Run-off is the insurance cover provided under certain policies when your practice ceases, whether voluntarily, as a result of retirement, merger or involuntarily, through insolvency or due to another closure event.
Why is run-off cover required?
Professional indemnity insurance (PII) is provided on a 'claims made' basis – that is, the cover applies at the date the claim is made, not when the error or omission causing the claim occurred. Losses on a PII policy are therefore 'long-tail liabilities', meaning it can often be several years after the work was completed by the time a claim arises.
Solicitors in England and Wales must have PII that complies with minimum terms and conditions (MTC) set by the SRA. MTC wording requires insurers to provide a minimum of six years run-off cover. This ensures that you and your clients continue to benefit from the very comprehensive cover your PII policy offers (up to £2m for a partnership, or £3m for LLPs and other incorporated entities) against any such 'long tail' liabilities. This provides a significant degree of protection for both the public and for partners in law firms, who might otherwise face personal liability for claims that arise after the firm in question has ceased. For claims arising after the six-month run-off cover has expired, the SIF (Solicitors' Indemnity Fund) will cover these for no additional charge.
Following the limitation period, liabilities will possibly fall back to the partners of the prior practice. Although, with recent news that the SRA have agreed to maintain SIFL for another year until 1 October 2022, it is unlikely that the SRA will be able to keep extending the proposed closure indefinitely. If and when this does close, then there will no longer be any indemnity provided to firms and their solicitors outside of this period.
How much does run-off cover cost?
Run-off cover incurs a one-off premium. The cost of this will vary from insurer to insurer and is set out in your policy wording as a percentage of the annual premium you have paid. Most insurers charge between 225% and 400% of the preceding year's annual 'primary layer' (the compulsory £2m/£3m) PII premium. The variation in the cost of run-off between insurers is due to their own assessment of risk of claims over the six year period, but the likelihood of a claim emerging should naturally diminish as time goes by.
What does run-off cover provide?
- Run-off cover is normally an endorsement added to an existing policy. This typically provides cover on the same terms and conditions and at the same limit of indemnity, as applied in the last policy year before the firm went into run-off
- It applies only to your primary layer insurance (normally £2m or £3m). If you need additional cover, you will have to buy excess layer policies each year
- Policy excesses usually continue to apply, and the principals of the firm will be liable to pay any applicable excesses on claims made during the run-off period (see below)
As a former principle, what are your liabilities for claims within the excess under run-off cover?
The answer is very much dependant on the terms agreed with your insurers within your primary policy wording. Some insurers waive any excess payable during the run-off period, whereas others may impose higher excesses without any cap.
Where an excess is payable, the responsibility for payment depends on the terms agreed with your primary insurer. Under the MTC, all principals, whether they are in a partnership, LLP or limited company, are liable to reimburse the insurer for any excess paid by an insurer on an insured's behalf. For large law firms it is possible to amend the MTC so that it is only the entity that is liable for payment of the excess, rather than the principals. Lockton has successfully negotiated amendment of “reimbursement of the excess” clauses for many of our larger clients. Please discuss this with your Lockton account executive for further clarification.
Why your choice of insurer is important
If your firm closes and goes into run-off, you will be required purchase run-off cover with your existing PII insurer as of that closing date.
The majority of insurers follow the self-insured excess of the last “active” annual policy. This normally means a standard £x-per claim excess, with an aggregate excess of three times £x.
Some insurers have more onerous arrangements, with one particular insurer imposing a trebled standard excess per-claim in run-off, including an uncapped aggregate. A number of underwriters impose the original per-claim excess with the annual aggregate excess of three times. These will generally reinstate each year of the run-off period.
Example case study 1
A firm has wound down due to the partners retiring. They pay their run-off premium and are now enjoying their well-deserved retirement. Five years pass, then they receive a notification of a claim. The former partners manage to dig out details of their policy and send the letter of claim to their broker, who in turn sends it on to the run-off insurer. Settlement is achieved and the former partner receives a demand from the excess. This is a complete shock to the partner, as the amount should be shared between his old partners, but they no longer have any contact.
How to avoid this scenario
Before any dissolution, it is important that the partners agree to each contribute to pay any excess while within the six year run-off period. Insurers will pursue any principal of the firm for the whole payment. It is for the individuals to ensure that they are reimbursed.
Example case study 2
A firm (ABC Solicitors) has been approached by a larger firm (DEF Solicitors) to merge. One of the conditions of the merger is that ABC must activate run-off, as DEF do not want the uncertainty of an unknown claim emerging and tarnishing the new combined firm's (XYZ Solicitors) claims experience. Both firms agree, and settle into the new firm. A claim is notified under the run-off policy from work undertaken by ABC Solicitors. Again, the liability to pay the excess falls to ABC's principals. Many former principals of ABC are long retired and untraceable, and the ones who are traceable do not have the funds to pay their share of the excess. It is therefore the responsibility of the remaining Principals at XYZ Solicitors who were the former principals in ABC Solicitors to fund the whole excess.
How to avoid this scenario
Ensure you discuss the small print of your policy with your broker. If you are considering a change of insurer, run-off requirements could be a vital consideration, particularly if there is a merger, sale or closure of the practice on the horizon.
Many firms insured with unrated insurers have subsequently become insolvent, which highlights the importance of choosing the right insurer. Firms that purchased their run-off cover from the likes of Balva, Berliner and Enterprise are unlikely to have any claims arising under that cover paid – leaving uncertainty for any former principals about what their future liabilities may be.
It is of paramount importance to be discerning and always consider the effect of run-off on your firm. Do not put yourself on the back-foot by only dealing with the consequences as and when they occur.
Alternative options to run-off
The cost of run-off is such that many firms seek alternative arrangements. If you are a sole practitioner considering retiring, or a principal in a firm that is looking to sell to or merge with another practice, it is important to plan well in advance if you are to avoid incurring a run-off premium. If another firm is prepared to buy your practice as a going concern, or merge and take on the past liabilities, there is no need to trigger run-off. Doing this does mean that the successor practice's own claims record could be adversely impacted by any future claims arising from work undertaken previously by your practice. They have to be confident that your practice is a 'good risk' before they are likely to agree to becoming a successor practice. Succession planning, retirement, and mergers are often complex matters that require careful advance consideration. Speak to us now for advice on how best to prepare your practice.