What is 'Runoff Insurance'

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

BREAKING DOWN 'Runoff Insurance'

Acquiring a company means taking possession not only of its assets, but also its liabilities, including those that may only be discovered in the future. Liabilities may arise because third parties feel that they were not treated fairly in contracts. Investors may feel upset with how the previous directors and officers ran the business. Competitors may also feel that their intellectual property rights were infringed upon. In order to protect itself from these liabilities, the acquiring company will have the company being acquired purchase runoff insurance.

A runoff policy is a type of claims-made policy rather than an occurrence policy. This is because the claim may be made several years after the incident that caused damage or loss, and occurrence policies provide coverage only during the period that the policy was active. The length of the runoff policy, referred to simply as the “runoff,” is typically set for several years after the policy becomes active. The provision is purchased by the company being acquired, with the purchase funds often being included in the acquisition price.

Professionals may also purchase runoff insurance to cover professional liabilities that occur after a business has closed. For example, a physician who closes his or her private practice may purchase runoff insurance in order to protect his or herself from claims filed by previous patients. This type of policy is typically renewed until the statute of limitations on filing a claim has passed. If the business continues to offer services, its policies typically extend indemnification, making the purchase of a runoff provision unnecessary.

How Runoff Insurance Works

Consider a hypothetical runoff policy written for a term between Jan. 1, 2017, and Jan. 1, 2018. In this situation, 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 January 1, 2018, to January 1, 2023, i.e., the 5-year period immediately following the end of the policy term.

Although runoff insurance provisions function in a similar manner to extended reporting period (ERP) provisions, there are several differences. First, ERPs are usually only for one-year terms, whereas runoff provisions normally encompass multi-year time spans. Second, while an ERP is most frequently purchased when an insured changes from one claims-made insurer to another, runoff provisions are generally used when one insured is acquired by or merges with another.

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