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Madoff Victims: Will Homeowners Insurance Help?

Don't get your hopes up too high, America. Fraud coverage does not typically come with homeowners insurance policies, and when it does, insurers will try to wriggle out of paying if they can.

Here's the story. In the late 1990s when I.D. theft first became prevalent, insurance companies figured they could capitalize on the public's fears (and create a useful product to put a positive gloss on it) by offering I.D. theft protection. Some insurers offered it as an extra that people could add onto their homeowners policies for about $80 a year. The policy promised to pay the costs of "restoration" or the costs of cleaning up the mess-- certified mail, notary seals, phone calls, maybe attorney fees, and up to $2,000 in lost wages. As for any actual losses, you were pretty much on your own.

But then says Richard Clarke, a senior vice-president with insurance broker J. Smith Lanier & Co., a couple of insurers, including AIG, took a giant step further. They offered to cover losses from fraud. AIG, for example, said that its Fraud SafeGuard policy" AIG would "secure your important assets -- money, securities, personal property, jewelry and collectibles" -- against "today's sophisticated criminals and new risks." AIG clearly anticipated a Madoff-like criminal. In its brochure, it cited an example of the threat from which it promised to protect policyholders: an attorney and stockbroker who pled guilty to bilking 41 investors out of $10.2 million. The policy, which paid up to $200,000, said it would cover cases of fraud, embezzlement or theft even if committed by your own accountant, lawyer, financial planner, stockbroker, doctor -- even your favorite charity.

So along comes Bernard Madoff, convicted and in prison for 150 years. AIG is now on the hook for any of its customers who bought Fraud SafeGuard. AIG says it has paid out "hundreds of eligible policyholders who suffered Madoff-related losses."
The company, however, denied a claim filed by Robert and Harlene Horowitz, Madoff investors from Los Angeles, even though they lost $8.5 million to Madoff.
AIG claims that the Horowitz's $8.5 million account balance was fiction, which is true. Madoff has admitted that he made up all the numbers. AIG says that the investment account "exceeded the amount of the capital contributions." The couple invested $4.7 million in 1997, according to their attorney Brad Friedman, and over the years, they withdrew about the same amount. Ergo, no coverage. Friedman, however, likens Fraud SafetyGuard to FDIC insurance. "It would pay you for the amount in your account," he says, i.e., it wouldn't deduct the interest or withdrawals you took. At the very least, he argues, AIG should pay some interest on their money because "It's inconceivable that the Horowitzes would get no earnings during the greatest bull market in history." And that makes sense. After all, say you deposited $10,000 in a bank, earned 5% (hah -- those days are gone, but let's suppose) over 20 years, you'd have $26,533. If you withdrew your original $10,000 and the bank went kablooey the next day, the FDIC would of course pay the remaining $16,533.
It's hard to wrap your head around the Horowitz's receiving fictional money. On the other hand, $200,000, the limit of the policy, isn't a very big return on $4.7 million for 11 years, only about 0.003% a year. So the Horowitzes have filed a class action lawsuit against AIG asking to be paid.

Insurance expert Clarke says that the outcome of the court case will depend on the language in the endorsement. "The brochure may have promised more than the policy covers," he says. "But people probably relied on the brochure. It will be difficult for the insurer to say they're not responsible for payment."

It would be nice to stop writing here, and I'm sure you'd like to stop reading, but I had another thought. The Securities Investor Protection Corporation, which insured accounts at Madoff's firm, contends, like AIG, that it has to pay only for losses of victims' initial investments (up to a limit of $500,000). Anybody who withdrew all his original money gets gornisht, which is Yiddish for "a kick in the pants." Investors in that fix have filed a lawsuit against the bankruptcy trustee and the SIPC saying they should be credited for the amount on their last account statements on November 30. If AIG winds up paying the Horowitzes their investment gains-- or, at the very least, their interest, that could set an interesting precedent which the SIPC may have to follow.