What is Run-Off Coverage for Directors & Officers Insurance Policies?
Run-Off insurance is designed to provide cover for former directors and officers in respect of claims for past acts occurring during their tenure on the board but have not yet materialized and/or been reported to the insurer.
Companies operating in the market environment may undertake a variety of transactions and activities during their life cycle, many of which affect the company’s Directors & Officers insurance (D&O) policy. An example of this is when a company goes through changes in their corporate structure: as insurance contracts are entered into based on information current at the time of inception, this activity has a significant impact on the company’s policy and must be notified to the insurer.
It’s important to consider the impact these changes might have on the D&O policy and whether the board and management need to obtain Run-Off insurance. D&O policies typically contain a “change in control” or “transaction” clause, which are triggered during a change to the corporate structure of a company; the D&O policy ordinarily ceases or requires policy amendments to cover only acts prior to the change of control. In all cases it is a matter to be notified to the insurer.
Why is Run-Off needed after the Transaction/Change in Control?
Following a change of control transaction, the outgoing board may not consider their exposure warrants the continued insurance cover, however they could still be the target of:
Even after the company appears not to exist anymore, the liability exposure continues for the directors & officers for the statute of limitation—7 years in Australia. In some transactions, there may even be a provision in the sale agreement requiring the entity to purchase run-off insurance as part of the sale process.
Why can’t I report an old claim to the old insurer?
D&O Insurance Policies – Claims-Made versus Occurrence Based Insurance:
There are two types of insurance policies — ‘claims-made’ and ‘occurrence based’.
Claims-made policies are for risks where the insurers are trying to limit or control their future exposure, where the policy that is in place at the time a claim is notified is the one which will respond. Some examples are Directors & Officers, Professional Indemnity, Cyber, Environmental and Medical Malpractice.
Occurrence based policies provide cover for losses that happened during the policy period – the policy that is in place when a claim occurred is the one which will respond, even if the policy has since expired. You can report a claim several years later and there doesn’t need to be an active policy to respond to the claim, as long as there was a policy in place when the claim actually occurred. Examples of this policy type are Public Liability and Products Liability.
Directors & Officers policies are on a ‘claims-made’ policy form, therefore there must be an active policy in place at the time of the claim and/or notification for that claim to be covered. If the policy has been lapsed and isn’t in place at the time the claim is made, it won’t respond to the claim, regardless of when the wrongful act occurred. This highlights the need to ensure continuity of insurance coverage at all times during the company’s life cycle, even post transaction and existence of the actual company.
What is the difference between Run-Off and Extended Reporting Period?
First, ERPs are generally a short-term extension built into the policy as part of the renewal, with options for 60 to 90 days only (typically for nil premium) or for a one-year term (for an additional charge), whereas Run-Off provisions normally cover multiple years. The extended reporting period provision allows the policyholder to continue to report claims to the insurance company.
Although Run-Off insurance provisions operate in a similar manner to Extended Reporting Period (“ERP”) provisions, there are several differences.
Second, while an ERP is most frequently purchased when an insured changes from one claims-made insurer to another or have not been offered renewal terms by their insurer, Run-Off policies are purchased in circumstances when one insured is acquired by or merges with another.
What are the common questions we receive around Run-Off insurance?
While policies have a different definition for “change of control” or “transaction”, here are some examples of the typical triggers:
This will depend entirely on the terms of the D&O policy and the specific nature of the relevant transaction. For an on-market takeover, this is usually when the Bidder Company has acquired control of more than 50% of the issued shares of the Target Company. Most policies make provision for the notification to the insurer to take place within a designated period of time, for example 30 days.
The policy remains on foot, but only to provide limited cover for wrongful acts by the directors and officers which took place prior to the date of the change of control transaction; the company will need to advise their insurer of the transaction as soon as practicable. The company will also need to take out a separate policy in the name of the new entity to ensure continuity of cover for the directors and officers after the expiry date of the policy.
Run-off insurance is purchased for a specified period of time, generally aligned with the statute of limitations applicable in the relevant jurisdiction. In Australia, the standard period is usually a minimum of 7 years. In other jurisdictions this period differs, for example in the United Kingdom the period is 6 years and in France up to 10 years.
Run-Off premiums are typically calculated as a multiple of the annual premium, assuming the insurer is comfortable with the transaction and past activities. For example, the insurer may allocate a factor (ex. 2.5X or 4X) applied to the premium applicable to the annual D&O policy over the run-off lifespan.
The run-off policy can be purchased on a stand-alone annual basis or for multiple consecutive years. In the event of a multiple year run-off policy, the pricing generally decreases over time in recognition that as more time elapses from the date of the transaction there is a reduced risk of a claim occurring.
Following a merger, acquisition or change in corporate structure, director’s indemnity agreements cease to exist; therefore, it is critical that ongoing insurance protection is established.
A Run-Off policy gives the directors and officers peace of mind that they have a policy they can put in the vault (for up to the statute of limitations) to cover past acts after there has been a change in control. Without it, the personal assets of directors and officers are exposed to losses as a result of their past actions.
Figure 1: Diagrammatic representation of D&O run-off policy
How can KBI help?
Navigating the particular nuances of a policy wording is something we do on behalf of our clients. We can assist in the transition phase to ensure that both former directors and officers, as well as the surviving entity’s board are adequately covered. It’s important to consider a run-off policy at the early stages of a transaction to secure competitive premiums at that time.
KBI is a boutique insurance brokerage with a focus on Directors’ & Officers’ insurance. Our team has placed Directors’ and Officers’ Liability Insurance for over 300 public companies in Australia, Asia, North America and Europe, including the ASX, TSX/TSX-V, SGX, LSE, Nasdaq, NYSE and LSE/AIM. Our team consists of senior brokers, lawyers and past ASX listing advisors. We add value to the process by helping our clients make an informed decision during the purchasing and claims process. We also continue to provide updates to our clients, so they are properly informed on the ever-changing landscape of Directors & Officers insurance.