When businesses change hands or shutter their operations, enormous liabilities often trail behind. Runoff insurance, also sometimes referred to as closeout insurance, serves as a strategic shield. Not only is it purchased by the company that's being acquired or ceasing operation, but it also serves to protect the acquiring company or successor from the potential storms of lawsuits directed towards the previous management.
Companies often house a cluster of assets, as well as a swarm of liabilities - some of which may only surface in the future. These liabilities can sprout from a variety of roots. Unhappy investors might take issue with the previous management. Stiffed third parties may feel that business contracts were skewed against them. Even competitors might step up and cry foul over intellectual property rights. As such, an acquiring company often requires a runoff insurance policy to be in place as a protective measure against these potential landmines.
Runoff insurance isn't typically an occurrence policy, meaning that it doesn't only cover incidents during its active period. It's actually a type of claims-made policy. The critical distinction here is that Runoff insurance has longevity, covering claims that may possibly emerge years after the original incident. Its lifespan, known as the 'runoff', is often set for several years after the policy takes effect, with purchase funds commonly bundled into the acquisition deal.
Even professionals can utilize runoff insurance to safeguard against liabilities post-closure. For instance, a doctor shutting down their private practice can secure runoff insurance as a guard against future patient claims. Such policies are usually kept active until the legal claim window closes. Should the business continue to operate in some capacity, its existing policies typically extend an umbrella of indemnity, rendering the need for a separate runoff provision redundant.
It's important to remember that runoff provisions are recommended add-ons to certain types of insurance policies. These include Directors and Officers insurance (D&O), Fiduciary Liability Insurance, Professional Liability or Errors & Omissions (E&O), and Employment Practices Liability (EPL) insurance.
An illustrative example of a runoff policy might span from Jan. 1, 2017 to Jan. 1, 2018. Here, coverages would extend to any claims resulting from wrongdoings committed within the active period and reported to the insurer until Jan. 1, 2023 - a five-year span post-policy term end.
A recent Global Insurance Runoff Survey by PricewaterhouseCoopers reported in 2021 that the North American runoff reserve was substantial when compared to $302 billion for the U.K. and Continental Europe Markets.
While runoff insurance policies bear certain similarities to Extended Reporting Period (ERP) provisions, they do come with distinct differences. ERPs generally run for a year and are usually triggered when the insured switches to a new insurer, whereas runoff provisions typically span multiple years and come into play when one insured entity is sold or merges with another.