One of the biggest mistakes you can make when leaving your practice is failing to consider that you can still face professional malpractice claims after your departure.
Retirement or changing careers does not protect an accounting professional from possible litigation from past clients or third parties. For a smooth and stress-free transition, professionals need to have a clear succession plan that details retiring partners and insurance needs.
Small accounting practices oversights
Often, many smaller accounting firms operate in a silo model. Each partner will make his or her decision about when to retire and the conditions. This can work to some degree, but without a succession plan that outlines key issues, these firms often find themselves in an unexpected crisis when one partner decides to leave the business abruptly.
The American Institute of CPAs (AICPA) Multi-Owner Survey Report revealed that 74% of multi-owner accounting firms anticipate facing succession planning challenges over the next five years. Simultaneously, less than half (44%) had taken steps to address the topic.
The only way to avoid succession challenges is by taking a proactive approach and discussing transition policies before anyone in your firm is close to retirement. This early approach generates the most productive conversations. It prevents any thoughts of departing partners thinking about reducing their compensation and allowing retiring partners to plan for their retirement adequately.
Accounting firms would also be wise to establish policies and rules for retired partners specifying the privileges and restrictions placed upon them post-retirement. Clearly defining these policies will help avoid conflicts and misunderstandings and allow retired partners to continue providing value to the firm.
Succession planning challenges
The AICPA Multi-Owner Survey Report identifies the two primary hurdles to succession planning among accounting professionals: lack of penalties for improperly transitioning clients and concerns about the future generation’s ability to run the firm.
64% of survey respondents had no penalty established for partners who leave and take clients, staff, receivables, or work-in-progress.
The other barrier to succession planning is the perceived lack of younger firm members ready to step into leadership positions. The number of respondents who identified this issue is declining but was still significant at 33% in 2016. The best way to address this aspect of succession planning is for senior partners to take an active role and mentor younger members.
In some cases, the lack of new leadership results from current leaders unwilling to step aside. Mandatory retirement age can help minimize this problem by setting a timeline and changing incentives.
Proactive risk assessment
The first step is establishing a formal succession plan. An effective succession plan can take three to five years to execute.
Here are key items to consider:
- Protect assets — Establish penalties for exiting partners that take clients or staff.
- Client relationships — Keep clients satisfied by communicating with them during the transition process.
- Clearly defined policies — What can former owners do and not do? Retired partners need clearly defined roles and policies to follow.
- Critical areas — Partner agreements, retirement obligations, and insurance.
Importance of indemnification and an extended reporting period endorsement (tail coverage)
Retiring accounting partners should ask the firm to indemnify them and carry liability coverage covering both active and former partners. If you’re retiring or selling your practice, you should also consider extended insurance coverage, known as an extended reporting period endorsement or tail coverage.” It protects you and your partners for an extended time after selling.
An Extended Reporting Period Endorsement provides you with insurance coverage if you’re named in a lawsuit. It’s recommended to carry a minimum of $1 million in tail coverage for five years after your departure. This recommendation is based on the average size and timing of professional liability claims against U.S. accounting professionals.
Legacy protection
Firm leaders should advocate for comprehensive and clear guidelines in their partnership agreements. The agreement should specify the minimum insurance requirements that protect both the firm and the departing partner’s income source in retirement.
It’s important to communicate with us if there’s been a significant change in your practice.
Learn more about our Errors and Omissions (E&O) Insurance Policies for Accountants and contact us today to answer your insurance and succession planning questions.