As we know, the Red Mountain http://www.uesp.net/wiki/Lore:Vvardenfell after The Ministry of Truth crashed into Vivec (the city). The eruption caused the population of Vvardenfell to flee to Solstheim. The Morrowind mainland was invaded by Argonians, though I'm unsure if they moved on to Vvardenfell. However, I wonder, could the Dunmer return to Vvardenfell? I mean, if it was not taken by the Argonians, after around 150 years, Vvardenfell would definitely be reinhabitable, atleast by real standards (yes, I know this is fantasy). So I wonder, couldn't the Dunmer, Argonians, or any other races for that sake, re-settle Vvardenfell. The quality of the soil would depend on how thick the ash-layer is, though the rehabilitation-process could take long time, it should be very possible to re-settle Vvardenfell after the time that has passed (unless Red Mountain have erupted much this one-and-a-half century).

On another completly different note, was Dagoth Ur actually killed in the encounter with the Nerevarine. Yes, I have played Morrowind (though it is a year since I did the Main Quest last time, so I don't remember the details exactly), and I know the fate of the Heart of Lorkhan, but I wonder, was it truly destroyed? Shattered perhaps, but still contained power? Dagoth Ur could have lost most of his power, but as last time, surviving on his weakened bonds with the Heart, bodiless, but immortal. UESP http://www.uesp.net/wiki/Morrowind:Dagoth_Ur_(god) that his bonds was weakened, not destroyed. The tribunal, on the other side, had a much weaker bond to the heart, and would die when killed, they would not stay immortal as Dagoth Ur.

Going further on this theory, Voryn Dagoth, companion of Nerevar, guarded the heart, and was twisted by it. Chances are with the weakening of the bond, would make him have a change of mind. No, I don't mean he would now embrace outsiders, but more of give up his plan on conqueerring Tamriel for himself with help of Corprus.
Azura as earlier seemed to be the patron of the Dunmer (Chimer). With the Argonian conquest of Morrowind, and with the possibly survival of Dagoth Ur, could she turn to him for help? Giving him a new body, freeing him from the bonds with the heart, or something else she saw fitting for him, for leading the Dunmer in a reconquest of Morrowind? Dagoth would probably like to reconquer his homelands , whatever his current state of mind. If he had turned back to his pre-Heart state, Azura may have allowed him to stay in power, if not, nothing is saying that another reincarnate of Nerevar (maybe the old one?) would come back and take kill(?) Dagoth Ur once again.

life....finds a way.

We don't know the extent of the destruction do we? Vvardenfell could very well no longer exist.

I would believe (though this is fantasy, anything can happen) that an volcanic eruption would not remove a piece of land from existence, neither sink it. It may be covered in ash, though. It is said that Red Mountain exlpoded, though I understood it as an eruption, nut I may be wrong. If it was a literal explosion, and Red Mountain blew up together with Vvardenfell, none could have escaped, and I'm pretty sure that the consequences would move farther than the island. Atleast thee population on mainland Morrowind should be affected someway by this. I have not read the Infernal City by the way, so I may be missing on important details, I don't know...