No one should be surprised that the United States Court of Appeals today reversed the decision of the Louisiana District Court on whether losses occasioned by rising water in New Orleans was the result of a “flood” and thus excluded from coverage under several different forms of “flood” exclusion. The case, In Re Katrina Canal Breaches Litigation (5th Cir. Aug. 2, 2007), centered on whether the negligence in the design and construction of the levees that allowed water to escape from the protective flood-control system should be considered to be the operative event for insurance purposes, such that the water damage resulting cannot be said to have arisen from a “flood.” The Fifth Circuit ruled that “even if the plaintiffs can prove that the levees were negligently designed, constructed, or maintained and that the breaches were due to this negligence, the flood exclusions in the plaintiffs’ policies unambiguously preclude their recovery.”
Under first-party property policies that provide coverage for all risks of physical loss — known as “all risk” or “open peril” policies — it is well established that “third party negligence” is a covered cause of loss. In other words, if damage to the insured’s own property occurs as a result of the negligence of a third party, the insured’s own insurance will apply, subject to whatever rights of subrogation the insurer may have (standing in the shoes of its insured/tort victim). But even if one has a covered cause of loss and covered property damage, coverage can be barred by the express terms of an exclusion, which is what the Fifth Circuit found in the Katrina Canal Breaches case. Allstate’s policy form in the case stated, as an example: “We do not cover loss to [insured] property . . . . consisting of or caused by: . . . Flood, including, but not limited to surface water, waves, tidal water or overflow of any body of water, or spray from any of these, whether or not driven by wind.”
Arguing that the term “flood” was ambiguous when considered in the context of third-party negligence that released water, the policyholders contended that the various flood exclusions should not apply, i.e., a man-made flood does not a “flood” make. The issue has considerable importance given that a decision in the policyholders’ favor would have rendered nugatory the flood exclusion in the bulk of New Orleans’ losses. (Put differently, should the costs of the loss be transferred to insurers via private market mechanisms or should they be transferred to the government through public mechanisms (the flood insurance program or the tax system), or should they not be transferred at all and thus the victims should bear the losses?)
The court followed a Colorado case in finding that a “large-scale inundation of water [is] a ‘flood.’” See Kane v. Royal Ins. Co., 768 P.2d 678, 681 (Colo. 1989). See slip op. at 33-35. The Fifth Circuit distinguished cases involving inundations from a water-main break as being something different in kind from the failure of a levee.
Finally, the court did not enter into the “efficient” or “concurrent” cause debate that has been central in the Mississippi litigation where questions have been presented whether a particular loss there was from wind, water, wind-driven rain, or some combination thereof, with one or more of those causes being covered and others, not. In this instance, the only cause of loss was water from the failure of the levees, which the court held was excluded by the flood exclusion.