How to properly handle exceptions when performing file io

...but is it possible to get a bit more fine-grained error messages.

Yes. Go ahead and catch IOException, and use the Exception.ToString() method to get a relatively relevant error message to display. Note that the exceptions generated by the .NET Framework will supply these useful strings, but if you are going to throw your own exception, you must remember to plug in that string into the Exception's constructor, like:

throw new FileNotFoundException("File not found");

Also, absolutely, as per Scott Dorman, use that using statement. The thing to notice, though, is that the using statement doesn't actually catch anything, which is the way it ought to be. Your test to see if the file exists, for instance, will introduce a race condition that may be rather vexing. It doesn't really do you any good to have it in there. So, now, for the reader we have:

try {  
    using (StreamReader reader = file.OpenText()) {  
        // Your processing code here  
    }  
} catch (IOException e) {  
    UI.AlertUserSomehow(e.ToString());  
}

In short, for basic file operations:
1. Use using
2, Wrap the using statement or function in a try/catch that catches IOException
3. Use Exception.ToString() in your catch to get a useful error message
4. Don't try to detect exceptional file issues yourself. Let .NET do the throwing for you.

The first thing you should change are your calls to StreamWriter and StreamReader to wrap them in a using statement, like this:

using (StreamReader reader = file.OpenText())
{
   List<string> text = new List<string>();
   while (!reader.EndOfStream)
   {
      text.Add(reader.ReadLine());
   }
}

This will take care of calling Close and Dispose for you and will actually wrap it in a try/finally block so the actual compiled code looks like this:

StreamReader reader = file.OpenText();
try
{
   List<string> text = new List<string>();
   while (!reader.EndOfStream)
   {
      text.Add(reader.ReadLine());
   }
}
finally
{
   if (reader != null)
      ((IDisposable)reader).Dispose();
}

The benefit here is that you ensure the stream gets closed even if an exception occurs.

As far as any more explicit exception handling, it really depends on what you want to happen. In your example you explicitly test if the file exists and throw a FileNotFoundException which may be enough for your users but it may not.