The stakes couldn't be higher, he said, noting “it will probably mean billions of dollars to whichever side loses.”

Mr. Thorpe cited a federal district court ruling at the end of March in a case against Allstate centering on the wind versus flood issue in which the judge acknowledged the validity of the flood exclusion but refused to dismiss the case. “So, both sides could take something from that,” he said.

Meanwhile, the call for “affordable” insurance rates for storm-prone areas “creates what is known as a moral hazard, because it encourages building in high-risk areas,” he said. A supply-demand imbalance could result from such rate suppression, since there will be more demand while carriers possibly exit the state, creating a supply crunch, he warned.

Mr. Thorpe also noted a significant spike in the issuance of catastrophe bonds at the end of 2005 in the aftermath of reinsurance capacity issues following the record losses.

Another Fitch analyst, Laura Porter, said Louisiana had been removed from “Rating Watch Negative” in recognition of “the state's prompt action to address projected shortfalls, substantial financial balances and significantly stronger revenue projections than initially expected in the aftermath of Hurricanes Katrina and Rita.”

The negative outlook reflected the continued uncertainty regarding recovery from the hurricanes given the magnitude of the disruptions and the extent of economic losses, she said.