Ponzi Coverage: A Unique Twist from ConnecticutKostin v. Pacific Indemnity is a recent federal decision from Connecticut denying insurance coverage that should be of particular interest to those impacted by a Ponzi scheme. In a coverage dispute arising out of the Madoff scandal, the court rejected the policyholder’s argument that Madoff’s misuse of funds constituted “wrongful entry” into her bank account and denied coverage for her clawback liability to the bankruptcy trustee.

The case is particularly interesting because it involves homeowners’ insurance, not the commercial crime or liability (D&O and E&O) policies often considered in coverage cases relating to Ponzi schemes. The insured, Susan Kostin, sought recovery under her family’s “Masterpiece” homeowner’s primary and excess liability policies. Kostin and her family lost millions from an account established to manage family assets, including principal and expected profits. The coverage dispute related specifically to a $3.75 million withdrawal clawed back by the bankruptcy trustee, plus $799,000 in attorneys’ fees and litigation costs spent on fighting to keep that money.

The court invoked several standard rules of policy construction, ultimately leading to its decision against coverage. The central question was whether the claims against Kostin included claims for “personal injury,” defined by the policies to include a legal obligation resulting from “wrongful entry or eviction.” This is a standard definition of “personal injury” seen in many different types of liability coverage. Here, Kostin saw a window of opportunity and made a creative argument: Madoff’s Ponzi entries into the account ledger were wrongful, so there should be “wrongful entry” coverage for Kostin’s liability to the trustee.

In the end, the court based its coverage denial on its distinction between two types of “wrongful entry”: unauthorized intrusions versus fraudulent accounting ledger entries. While “unauthorized intrusions” into accounts might be covered, the court held “fraudulent accounting” entries would not be covered. In creating that distinction, the court focused on the fact that “wrongful entry” is coupled with the term “eviction” in the policy’s definition of “personal injury.” Kostin never alleged that Madoff was operating the account without authorization, so the court found no “wrongful entry.”

The decision was appealed to the Second Circuit. That result on appeal could be important and significant to other Ponzi victims seeking coverage under the personal liability provisions offered by some homeowners’ insurance policies.

Two takeaways here: First, do not assume that coverage is unavailable for clawback liability for Ponzi schemes, even if homeowners’ coverage is the only available policy. Second, keep in mind that the underlying allegations almost always drive the threshold liability coverage decision, particularly as to the duty to defend. For Kostin, the result might have been different if the alleged basis for her liability had instead been Madoff’s use of personal financial information to gain unauthorized access to her bank account. That type of allegation might qualify as “wrongful entry” under the trial court’s analysis.

Trigger for Hurricane and Named Storm DeductiblesRecent damage from Hurricanes Harvey, Irma, and Maria have focused attention on special “named storm” and “hurricane” deductible endorsements found in most property insurance policies issued for coastal areas. Such endorsements typically convert the insured’s deductible from a fixed amount to a percentage of the property value, such as 1, 2, 5, or 10 percent, for damage caused by certain categories of storms. These percentages are usually taken from the insured value of the property, not merely the amount of damage, so when triggered the endorsement can result in a substantial increase in the out-of-pocket cost for the policyholder.

Several names are used for these endorsements. “Hurricane” deductibles generally apply when a storm has been designated a hurricane by the National Weather Service. “Named Storm” deductibles are broader and include declared tropical storms. “Windstorm” deductibles are the broadest of all and may apply to damage caused by almost any high wind weather event.

Circumstances triggering the deductible can vary significantly depending on the policy and state in which the insured property is located, so the individual policy language and state regulation must be reviewed to determine when the deductible applies. ISO Commercial Property Endorsement CP 03 25 (“Named Storm Percentage Deductible”), for example, provides that a “Named Storm” begins at the time the National Weather Service issues a watch or warning for the area in which the insured premises is located, and ends 72 hours after the termination of the last watch or warning issued for that area.

In some states, regulations have altered the circumstances for triggering the deductible by mandating the scope and duration of a “hurricane.” For example, Florida defines a “hurricane” for residential property insurance purposes as beginning at the time the National Weather Service issues a hurricane watch or warning for any part of Florida and ending 72 hours after the termination of the last hurricane watch or hurricane warning anywhere in the state. Because of the broad scope of this definition, policyholders in some areas may pay a “hurricane deductible” even though the insured property was never subjected to hurricane-force winds.

Where the insurer contends that a percentage deductible applies on account of a hurricane or tropical storm, policyholders should carefully review the policy language and insurance regulations in their state, as well as the actual conditions that caused property damage, to determine if there is an argument against the increased deductible.