Runoff Insurance comes into play when a business is taking the next big step in their investments like acquisitions, mergers or ceasing operations.
In a business that performs such high-risk activities, liabilities from prior activities are very likely to arise. Runoff insurance acts as a safety net for businesses and professionals, providing them coverage for claims made after a policy ends.
What is Runoff Insurance?
Also known as ‘Runoff liability insurance’ or ‘Tail insurance’, Runoff insurance is a type of insurance coverage that continues to protect a company or individual for claims made after a policy has expired or been canceled.
Furthermore, it is particularly common in industries with long-tail liabilities, such as law, medicine, and professional services. This insurance is a crucial safeguard for businesses and professionals navigating transitions such as closures, mergers, or retirement.
Additionally, it ensures continued protection against liabilities arising from past actions, providing peace of mind and financial security.
Why is This Insurance Important?
Even after a business closes or merges, legal liabilities from its past activities can still surface years later. Such claims would have to be handled out-of-pocket without the insurance, potentially leading to severe financial consequences.
How Does It Work?
Runoff insurance extends the coverage period of a claims-made policy. Claims-made policies cover incidents reported while the policy is active. Furthermore, once the policy ends, no further claims can be made unless runoff insurance is purchased.
What Does Runoff Insurance Cover?
This insurance provides coverage for legal liabilities and financial claims arising from incidents during the original policy’s active period. What’s more, specific coverage details may vary by policy and industry.
Professional Liability
The policy covers errors, omissions, or negligence in professional services. For example, a financial advisor who sold a misrepresented product before retirement may face a lawsuit years later.
Directors and Officers (D&O) Liability
This liability policy protects executives against lawsuits stemming from decisions made while they were in office. For example, a former board member could be sued for mismanagement discovered after a merger.
Errors and Omissions
This applies to professionals like consultants, engineers, or IT specialists for services rendered before the policy expired.
Medical Malpractice
On the other hand, this provides coverage for claims against healthcare professionals for incidents occurring before their policy ended.
Who Needs Runoff Insurance?
Runoff insurance is essential for businesses or professionals in specific scenarios, including:
Business Mergers or Acquisitions
When one company plans to acquire another, liabilities from the acquired business’s past activities may surface later.
Business Closures
Even after the company shuts down, it still remains vulnerable to lawsuits related to its prior operations.
Professional Retirement
Professionals such as doctors, lawyers, and accountants often opt for a policy to cover potential claims made after retirement.
Changes in Corporate Structure
Businesses that are undergoing restructuring or significant operational changes may need to get runoff coverage to protect against prior liabilities.
How Much Does This Insurance Cost?
The cost of this insurance depends on various factors, like the industry, the scope of coverage, and the duration of the runoff period. Furthermore, the premiums are calculated as a percentage of the original policy’s annual premium. Here are some of the influencing factors that affect the cost of this insurance:
- Policy Duration: If there are longer runoff periods, it could result in higher costs.
- Claims History: Companies or individuals who have a long of claims are more likely to pay more.
- Industry Risk: High-risk industries like healthcare or finance face higher premiums.
- Coverage Limits: Higher coverage limits are also known to increase one’s premiums.
On average, runoff insurance can cost between 100% to 300% of the original policy’s annual premium, and this depends on the duration of the coverage period.
Advantages and Disadvantages
Here are some advantages and disadvantages that come associated with this insurance model:
Advantages:
- This insurance protects against unexpected liabilities years after a policy ends.
- It also ensures uninterrupted coverage for claims tied to past activities.
- The policy can also be tailored to meet the specific needs of businesses or professionals.
Disadvantages:
- Premiums can be significantly higher than standard policies.
- Policies may include limitations or exclusions.
- Not all businesses or professionals recognize the need for runoff coverage.
Is It Worth It?
For businesses and professionals with potential long-term liabilities, runoff insurance is highly beneficial.
Furthermore, the cost of defending against a lawsuit or paying damages can far exceed the premiums for a runoff policy. It is particularly valuable for those in high-risk industries or those planning major transitions such as retirement or mergers.
Frequently Asked Questions
Here are some frequently asked questions you can check out:
What happens if I don’t have runoff insurance?
Without the runoff insurance, you are personally or corporately liable for any claims made after the policy ends. Unfortunately, this could lead to significant financial and legal challenges.
Does runoff insurance cover new claims?
No, runoff insurance only covers claims tied to incidents that occurred during the active period of the original policy.
How long does it last?
The duration of runoff coverage depends on the policy terms. It can range from a few years to an indefinite period, depending on the agreement and industry requirements.
Can I purchase another insurance after a policy ends?
It’s best to purchase runoff coverage before the original policy ends to avoid gaps. Some insurers may allow late purchases, but this often comes with higher premiums.