American International Group Inc was sued on Wednesday by two California residents who said their homeowner insurance policies entitled them to coverage on losses from Bernard Madoff's Ponzi scheme.

The federal lawsuit was filed in Manhattan by Robert and Harlene Horowitz, who said they lost $8.5 million in the Madoff scandal, and seeks class-action status on behalf of potentially thousands of policyholders.

The Horowitzes alleged that AIG refused to honor AIG Fraud SafeGuard coverage in policies they obtained from subsidiaries of the insurer, even though the coverage insures against losses resulting directly from fraud, embezzlement, or forgery.

According to the lawsuit, the Horowitz Family Trust had a more than $8.5 million balance on its November 30, 2008 account statement from Bernard L. Madoff Investment Securities LLC, which was Madoff's investment advisory arm.

The lawsuit seeks class-action status on behalf of Madoff investors who also had policies with the Fraud SafeGuard coverage. Milberg LLP, a securities class-action specialist, represents the Horowitzes.

AIG spokeswoman Christina Pretto and Milberg partner Brad Friedman did not immediately return calls seeking comment.

The case adds to legal problems for New York-based AIG, which is trying to sell assets to help repay the government after getting roughly $180 billion of federal bailouts. The government owns close to 80 percent of the insurer.

Madoff, 71, is serving a 150-year sentence in a federal prison in North Carolina after admitting in March to running a $65 billion Ponzi scheme.

A Ponzi scheme is where money is taken from later investors to pay off earlier investors. Prosecutors have said Madoff's accounts never held as much as he claimed.

It was not immediately clear on what basis Madoff's firm calculated the $8.5 million supposedly in the Horowitz trust's account.

Many disputes in the recovery process for Madoff's former customers turn on the degree to which amounts shown on their account statements were a product of Madoff's crimes, and thus illusory.

The lawsuit is Horowitz v. AIG, U.S. District Court, Southern District of New York (Manhattan), No. 09-7312.

California Aig