Run Off Insurance: Protection Against Claims After Closing a Business
For a period after a business has closed down, many owners purchase run off insurance, a type of professional indemnity insurance, in order to protect themselves against claims that relate to work carried out before their business finished trading.
Most business owners will be familiar with professional indemnity insurance, and run off insurance is simply an extension of this. It often works on a “claims made” basis, rather than “claims occurring.” The two are similar, but a “claims occurring” stipulation provides protection after a policy has ended.
Understanding the term “claims made” is key to knowing how this kind of insurance can help you after your business has stopped trading.
In relation to professional indemnity insurance, “claims made” means that any work carried out in the past will be insured against future legal action, providing the work was completed within the coverage dates and the policy is still active. Run off cover applies to a period after a business has stopped trading when damages claims are still a possibility.
In the case of a partnership without a limited liability, it is especially important to purchase this type of insurance after a dissolution, as liability cannot be removed during the winding up process.
Run off insurance explained
The types of firms that can benefit from professional indemnity insurance include sole traders and limited liability partnerships (LLPs). Within these organisations, PI insurance covers existing and previous staff members and directors. After an organisation has closed down, run off insurance will provide cover for legal costs and upheld claims relating to anyone protected under such a policy.
For sole traders and smaller firms, retirement is a common reason for purchasing run off insurance, whereas larger firms are often passed on to a new generation of owners who can continue the existing PI policies. This means taking on the liabilities of a previous administration, which is not appealing to some.
In this case, organising a run-off policy might be the best course of action to protect against future claims relating to work completed in the past.
Who can benefit from run off insurance?
Any professional organisation that has ceased trading and is looking to extend their PI cover in order to protect themselves from historical claims will need this essential type of indemnity insurance.
Professional businesses close down for many reasons, including foreclosure, acquisition and retirement. In cases such as these, it may be necessary to extend an indemnity policy beyond the end of trading in order to comply with regulations, or simply to take the sensible option and protect against all eventualities.
These eventualities may include claims of negligence that breach a contract, or could be considered a tort. A business and it’s partners or directors does not simply remove itself from its client responsibilities once it ceases trading. Professionals have to prepare for the possibility of claims such as those mentioned years into the future.
The definition of a professional is nowadays broader than it once was. It used to be that when one thought of a professional, it was engineers, architects, accountants or surveyors that came to mind, but now people who provide a variety of services to their clients are also considered professionals.
Clients rely on the services of consultants, specialists and experts, so if a professional who practices under one of these terms is negligent, makes a mistake or fails to provide something important, they can be held accountable for the damages or disruption caused to a client.
Purchasing a run off policy
Run off insurance is slightly different to standard professional indemnity insurance, so you will need to inform your insurer in order to maintain protection against claims after ceasing trading. Your insurer will update your existing policy, limiting its cover for work completed only before the date your business closed down, and not after. This is an endorsement that insurers use until an existing policy expires.
An insurer can then offer a new run off policy. In order to successfully renew a policy beyond the closure of your business, you may need to provide a history of your business activities since the last renewal until the date you ceased trading, on what is called a proposal form.
A run off insurance policy will often include the same terms as a previous professional indemnity insurance policy, but with an added endorsement detailing the run off aspect. You can choose not to renew your policy or extend it for an extra twelve months. During this time, your insurer will contact you concerning any claims that relate to before your business closed, providing those claims fall within the period your indemnity policies have been active.
The risk that comes with not renewing a policy, or not seeking cover from another insurer after closing a business is high. A claim that is made against your business doesn’t have to be especially credible, yet you would need to defend against that claim and incur the legal costs. And in more credible cases, the damages payout is often very costly.
In terms of the length of time run off insurance should be maintained for, this can be determined by a number of factors. For professional organisations regulated by an official body, the length of time is usually six years, and this is a common standard across many professions. However, some professions and areas of business will require a shorter run off period while others will need to be indemnified for longer.
Determining the length of a run off insurance plan
Besides the guidelines set out by the relevant professional bodies, one important factor that can determine the run off period required is legislation. Finding out how many years after an alleged case of negligence a client is no longer able to make a claim under legal limitation periods is often a good determination of the length of time you would need to maintain run off insurance for.
Six years is also, like the standard for professional bodies, the period for claiming negligence in regard to a tort or breach of contract. In the case of a tort, a client can pursue damages up to six years after losing out as a result of the negligent actions on the part of a business. Likewise, breach of contract cases can be claimed against from the moment the work has finished. Professionals are also liable for negligence in relation to non-clients who they have a duty of care towards.
For cases in which the damages were incurred some time after the negligent act, clients can make a claim in tort several years beyond the standard cut-off point for contract breaches. Similarly, a claimant deadline can be extended for deed agreements to 12 years after the work has finished, and this deadline can be widened even further for claims in tort that involve hidden damages that only appear much further down the line, and can be proven.
Contracts signed as deeds, such as Collateral Warranty contracts and letters of appointment, can extend the length of time needed for a run off insurance policy. Details of the obligations a professional has concerning any work undertaken can be found in the contract, which will show the period of liability. As always, a contract should be considered carefully with the help of legal experts before it is signed.
Multi-year premium policies
Insurers sometimes provide the option to buy a premium run off policy that covers for longer than 12 months, which is the standard for most. However, paying an up-front fee for a multi-year policy is not something many insurers offer, and those who do usually limit their run off policies to six years. The decision on what type of policy you should choose should be an informed one, with advice from legal experts who can assess your obligations and liabilities before making a call on the length of cover to opt for.
Advantages of multi-year run off policy:
You benefit from a fixed price, even after making a claim or when the market rates change.
There is no requirement to renew your policy every year.
- The long-term costs are usually cheaper than renewing annually.
Disadvantages of multi-year run off policy:
The short-term costs are greater than the annual renewal methods of payment.
Insurers can sometimes close down, so there is an element of risk in committing to a long-term premium. However, professional indemnity experts have ways to accurately check the stability of a company before suggesting a certain policy.
- In a situation in which a professional starts practising again, any work completed prior to the run off period cannot be covered for in a new professional indemnity insurance plan.
How the cost changes over time
When a practice closes down and there are still run off payments to be made on an annual basis, this is where problems can arise because a closed business doesn’t make any money.
The premium on a run off insurance policy tends to remain the same for the first few years, showing that insurers see the level of risk as effectively the same in the early years after a business has closed down. In other words, the chance of a person making a claim doesn’t diminish significantly until some time later.
Run off premiums generally decrease annually by as much as 25% after the first year, providing there are no claims coming in and the market rate doesn’t increase.
We regularly advise clients on run off planning and options so to talk to an adviser please call us on 0345 251 4000.
This article is intended for information purposes only. Whilst all care has been taken to ensure the accuracy of the article it is not to be regarded as a substitute for specific advice. © 2016 Professional Indemnity Insurance Brokers Ltd