NEW YORK--Bernard Madoff's alleged $50 billion fraud is likely to produce significant insured losses and put additional pressure on the industry's already battered professional liability lines, observers say.

Aon Benfield estimates the direct insured losses resulting from the investment fraud at $760 million to $3.8 billion, with a best estimate of $1.8 billion, according to a preliminary analysis released last week by the Chicago-based reinsurance brokerage.

Suits against money management firms that sent investors to Bernard L. Madoff Investments Securities L.L.C. have mounted since last month, when federal prosecutors charged the Wall Street fund manager with running a massive Ponzi scheme.

Claims are being directed at financial institutions, investment funds and money managers who dealt with Mr. Madoff; some lawsuits extend to include parent companies, accounting firms and auditors tied to the investments, said Kevin LaCroix, a partner with executive liability intermediary OakBridge Insurance Services L.L.C. in Beachwood, Ohio.

For example, a suit against investment adviser Ascot Partners L.P.--which invested nearly $1.8 billion in assets with Mr. Madoff--also named Ascot's auditor, BDO Seidman L.L.P.

"Basically, anyone who stood in between the investor and Madoff" could be targeted, Mr. LaCroix said. "There are a lot of links in the chain" and "burned investors will be examining all the relationships as they try to recover their losses."

The size and scope of this scheme "will add up to a lot of liability somewhere" said Greg Flood, the New York-based president of IronPro, a professional liability division of Bermuda-based Ironshore Insurance Ltd. "Industrywide claims costs between $1 billion and $2 billion would be very easy to imagine," he said. Mr. Flood said he was not aware of any Madoff-related exposure at Ironshore.

Focus on due diligence

Lawsuits are likely to focus on the due diligence performed by the institutions that invested clients' money with Mr. Madoff. Other allegations could include negligence, mismanagement and breach of fiduciary duty, legal experts say.

New York-based Fairfield Greenwich Group, a large institutional investors in Madoff funds, faces a $7.5 billion suit by investors. In the suit, plaintiffs argued the hedge fund managers collected millions of dollars in fees while failing to carry out due diligence that would have uncovered the fraud.

Claimants primarily will call upon firms' errors and omissions and directors and officers liability policies, but other types of coverage also may be sought to pay for the losses, including crime insurance and fidelity bonds, observers say.

Subprime loan-related claims already have generated an estimated $3.5 billion worth of D&O claims for financial institutions and pushed up prices for liability coverage for financial institutions by as much as 100%, according to market experts (BI, Jan. 12, 2009).

D&O rates for financial institutions have risen for the past five quarters year over year and, given the Madoff impact, "we expect that trend may continue," said Michael O'Connell, New York-based managing director of the financial institutions practice for Aon Risk Services, a unit of Aon Corp.

"It's certainly something the E&O and D&O lines are bracing for," said Michael White, senior vp-financial institutions industry leader for the executive risks practice for Willis HRH in New York. He noted that recent renewal negotiations for financial institution coverage have featured a heightened interest by underwriters in clients' potential exposure to Mr. Madoff. Industry observers also say they would not be surprised to see insurers writing Madoff exclusions into policies.

Among the leading providers of financial institution insurance generally are American International Group Inc., Chubb Corp., ACE Ltd. and XL Capital Ltd. are likely to face the highest claims, observers say. AIG and ACE declined to comment, while Chubb and XL did not respond to requests for comment.

The final cost to insurers may depend on the amount of coverage the institutions bought, but losses could be restricted because money management firms typically cannot purchase high limits, observers say.

"Most of the firms would not have adequate limits of coverage to indemnify the people who would sue," said Marshall Gilinksy, a shareholder in the New York office of Anderson Kill & Olick P.C. He noted that typical E&O policy limits for financial advisory firms might be about $15 million to $20 million and available up to $30 million. Limits for financial institutions are more difficult to generalize, he said.

"It would not be unusual for a money management firm to have limits of $10 million" for E&O liability, Mr. LaCroix said.

Defense costs, which are expected to be "significant," are likely to erode policy limits because liability coverage typically includes defense costs inside limits, legal experts say.

Insurers also may be looking closely to see whether the allegations raised trigger coverage exclusions, particularly those around conduct resulting in personal profit or gain, said Mr. LaCroix.

But Willis' Mr. White said he thinks "it's going to be difficult (for the carriers) to try to deny coverage" broadly due to the nature of the investors' claims.