Understanding D&O Runoff Policies

Directors and officers liability (D&O) insurance is a vital safeguard for business leaders making decisions on behalf of their organizations. However, when a company is merged with or acquired by another entity, these leaders may face personal liability if their D&O insurance is canceled or expires. In these scenarios, a D&O runoff policy becomes crucial, as it provides coverage for claims stemming from actions taken before the business transition. This protection safeguards personal assets and ensures continuity of coverage.

Purposes of D&O Runoff Policies

D&O runoff policies are designed to provide coverage for business leaders (e.g., senior executives and the board of directors) during transitions like mergers, acquisitions and structural changes. Coverage for claims that arise from actions that occurred before this transaction may not be covered under the acquiring entity’s D&O coverage, leaving former directors and officers personally liable. A D&O runoff policy ensures continuity of coverage, mitigating these risks and protecting personal assets.

Key Features of D&O Runoff Policies

D&O runoff policies are “claims-made” policies, meaning they cover claims made while the policy is active, regardless of when the alleged act that gave rise to the claim occurred. They generally provide coverage for claims such as mismanagement, breaches of fiduciary duty and other alleged wrongful acts committed during the insured’s tenure.

Runoff coverage may be written as an endorsement of an existing D&O policy or as a standalone policy. It may be customized to provide tailored coverage to an organization’s unique risk profile.

Unlike extended reporting period (ERP) provisions, which generally provide limited coverage for a specific duration after the original policy expires, D&O runoff policies can extend coverage for up to six years after the transaction. Additionally, runoff policies and ERPs may have different terms of coverage scope, limits and durations. A runoff policy typically offers broader and longer-term protection, making it essential for significant transactions.

Common Scenarios Requiring a D&O

Runoff Policy Several scenarios may create the need for securing a D&O runoff policy, including:

• Mergers and acquisitions (M&A)—Business leaders, including outgoing executives and board members, may face claims related to their pre-transaction actions. Even directors who remain in place following the transition may benefit from a D&O runoff policy, as the acquiring entity’s insurance may not provide retroactive coverage.
• Bankruptcy or dissolution—Outgoing business leaders may need to secure coverage to protect against claims arising during a business’s wind-down period.
• Ownership structure changes—If an event changes over 50% of the company’s voting power or board composition, D&O runoff insurance may be necessary to protect outgoing leadership.

In some situations, buyers of private companies may mandate a D&O runoff policy as part of the transaction. Typically, the company being sold bears the cost of the policy, but it may also be negotiated as a part of the deal.

Risks of Not Having a D&O Runoff Policy

Failure to secure a runoff policy can lead to several negative consequences. For example, without a runoff policy, former directors or officers may be held personally responsible for legal costs and damages arising from claims related to their past management decisions. This could lead to the loss of their assets to satisfy the claim, creating significant financial hardship.

How to Obtain and Implement a D&O Runoff Policy

When securing a D&O runoff policy, business leaders should first review the runoff provisions in their original D&O policy to determine the length and type of coverage needed. Ensuring adequate tail coverage that aligns with the statute of limitations in applicable jurisdictions is crucial to mitigating long-term liability risks. Additionally, leaders should confirm that the policy includes sufficient limits to address potential claims. During major business transitions, it is essential to negotiate terms with insurers and seek guidance from experienced insurance brokers or legal counsel to develop tailored solutions that align with the organization’s unique risks.

Risk Management Tips

To mitigate risks during business transitions, leaders should:

• Plan ahead to secure appropriate D&O runoff insurance.
• Review the terms of the existing D&O policy for relevant runoff provisions.
• Consult experienced professionals to address complex risk scenarios.

Final Thoughts

Transition periods, such as M&As and dissolutions, create unique liability exposures for business leaders. A D&O runoff policy is a critical tool for bridging gaps and protecting assets. By planning ahead and working with experienced the team at Dowd Insurance, business leaders can ensure seamless coverage during these pivotal moments.

Contact us today for more information.