What's runoff insurance? How does it works?

Runoff insurance, also known as closeout insurance, is a specialized type of liability insurance designed to protect businesses from claims that arise after a company has been acquired, merged, or has ceased operations. This article delves into the intricacies of runoff insurance, its significance, and how it functions.

Runoff insurance provides coverage for claims made against a company after it has been acquired, merged, or ceased operations. Essentially, it acts as a safety net for the acquiring company, shielding it from potential lawsuits against the directors and officers of the acquired entity. During the process of an acquisition, the company that is being acquired will get runoff insurance. This insurance will protect the acquiring firm from being held liable for any lawsuits that are filed against the directors and officers of the acquired company.

Key Features of Runoff Insurance

Claims-Made Policy: Unlike occurrence policies that cover incidents happening during the policy period, runoff insurance is a type of claims-made policy. This means it covers claims reported during the policy period, even if the incident occurred in the past.

Extended Coverage: Runoff policies typically extend coverage for several years after the policy becomes active, providing long-term protection against unforeseen liabilities.

Professional and Business Protection: Professionals such as doctors or lawyers who close their practices can also benefit from runoff insurance, ensuring they are protected from claims filed by previous clients or patients.

Why Runoff Insurance is Essential

Acquiring a company involves taking on not just its assets but also its liabilities. These liabilities can emerge from various sources, such as:

Contract Disputes: Third parties might feel they were not treated fairly in contracts.

Investor Grievances: Investors might be unhappy with the previous management's decisions.

Intellectual Property Claims: Competitors might allege infringement of intellectual property rights.

To mitigate these risks, the acquiring company often requires the acquired company to purchase runoff insurance. This coverage ensures that any claims arising from past actions are addressed, protecting the acquiring company from potential financial and legal repercussions.

How Runoff Insurance Works

Runoff insurance operates by extending the reporting period for claims. For example, consider a runoff policy written for a term between Jan. 1, 2017, and Jan. 1, 2018. In this scenario, 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. This extended reporting period ensures that any claims made after the policy term are still covered.

Types of Insurance Policies with Runoff Provisions

Several types of insurance policies can include runoff provisions, such as:

Directors and Officers (D&O) Insurance: Protects directors and officers from claims related to their managerial decisions.

Fiduciary Liability Insurance: Covers liabilities arising from the management of employee benefit plans.

Professional Liability (E&O) Insurance: Protects professionals from claims of negligence or errors in their services.

Employment Practices Liability (EPL) Insurance: Covers claims related to employment practices, such as wrongful termination or harassment.

Example of Runoff Insurance in Action

Consider a hypothetical scenario where a financial institution discovers errors in their loan documents years after ceasing operations. These errors lead to costly litigation. Fortunately, the institution had purchased runoff insurance, which covered the legal costs and settlements, demonstrating the financial protection provided by such policies.

Special Considerations

While similar to extended reporting period (ERP) provisions, runoff insurance differs in several ways:

Duration: ERPs typically last for one year, whereas runoff provisions can extend for multiple years.

Usage: ERPs are often used when switching insurers, while runoff provisions are used during mergers or acquisitions.

Runoff insurance is a crucial component for businesses undergoing mergers, acquisitions, or closures. It provides peace of mind by covering potential claims arising from past actions, ensuring that the acquiring company or the professionals involved are protected from unforeseen liabilities. As the business landscape continues to evolve, having robust runoff insurance can be the difference between financial stability and significant financial losses.