What Is Runoff Insurance?
Let me explain runoff insurance directly: it's a provision in an insurance policy that covers claims made against companies that have been acquired, merged, or have ceased operations. You might also hear it called closeout insurance, and it's typically purchased by the company being acquired to indemnify the acquiring company—meaning it exempts them from liability in lawsuits against the directors and officers of the acquired company.
Key Takeaways
Runoff insurance protects an acquiring company from legal claims made against a company being acquired or one that has merged or ceased operations. This type of policy applies for a certain period after it becomes active, functioning as a claims-made policy rather than an occurrence policy. Runoff policies are similar to extended reporting period provisions, but they apply to multi-year periods, not just one year.
Understanding Runoff Insurance
When you acquire a company, you're taking on its assets, but also its liabilities, including those that might only surface later. These obligations can come from various sources—third parties might claim they weren't treated fairly in contracts, investors could be upset with how previous directors and officers managed the business, or competitors might allege infringement of intellectual property rights. As the acquiring company, you might require the target company to buy runoff insurance to shield yourself from these liabilities.
Runoff insurance is a claims-made policy, not an occurrence policy, because claims can be filed years after the incident that caused damage or loss, and occurrence policies only cover the active policy period. The runoff period is usually set for several years after the policy starts, and the acquiring company often funds this purchase as part of the acquisition price.
Professionals can also get runoff insurance to cover liabilities after their business closes. For instance, if you're a physician shutting down your private practice, you might buy this to protect against claims from former patients. You'd renew it until the statute of limitations for filing claims expires. If your business keeps operating and providing services, its existing policies usually handle indemnification, so you wouldn't need a runoff provision.
Important Insurance Policies for Runoff Provisions
- Directors and officers (D&O) insurance
- Fiduciary liability insurance
- Professional liability (E&O) insurance
- Employment practices liability (EPL) insurance
Runoff Insurance Example
Consider this hypothetical: suppose there's a runoff policy written for a term from January 1, 2017, to January 1, 2018. In this case, coverage would apply to all claims caused by wrongful acts between those dates, as long as they're reported to the insurer from January 1, 2018, to January 1, 2023—that's the five years right after the policy term ends.
Runoff Reserve Statistics
To give you some scale, the North American runoff reserve in 2021 was $402 billion, according to PricewaterhouseCoopers' Global Insurance Runoff Survey 2021, compared to $302 billion for the U.K. and Continental Europe markets.
Special Considerations
Runoff insurance provisions work much like extended reporting period (ERP) provisions, but there are key differences. ERPs are usually for just one year, while runoff provisions cover multi-year periods. Also, you buy ERPs when switching from one claims-made insurer to another, whereas runoff provisions come into play when one company acquires or merges with another.
