Understanding Runoff Insurance and How It Works

What Is Runoff Insurance?

Runoff insurance is an insurance provision that covers claims made against companies that have been acquired, merged, or ceased operations. This type of insurance, also known as closeout insurance, is purchased by the acquiring company. It indemnifies the acquiring company from lawsuits against the directors and officers of the acquired company.

Key Takeaways

• Runoff insurance protects acquiring companies from legal claims made against companies being acquired, merged, or ceased operations.
• A runoff policy applies for a certain period after the policy is active, acting 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.

Understanding Runoff Insurance

Acquiring a company means taking possession of its assets and liabilities, including those that may arise in the future. These liabilities can include contractual disputes with third parties, dissatisfaction among investors regarding previous management, and claims of intellectual property infringement by competitors. To protect itself from these liabilities, the acquiring company may require the company being acquired to purchase runoff insurance.

Runoff insurance works as a claims-made policy, meaning that claims can be made years after the incident that caused damage or loss. The runoff policy is typically valid for a set number of years after becoming active. The acquiring company purchases this provision, with the costs often included in the acquisition price.

Professionals who close their businesses, such as physicians, may also purchase runoff insurance to cover professional liabilities that may arise after closure. Typically, these policies are renewed until the statute of limitations on filing a claim has passed. If the business continues to operate, its existing policies usually provide indemnification, making the purchase of a runoff provision unnecessary.

Runoff provisions should be included in the following insurance policies: directors and officers (D&O) insurance, fiduciary liability insurance, professional liability (E&O) insurance, and employment practices liability (EPL) insurance.

Runoff Insurance Example

$402 billion

The North American runoff reserve in 2021, according to PricewaterhouseCoopers’ Global Insurance Runoff Survey 2021, was $402 billion. The U.K. and Continental Europe markets had a runoff reserve of $302 billion.

Special Considerations

Although runoff insurance provisions are similar to extended reporting period (ERP) provisions, there are some differences. ERPs usually cover one-year terms, while runoff provisions cover multi-year periods. Furthermore, ERPs are often purchased when individuals switch claims-made insurers, whereas runoff provisions are used in cases of company acquisitions or mergers.