Aon Benfield, a reinsurance intermediary and capital advisor, is predicting that direct insured losses resulting from the alleged Bernard Madoff Ponzi scheme could reach as high as $3.8 billion.

Madoff was arrested last month after allegedly confessing to fraud that involved paying early investors with money gained from subsequent investors.

“While the maximum potential exposed insurance limits are estimated to be more than $6 billion, the range of direct insured losses will be a far smaller number, most likely somewhere between $760 million and $3.8 billion, with a best estimate of $1.8 billion,” said Stephen Mildenhall, head of Aon Benfield’s actuarial and enterprise risk management practice, in a release. “These figures represent material costs, but are not likely to have a significant impact on the insurance industry.”

Aon said that the high end of the likely range of insured losses represents less than 20 loss-ratio points, and will affect the following coverages: directors & officers, errors & omissions, and fidelity. Since most insurance claims will be concentrated in the financial institution sector, the loss ratio within this specific segment may be significant, Aon reasoned. Based on estimated financial institution insurance premiums, the company said that the loss-ratio impact could range from 40-180 loss-ratio points in this specific segment. Given the claims-made nature of most professional liability coverage, Aon said losses would likely be spread over policy years 2007 and 2008 (or report years 2008 and 2009).

Litigation costs and reimbursement are also likely to cost insurers. According to Marshall Gilinsky, a shareholder at the law firm of Anderson Kill & Olick, insurance will play an important role in protecting those exposed to liability for their clients’ Madoff-related losses (banks, feeder funds, investment advisors, and auditors) and in providing what could be significant recompense for clients who were wronged by such intermediaries. Gilinsky said that the chief value of third-party insurance, which covers the policyholder’s liability to outside parties, will probably rest more in the insurance company’s duty to provide a legal defense for the policyholder than in the duty to indemnify. “The Madoff-related liabilities and losses of the key figures in this saga generally are so large that they will far outstrip policy limits,” said Gilinsky. “At the same time, D&O, E&O, and other forms of third-party insurance should in many cases cover some if not all of policyholders’ defense costs and possibly much or perhaps even all of the policyholder’s liabilities — meaning that some investors stand to recover much of what otherwise is thought to have been lost.”

For a copy of Aon’s preliminary report, go to www.aon.com.

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