What Is Runoff Insurance?
Runoff insurance is a specialized coverage provision designed to protect against claims made on behalf of companies that have been acquired, merged, or have ceased operations. Also known as closeout insurance, it’s typically purchased by the acquired company to indemnify the acquiring entity from litigation involving the former’s directors and officers.
Key Takeaways
- Protective Coverage: Runoff insurance safeguards the acquiring company against legal claims targeting the acquired entity or from operations that have since merged or closed down.
- Claims-Made Policy: This insurance acts as a claims-made policy over a specified run period rather than an occurrence policy.
- Extended Coverage: Unlike extended reporting period provisions, runoff policies cover multi-year durations, ensuring comprehensive protection.
Why Runoff Insurance Matters
When acquiring a company, one must consider not only its assets but also future liabilities that could arise. These liabilities might stem from disgruntled third parties, investors’ dissatisfaction, or intellectual property disputes. To mitigate such post-acquisition risks, acquiring entities often mandate runoff insurance.
A claims-made runoff policy ensures coverage for claims reported several years after the incident occurred, filling the gap left by occurrence policies that cover incidents only during the active policy period. Typically, the period covered by the runoff, often referred to simply as the “runoff,” extends several years post-policy activation and is factored into acquisition costs.
Scenarios Requiring Runoff Insurance
Professionals closing their businesses should consider runoff policies to manage any post-closure claims. For instance, a physician closing a private practice might secure runoff insurance to protect against future patient claims. The policy is renewed until the claim statute of limitations runs out. Maintaining an active business negates the need for such deeply extended coverage since industry-standard indemnification continues.
Common policies incorporating runoff provisions include:
- Directors and Officers (D&O) Insurance
- Fiduciary Liability Insurance
- Professional Liability (E&O) Insurance
- Employment Practices Liability (EPL) Insurance
Practical Example of Runoff Insurance Application
Imagine you have a runoff policy active from Jan. 1, 2017, to Jan. 1, 2018. Coverage under this policy would apply to claims from wrongful acts between these dates, reported thereafter until Jan. 1, 2023. Thus, the policy ensures a five-year coverage period post-term, safeguarding from deferred exposure risks.
$402 Billion
In 2021, North American runoff reserves were valued at $402 billion, per PricewaterhouseCoopers’ Global Insurance Runoff Survey 2021. This valuation highlights the importance and substantial scale of runoff provisions compared to the $302 billion seen in the U.K. and Continental Europe Markets.
Special Considerations: Understanding Extended Reporting Periods (ERP) vs. Runoff Provisions
While both runoff provisions and ERPs share similarities in function, they’re distinct in application and duration:
- Duration: ERPs generally cover one-year terms, whereas runoff provisions extend across multi-year periods, ensuring longer-term protection.
- Circumstances: ERPs are mainly used when switching between claims-made insurers, in contrast to runoff provisions designed for scenarios involving mergers or acquisitions.
Being informed about these nuanced differences will better prepare businesses for strategic risk management during acquisitions and operational transitions.
Related Terms: claims-made policy, extended reporting period, D&O insurance, E&O insurance, liability coverage.
References
- PricewaterhouseCoopers. “Global Insurance Run-off Survey 2021”.
