(Adds comments by insurers) NEW YORK, Dec 27 (Reuters) - A federal judge has sent back to Mississippi state court a lawsuit demanding that insurers pay flood damages to thousands of Hurricane Katrina victims, increasing the chances of a ruling against the companies. "It's a nice Christmas present," Mississippi Attorney General Jim Hood said at a news conference on Wednesday. Hood, who brought the suit on behalf of state residents 15 months ago, said that if insurers did not negotiate settlements by spring, he expected Congress, led by Mississippi Senator Trent Lott, to investigate the industry. The lawsuit claims that the five insurers had refused to pay for damages from "storm surge," the 30-foot (10-meter) -high wall of water whipped up by Katrina's winds that destroyed property worth billions of dollars in August 2005. The insurers, led by Allstate Corp. <ALL.N>, State Farm Mutual Automobile Insurance Co. and Nationwide Mutual Insurance Co., claimed that flood damages were excluded from their policies and were covered under federal flood insurance. Nationwide Mutual is the parent of Nationwide Financial Services Inc. <NFS.N>. The insurers had wanted the case to be heard in federal court, where judges have ruled against awarding flood damages. The case now goes to state court in Hinds County, Mississippi, where it will be decided by a local judge. "Insurers will be unhappy about this ruling," Robert Hartwig, chief economist at the Insurance Information Institute, told Reuters. He noted, however, that federal judges had already ruled that flood damages are not covered by regular insurance, "and in the world of courts, precedent is everything." The companies expressed disappointment at the ruling. "But we are confident that the Mississippi state courts will also recognize that flood coverage is excluded," State Farm spokesman Fraser Engerman said. Joe Case, at Nationwide, told Reuters: "We are committed to defending the language in our policy." In his news conference, Hood said he was ready to take the case to court but urged the insurers to negotiate a settlement with him and Mississippi residents. Hartwig said that would be a mistake for all concerned. Not only could it cost insurers billions of dollars, but ultimately the companies would likely withdraw from the market, leaving Mississippi to fund its own homeowner policies, he said. Allstate has already exited coastal markets as far north as Connecticut.
