Bernard Madoff, president and founder of Bernard L. Mandoff Investment Securities LLC, right, walks out of Manhattan federal court in New York, Jan. 5, 2009. Photographer: Jin Lee/Bloomberg News
Bernard Madoff’s alleged Ponzi scheme may cost insurers who cover financial institutions more than $1 billion as they pay legal costs for investment managers who gave client money to Madoff, an industry executive said.
Insurers who sell such coverage never expected, or charged their clients, for the possibility of investor losses in such a massive fraud, said Greg Flood, the president of the management liability practice at Ironshore Inc., the Bermuda-based insurer.
“This isn’t supposed to happen in America,” Flood said. “There will be extraordinary losses paid for this year.” About $1 billion in claims costs industrywide “wouldn’t be too difficult to imagine.”
The final cost to insurers will depend on how many of the hedge funds and banks that directed money to Madoff had insurance, and the results of legal proceedings. Insurers of executives and corporate boards, a group that includes Zurich- based Ace Ltd.,XL Holdings Ltd., Chubb Corp. and American International Group Inc., already face a raft of claims after the collapse of the subprime mortgage market.
As Madoff cases go to court, expenses will accumulate because insurers selling “errors and omissions coverage” typically have an obligation to advance payment for defense, said Matthew Schlesinger, a partner at Reed Smith LLP in Washington.
Legal Fees
“Defense costs for funds facing Madoff-related suits could be high,” said Schlesinger, who specializes in recovering money from insurers. The cases “may turn on what funds knew about Madoff and whether or not funds managed investments appropriately.”
Before his arrest on a charge of securities fraud on Dec. 11, Madoff confessed to his sons that his “giant Ponzi scheme” may have cost clients as much as $50 billion, according to an FBI complaint. Some of those investors include so-called funds-of- funds, which invest customer money in a variety of hedge funds.
A total of $1 billion in claims from Madoff litigation “feels a little low to me,” said Lauri Floresca, senior managing director at Nasdaq OMX Group Inc.’s Carpenter Moore insurance brokerage. “The big unknown is how many companies will end up having insurance.”
Securities-fraud class-action lawsuits rose last year to the highest level since 2004. That may push insurer liability costs tied to subprime suits over $4.5 billion, according to Floresca.
Substantial Reserves
Chubb was spending more on professional liability claims and expenses in most of 2008 than the company collected in premiums for the coverage, Chief Executive Officer John Finnegan said in an Oct. 23 conference call.
“It is an evolving situation, and obviously it has not been evolving favorably recently,” Finnegan said. “But we are reserving pretty substantially for that class of business.”
Ace advanced 25 cents to $49.75 at 4:15 p.m. in New York Stock Exchange composite trading. Warren, New Jersey-based Chubb fell $1.18, or 2.5 percent, to $45.25, while Bermuda-based XL slipped 3 cents to $4.30. New York-based AIG dropped 3 cents to $1.62.
Hedge funds and unregulated investment vehicles catering to the wealthy, which made up a portion of Madoff’s investors, often don’t buy coverage, said Frank Vento, head of investment management practice at Marsh & McLennan Cos.’s flagship brokerage unit. New York-based Marsh & McLennan, the second-biggest insurance broker, hasn’t noticed an increase in claims stemming from Madoff, said Vento, of Marsh Inc.
“I think it’s too early to tell,” Vento said. Registered mutual funds and their advisers pay about $250 million for errors and omissions insurance each year, Vento said.
AIG’s Christina Pretto, Ace’s Stephen Wasdick and Chubb’s Mark Greenberg declined to comment. XL spokeswoman Carol Parker Trott didn’t return a call.
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