Hurricane Katrina: Will Insurance Cover the Damage? The First Trial Suggests the Answer is Yes and No

Friday, Aug. 18, 2006

This is one in a special series of columns on legal issues arising in the aftermath of Hurricane Katrina. - Ed.

On Tuesday, August 15, Paul and Julie Leonard walked out of a federal courthouse with a little over $1,200 to compensate them for the $130,000 worth of Hurricane Katrina-caused damage to their home. But, in part thanks to them, homeowners along the Gulf Coast are likely to walk away with a lot more.

That's the upshot of U.S. District Judge L.T. Senter's ruling, handed down after a bench trial pitting the Leonards (and prominent tobacco lawyer Richard Scruggs) against Nationwide Mutual Insurance Company. While the ruling breaks no new legal ground, it is significant nonetheless, for this was the first full trial of Katrina-related insurance issues affecting thousands of homeowners.

Moreover, since Judge Senter is currently presiding over more than 700 homeowners' claims, his decision effectively determines the law that will be applied to all those cases in the future.

The Leonards' Story, Their Policy, and The Theory of Their Suit

The Leonard residence is located in Pascagoula, Mississippi, near the Mississippi Sound. On August 29, winds in excess of 100 miles per hour created a "storm surge," driving a wall of water seventeen feet above sea level five hundred feet from shore, into the Leonard neighborhood. Unfortunately, the Leonard's home was elevated only twelve feet above sea level - meaning that the lower level of the home was submerged and extensively damaged, although the second floor was untouched. Minor damage to roof shingles, and a nearly obliterated garage complete a now-familiar (though, as we shall see, hardly universal) picture of a hurricane-devastated home.

As I discussed in my last FindLaw column, the standard homeowners insurance policy - such as the Leonards' - provides coverage for windstorm losses, but excludes damages caused by "flood, surface water, waves, tidal waves, overflow of a body of water, or spray from these, whether or not driven by wind." In case the point was not clear enough, the policy further specified that both direct and indirect losses resulting from flooding were excluded, "even if another peril or event contributed concurrently or in any sequence to cause the loss." However, this language looks clearer than it really is - particularly when one pauses to consider the variety of ways in which wind and water can interact to damage a home.

The Leonards' case rested on two legal theories: First, they argued that the wind-driven storm surge off the sound was a species of "windstorm" loss, and thus that all the damage it wreaked was covered. Alternatively, they claimed that approximately one-third of the damages were attributable to wind alone, and thus that at least this portion of their losses was covered by their policy.

Is a Storm Surge a Flood? The Judge Rightly Said Yes.

The first argument - that these were "windstorm" losses covered by the policy - has received a lot of attention in the media. But the judge gave it short shrift - and rightly so.

Judge Senter made clear that storm surge is a species of flooding excluded by standard insurance policies (and covered by the flood insurance the Leonards specifically declined to purchase).

This is the correct answer. Unquestionably, the surge was created by the hurricane winds. In the abstract, one might imagine the surge of water to be no different than a tree or other mass that is borne by the wind and crashes into a home. But storm surges are precisely the kind of flooding losses that insurers have systematically excluded from homeowners policies since the aftermath of the devastating 1927 floods along the Mississippi.

Why the exclusion? Because a storm surge does not incidentally involve water; rather, the risk exists precisely because of a home's proximity to water. One may contrast this with the case of a roof torn off by high winds, and inundated with rain. Although water damage is normally excluded, the standard policy makes an exception for a roof's inundation when it happens this way, because the inundation is truly secondary to (and caused by) a covered peril - windstorm.

Simply put, it is difficult to imagine circumstances in which consumers could believe that they had coverage for a wall of water blown off a nearby lake, yet at the same time understand that they do not have flood insurance. Or put another way, when the Leonards passed up flood insurance, they chose to bear the risk of flooding themselves. Thus, Judge Senter's holding here is consistent with the reasonable expectations of policyholders.

The Leonards' position is sympathetic: Who would have thought such a huge wall of water could travel so far into their neighborhood? But the proper entity to respond is Congress, not their private homeowners insurer. Incidentally, Congress has approved retroactive grants of flood insurance coverage to Katrina victims who declined to purchase it upfront. This goes some way towards explaining why the federal flood insurance program is man-made disaster.

The ACC Clause: Don't Take It Literally

On the second argument - allocation of loss between wind and flooding - the Leonards had good law, but bad facts. As noted above, the policy specifically excluded direct and indirect losses resulting from flooding "even if another peril or event contributed concurrently or in any sequence to cause the loss." This is known as an "anti-concurrent causation" (ACC) clause. ACC language evolved gradually over time, but became very common after insurers lost a number of significant cases in the early 1980s.

Reiterating his prior and well-grounded rulings, Judge Senter deemed the ACC clause ambiguous. Insurance law generally resolves ambiguities in the policyholder's favor. Read literally, the clause would exclude coverage where the total loss was comprised of both covered perils such as wind, and uncovered perils such as water. (The "torn roof" example I described earlier is essentially a limited exception to this rule). Judge Senter identified several ways in which the exclusion would unfairly deprive homeowners of coverage they would reasonably expect, creating what he correctly described as "illusory" insurance coverage.

Although "reasonable expectations" of insurance coverage lie at the core of insurance contract interpretation, insurers and some insurance professionals argue that conforming the policy to homeowners' expectations is judicial overreach. The ACC language says that flooding isn't covered no matter what, so why can't homeowners just read the policy?

Perhaps. But it's significant that insurers themselves rarely behave as if they intend to take ACC language at face value; in practice, they extend coverage in many instances where they could invoke the ACC if they chose. Even in the Leonard case itself, as Judge Senter wryly noted, "Nationwide has not invoked this policy provision to deny coverage to the Leonards for what everyone recognizes to be wind damage." Nationwide could have used the mixed nature of the damage to argue there was no coverage at all; it didn't. Instead, even Nationwide acknowledged by its actions that the policy simply couldn't mean exactly what it said.

In a perfect world, insurers would write policies that clearly distinguish between wind and water, and fairly allocate a portion of the loss to the policy. In an imperfect world - our world - insurers' zeal for "watertight" but implausible policy language compels judicial intervention.

It is thus unsurprising that Judge Senter found that the ACC ambiguous, and therefore construed it so as to ensure coverage for wind-caused damage, even if flooding interacts with that wind in some way. Indeed, Judge Senter held that, once the Leonards established wind damage, the burden shifted to Nationwide to prove what portion was attributable to excluded flooding. Unless Nationwide carried this burden, the damage was covered.

Why the Leonards Ultimately Lost, and What Happens Next

Unfortunately for the Leonards, Judge Senter ultimately found that, as a factual matter, the damage to their home was caused almost entirely by the excluded storm surge, and was essentially complete by the time of the subsequent wind damage. He thus upheld Nationwide's handling of their claim; indeed, Nationwide appears to have slightly overpaid them.

The meaning of this decision for Katrina litigation is illuminated by another ruling Judge Senter made last Monday. In Guice v. State Farm, Judge Senter refused to certify a class action for claims arising from Katrina's damage, because homeowners' claims will turn on the specific facts in each case. The lead plaintiff's home was apparently destroyed by a combination of wind and water. She argued that, because windstorm is covered, she was entitled to full recovery for all damages; State Farm argued that, because flooding is not covered, she was entitled to nothing. Judge Senter observed:

Thus, while Plaintiff and State Farm have focused on diametrically opposed interpretations of the policy language in an attempt to position themselves to gain instant victory, the fact remains that there are disputed issues that will determine the scope of coverage under the policy…[i]t is my opinion, upon a thorough review of the terms of the State Farm policy, that the damage attributable to wind and rain will be covered, regardless of whether an inflow of water caused additional damage that would be excluded from coverage.

The combination of these rulings suggests that where wind and water act concurrently or in sequence, courts in Katrina cases will try to allocate losses between policyholders and their insurers based on the discrete causal contributions of wind and water. This is an extraordinarily difficult task.

Consider so called "slab" cases - where a foundation is all that remains. There, policyholders will win full damages if they can prove that the house was totally destroyed by a windstorm first, even if it likely would have been washed away by subsequent flooding. In that sense, they will be lucky if the windstorm preceded the flooding. Future trials are likely to reveal every imaginable combination along the continuum of factual possibility, from pure windstorm losses to catastrophic flooding. And with class action status denied, these specific facts will need to be litigated case by case.

Judge Senter's rulings this week end the Leonards' case, and presage the terms for many of the cases to follow. While other courts along the Gulf are not bound by Judge Senter's decision, his thoughtful series of rulings, made with the benefit of a full record of the mechanics of hurricane damage, is certain to be influential. Accordingly, Katrina homeowners are likely to extract greater damages from their insurers than insurers' public statements thus far concede.

Class action treatment might have given plaintiffs more leverage, since the potential damage award in a class action would have been huge. But insurers, too, will want to avoid the expensive factual back-and-forth that individual trials will require. I suspect that insurers and many plaintiffs will come to terms on the basis of informal subclasses on a neighborhood-by-neighborhood basis.

Adam F. Scales is an Associate Professor of Law at Washington and Lee University and Visiting Professor of Law at the University of Connecticut School of Law. He is a former Chair of the Association of American Law Schools Section on Insurance Law.

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