protection and safety experts in government and private industry alike have questioned whether adequate steps were taken to upgrade and maintain the levee system to protect against this type of disaster. In addition, state, local and federal officials were criticized for their handling of the post-hurricane relief effort, potentially spurring additional claims.

Given the massive loss of life and property that occurred in New Orleans following the hurricanes, litigation will almost certainly follow seeking to assign legal blame for these failures. Such claims are not without precedent, as claims have been brought related to failed levees all along the Mississippi River corridor and in California, often resulting in nine-figure payments to victims. Obviously, the New Orleans tragedy has the potential to be the largest such case in this nation’s history.


Godfrey & Kahn provides legal services to many domestic and foreign insurance companies and trade associations. This alert is intended for information purposes only and is not intended as legal advice on specific matters or factual situations.

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