In a recent analysis, reinsurance broker Aon Benfield put a best estimate of direct insurance losses from the alleged Ponzi scheme orchestrated by Bernard Madoff at $1.8 billion, citing a range of $760 million and $3.8 billion around that estimate.
Translating the dollar figures into underwriting profit ratios, Aon Benfield said that the $3.8 billion high end of the likely range of insured losses represents less than 20 loss ratio points on premiums collected for impacted liability lines–global directors and officers liability, errors and omissions coverage (professional liability), 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 Benfield said, noting that based on estimated financial institution insurance premiums, the loss ratio impact could range from 40-to-180 loss ratio points in this specific segment.
To develop its insurance loss estimates for Madoff-related claims, Aon Benfield analyzed possible exposure to four categories of potential defendants which could be protected by D&O and E&O insurance:
o Asset management firms that ran so-called "feeder funds"–funds that directed investor capital to Mr. Madoff or his firm, Bernard Madoff Investment Securities.
o Foreign banks and insurers that placed investors' assets and their own assets under Mr. Madoff's management.
o Charitable organizations and public institutions, whose boards may be sued by disgruntled donors for performing insufficient due diligence on investments with Mr. Madoff.
o The main culprit–Bernard Madoff Investment Securities.
The Aon Benfield report notes that payouts by insurers of Bernard Madoff Investment Securities could be limited by policy language excluding fraudulent acts.
For the other three categories, the report summarizes estimates of limits and attachments purchased, limits exposed, and direct insurance losses.
o Limits Purchased:
A summary setting forth typical low, medium and high levels of limits purchased reveals wide ranges for financial firms in particular. For foreign banks and insurers, for example, purchased limits range from a low of $10 million to a high limit of $750 million, with a medium limit for such firms coming in at around $100 million.
o Limits Exposed:
Stephen Mildenhall, head of Aon Benfield's Actuarial and Enterprise Risk Management practice, said the high degree of uncertainty around purchased limits is driving a big range around the estimate of potential limits exposed (maximum losses payable under insurance policies), which extends from a low of $1.3 billion to $6.4 billion.
To calculate limits exposed, Mr. Mildenhall said Aon Benfield gathered information on investment losses associated with roughly 140 Madoff victims identified in articles in the Wall Street Journal, Bloomberg News and other press sources, reasoning that for each announced victim there could be a potential lawsuit against one of the three types of entities analyzed–asset management firms, foreign banks and insurers or charities.
The news sources cited actual dollar losses for about 100 of the victims, he said, adding that Aon Benfield proceeded with its analysis by assigning a potential defendant category to each victim.
Depending on the type of insured, the broker selected the potential limit that could be in play from the table of low, medium or high range limits by category of defendant. The high-end $6.4 billion figure assumes all defendants purchased high limits policies, he explained.
"For a lot of the big European banks, the potential economic loss would be in excess of the policy limits that they're likely to have purchased," he said.
According to the report, foreign banks and insurers account for $4.9 billion of the $6.4 billion high estimate of potential limits exposed, with asset management firms accounting for $1.2 billion and charities only $222 million.
o Direct Losses:
Moving from the estimate of potential limits exposed to the final calculation of direct insured losses, Mr. Mildenhall noted that the exposed limits are only paid if every policyholder is found 100 percent liable for their full exposure.
"There's some chance here that suits are going to get dismissed," he said, explaining that more likely scenarios assume varying degrees of liability for different policyholders.
In the report, Aon Benfield applied a 60 percent factor to the exposed limit totals for asset management firms and for foreign banks and insurers–developing insurance loss estimates ranging from $169 million to $738 million for the asset managers and $590 million to $3 billion for the foreign banks and insurers.
The best estimates within the ranges are $371 million for the asset firms and $1.5 billion for the banks and insurers, with charities contributing only $6 million to the overall best estimate of $1.8 billion.
For the analysis of charities, Aon Benfield assumed the insurance losses would only be 5 percent of exposed limits, in contrast to 60 percent for the other categories of insured firms that are potential lawsuit defendants.
Brian Alvers, a senior vice president, explained that Aon Benfield reviewed industry data on other events to analyze dismissal rates and also talked to other industry experts.
Explaining the 95 percent dismissal rate assumption for charities, a foreseeable D&O suit might come from a large donor, but the donor might be on the board of the charity. "They wouldn't be able to sue themselves. So those things would probably go away," he said.
Mr. Mildenhall pointed out that the Aon Benfield estimate for Madoff litigation is an estimate of direct insurance losses, and therefore does not include any provision for the next ring of defendants now being sued–third parties like audit firms, which tend to self-insure, according to the broker.
© Arc, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to TMSalesOperations@arc-network.com. For more information visit Asset & Logo Licensing.