Key Takeaways
- Runoff insurance provides liability coverage for companies after they have been acquired, merged, or ceased operations, protecting the acquiring company from potential lawsuits against directors and officers.
- This type of insurance functions as a claims-made policy, covering claims brought forward even years after the alleged incident, unlike occurrence policies that only cover incidents during the active policy period.
- Runoff insurance is crucial during acquisitions as it shields the acquiring entity from undiscovered liabilities or disputes that might arise post-acquisition, such as contract disputes, investor grievances, or intellectual property issues.
- Professionals, such as physicians, can also use runoff insurance to cover liabilities after closing their practice, ensuring they are protected from potential claims made after their business ceases operations.
- While similar to extended reporting period provisions, runoff insurance differs as it usually spans multiple years and is specifically employed during acquisitions or mergers, rather than routine policy transitions.
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What Is Runoff Insurance?
Runoff insurance is a policy that covers claims against companies that are acquired, merged, or closed. Runoff insurance, also known as closeout insurance, is purchased by the company being acquired and indemnifies—exempts from liability—the acquiring company from lawsuits against the directors and officers of the acquired company.
How Runoff Insurance Protects Acquiring Companies
Acquiring a company means taking possession of its assets, but also its liabilities, including those only be discovered in the future. Obligations arise for many reasons. Third parties may feel that they were not treated fairly in contracts. Investors may feel upset with how the previous directors and officers ran the business. Competitors may claim infringement of intellectual property rights. Acquiring companies may require the purchased company to get runoff insurance to cover liabilities.
A runoff policy is a type of claims-made policy rather than an occurrence policy. The difference in policy type is because the claim may be made several years after the incident that caused damage or loss, and occurrence policies provide coverage only during the period that the policy was active. The runoff policy, known as “runoff,” usually lasts several years after activation. The provision is purchased by the acquiring company, and the purchase funds are often included in the acquisition price.
Professionals can buy runoff insurance to cover liabilities that emerge after closing a business. For example, a doctor closing a private practice might buy runoff insurance for protection against past patient claims. This policy is renewed until the claim’s filing period expires. If the business continues to offer services, its policies typically extend indemnification making the purchase of a runoff provision unnecessary.
Important
The following insurance policies should have a runoff provision: directors and officers (D&O) insurance, fiduciary liability insurance, professional liability (E&O) insurance, and employment practices liability (EPL) insurance.
Example of Runoff Insurance
Consider a hypothetical runoff policy written for a term between Jan. 1, 2017, and Jan. 1, 2018. In this situation, coverage will apply to all claims caused by wrongful acts committed between Jan. 1, 2017, and Jan. 1, 2018, that are reported to the insurer from Jan. 1, 2018, to Jan. 1, 2023. That is, the five years immediately following the end of the policy term.
$402 billion
The North American runoff reserve in 2021, per PricewaterhouseCoopers’ Global Insurance Runoff Survey 2021—compared to $302 billion for the U.K. and Continental Europe Markets.
Important Factors to Consider About Runoff Insurance
Runoff insurance provisions are like extended reporting period, but they have key differences. First, ERPs usually last one year, while runoff provisions cover multiple years. Second, people buy ERPs when switching insurers, but runoff provisions are for company mergers or acquisitions.
