When you acquire a company, you’re not just getting its assets; you’re also inheriting its liabilities. These liabilities might surface unexpectedly in the future, leading to legal disputes or financial losses. That’s where runoff insurance comes into play, offering protection against potential claims that may arise after a business transaction.
What is Runoff Insurance?
Runoff insurance is a type of policy designed to cover claims made against a company for incidents that occurred before the policy was active. Unlike occurrence policies, which only provide coverage during the policy period, runoff insurance is claims-made, meaning it covers claims reported during a specific timeframe, even if the incident happened years earlier.
Why is it Needed?
Acquiring companies often demand runoff insurance to shield themselves from unforeseen liabilities associated with the acquired business. These liabilities could stem from contracts disputes, dissatisfaction among investors, or allegations of intellectual property infringement. By purchasing runoff insurance, the acquiring company safeguards itself against potential financial losses arising from such claims.
Who Buys Runoff Insurance?
Apart from acquiring companies, professionals like doctors or lawyers may also opt for runoff insurance to protect themselves from future claims after they’ve closed their practices. For instance, a physician might purchase runoff insurance to cover any malpractice claims filed by former patients even after retiring.
Key Policies with Runoff Provision:
Several insurance policies benefit from a runoff provision, including directors and officers (D&O) insurance, fiduciary liability insurance, professional liability (E&O) insurance, and employment practices liability (EPL) insurance. These policies ensure continued coverage for past actions, even after the policy has expired.
Understanding the Terms:
Let’s consider an example: a runoff policy running from Jan. 1, 2017, to Jan. 1, 2018. In this scenario, coverage extends to claims arising from wrongful acts during this period, reported to the insurer from Jan. 1, 2018, to Jan. 1, 2023. Essentially, it provides protection for five years following the policy’s end date.
Special Considerations:
Although similar to extended reporting period (ERP) provisions, runoff insurance has distinct features. ERPs usually cover one-year terms, primarily when switching insurers, whereas runoff provisions span multi-year periods and are commonly used in mergers or acquisitions.
Conclusion:
Runoff insurance serves as a crucial safeguard for businesses and professionals, offering protection against potential liabilities that may arise from past actions. By understanding its purpose and provisions, companies can mitigate risks associated with acquisitions, while professionals can ensure peace of mind even after retirement.