Katrina Lawsuit to Go to Appeal

In November, a judge gave hope to homeowners trying to collect insurance money for flood damage caused by Hurricane Katrina. Now, that decision is under scrutiny.

U.S. District Judge Stanwood Duval Jr. sided with policyholders who argued that language excluding water damage from some of their insurance policies was ambiguous.

Duval said the policies did not distinguish between floods caused by an act of God - such as excessive rainfall - and floods caused by an act of man, which would include the levee breaches following Katrina's landfall.

Duval allowed a lawsuit against The Allstate Corp. (nyse: ALL - news - people ), The St. Paul Travelers Companies Inc. and other insurers to proceed, but said the issue of "flood exclusion" could be appealed immediately by the companies.

A hearing on the appeal will be held Wednesday at the 5th U.S. Circuit Court of Appeals. A three-judge panel was scheduled to hear arguments from lawyers for policyholders and several insurance companies.

Insurers say their homeowner policies do not cover damage from any type of flooding, including water from the levees that broke in the aftermath of the Aug. 29, 2005, storm.

The insurance industry stands to lose an estimated $1 billion in Louisiana if policyholders successfully challenge companies' refusal to cover damage from levee breaches, said Robert Hartwig, chief economist at the industry-funded Insurance Information Institute in New York.

In court papers, a lawyer for policyholders with consolidated cases against insurers said Duval properly concluded that the definition of "flood" in policies is limited to "naturally occurring events."

But plaintiffs' attorney John Ellison accuses insurers of purposely not defining the term 'flood' and deliberately drafting vague policy language "to frustrate the reasonable expectations of Louisiana homeowner policyholders from whom they collected premiums for years."

Lexington Insurance Co. attorneys argue that punishing insurers for failing to define common words like "flood" could force them to engage in "defensive over-specification, which would inevitably lead to longer policies that are less comprehensible to most policyholders."

Duval agreed last year to dismiss State Farm Insurance Cos. from the litigation. He ruled that State Farm's policies included language that clearly excluded all flood damage, regardless of the cause.