What is Run-Off Insurance?
When your business is sold, closed, merged with another, or you simply stop operating, how can you ensure you are still protected from claims for work performed in the past? Losses can happen years after the work is completed, even if your business and subsequently your insurance policies are no longer active, which is where “run-off insurance” is important.
Run-off insurance is relevant to clients when they’re shutting down their business, selling or merging their business (change of control), or the insurer is not willing to renew the policy.
Depending on your specific liability requirements, your policy will be written on either a claims-made or occurrence basis. Run-off insurance is a provision in a claims-made policy to ensure the insured remains covered for a certain period after their policy has lapsed or been cancelled. Basically, it means that the insurer remains liable for claims caused by wrongful acts that took place under an expired or cancelled policy, for as long as the run-off period.
Although clients may be cordial during the work or project, it’s not uncommon to receive a notice of a claim against you or your company well after the work has occurred. The client may not have been aware of the incident initially or it may have taken time to come to fruition. Regardless, claims can arise long after your work has been completed. This is where run-off insurance may be necessary.
Why can’t potential claims relating to past events be referred to the old insurer?
Claims-made vs occurrence
With claims-made liability, the insured is covered for claims made against them as long as their policy is current—hence the name “Claims-Made”. The date the incident occurred is irrelevant because this type of policy covers liability for any claims made during the current period of insurance — unless the date of the incident is before the start date of the cover. When looking at a claims-made policy, it’s important to consider the retroactive date. If there is not an unlimited retroactive date, the date specified will be used as the starting point for cover. Any claims made against you relating to events that occurred prior to this date may not be covered.
Occurrence-based liability means regardless of when the claim is made, the event will be covered by the insurance policy that was current at the time the event occurred — even if that policy has since lapsed. If a claim is made against you for an event that occurred years ago, the claim needs to be referred to whomever the insurer was at the time of occurrence.
Run-off coverage is not required with occurrence-based liability because the event is covered as long as it occurred during the period that policy was in force. But, if your insurance was a claims-made policy, you don’t have the same benefits as an occurrence-based policy. Therefore, run-off insurance may be necessary to ensure you are covered for any claims that could arise in the future.
For example, Professional Indemnity insurance is written on a claims-made basis. If your PI insurance policy has lapsed, and a former client decides to sue for damages, this claim cannot be referred to the old insurer — referring to the old insurer is only possible with occurrence-based claims. To be protected for future liability after your policy has lapsed, you need run-off insurance.
Types of policies that require run-off consideration
There are various types of insurance policies where run-off insurance is an important consideration to ensure protection after the claims-made policy has ended. See examples of common claims made policy classes below:
How does run-off work?
To get a feel for how run-off works, consider a financial advisor who has provided negligent advice to a client, causing a significant loss.
As you can see from the flowchart, the client acted on the advice in February 2015, and the advisor retired three years later. The Professional Indemnity insurance is subsequently cancelled. In 2019 the client suffered a loss and decided to sue on the basis that the negligent advice caused their loss.
Without run-off insurance, the financial advisor is liable to pay any damages resulting from this lawsuit. With run-off insurance, the advisor is protected for any claims made during the run-off period for past acts
Figure 1: Diagrammatic representation of a real-world run-off policy case study
Why do I need run-off cover?
There are various reasons why you may need run-off cover, and generally, it’s because your business is ending, changing, or the insurer is not willing to renew. This event typically sees the end of your insurance policy, but not the end of legal liability. If you choose to forgo run-off insurance, it will be as if you never had insurance at all if a dispute was to arise. You could be liable personally for claims caused by wrongful acts.
The main circumstances that warrant run-off cover are:
Typically, it’s best practice to ensure that the period of run-off insurance purchased reflects your contractual obligations and the relevant statute of limitations. Other relevant factors to consider when determining the length of the run-off period are the laws and jurisdictions that apply to contracts in each country, state and territory that you conduct business in.
For more information on the statutory limitation (civil proceedings) in Australia, click here: Parliament of Australia
Run Off FAQ
How long should run off be purchased for?
Generally speaking, to the standard run-off policy is for seven years in Australia. This means that once the seven years have elapsed, usually, legal proceedings cannot go ahead, meaning the insureds liability exposure has ended. The statute of limitation can vary depending on the offence. For example, the timeline for medical malpractice may only be up to three years.
How is the pricing of run off determined?
The cost is usually a percentage of the original premium of the expired policy. Run off cover can be purchased for one year or multiple consecutive years. The pricing of the multiple year policies generally declines in line with time, to reflect the decreasing risk of a claim occurring, but is typically payable as a lump sum.
Why do I need run off insurance if the company no longer exists?
Under breach of contract and tort law, somebody can lodge a dispute against the company, its directors and management after the fact. For example, if a client has a legitimate claim from the last day the company was trading, they can commence legal proceedings. Holding run-off cover provides protection in this scenario.
Figure 2: Diagrammatic representation of D&O run-off policy
In this image, the date of acquisition of the company is 1st January 2019. This is the date the initial policy ceases, and the directors are no longer covered for any events taking place after 1st January 2019. If a claim arises relating to a wrongful act that took place before 1st January 2019, without run off cover, it would be as if the directors never had insurance at all. They would personally be held liable to pay damages. With run off cover, they are protected for the duration of the statute of limitation.
Due to the statute of limitation, finishing up your position in a business doesn’t mean you’re legally out of the woods in the event someone decides to take legal action against you. Run off insurance maintains your cover for the period you were in business.
How can KBI help?
Experts in insurance and strategy, we are well equipped to help you navigate your insurance needs. Whatever phase you or your business are in, we work closely with you to find an insurance solution to suit your needs.
Considering run off cover while you’re planning for a change in corporate structure, business closure or retirement, can help to secure the most competitive premiums. For more information or advice regarding how to move forward, give us a call on 1300 907 344
Have any questions?
Talk to one of our Specialist Insurance Brokers today!
*This information is general in nature and is not intended to be financial advice. Any individual relying on the above does so at their own risk.