A hammer clause is an insurance policy clause permitting the insurer to compel the insured to settle a claim, and is also referred to as a settlement cap provision. The power is given to the insurer to force the insured to settle. Because of this, businesses should invest in an executive protection plan for proper protection in the event of a claim.
Breaking Down Hammer Clauses
A hammer clause allows the insurer to force the insured to settle by placing a cap on the amount of indemnification that they are willing to provide. For instance, the cap may be set at the amount the insurer believes the settlement is worth. If the insured refuses to settle, they could be held responsible for their own defense costs.
Insurers indemnify their policyholders from the risks outlined in the policy that they purchase. If a claim is made, the insurer is responsible for helping settle the loss. Sometimes, there will be a difference of opinion on what the settlement value should be. The insurer seeks to limit settlement costs (legal fees and claims adjuster fees) which can grow at a rapid rate throughout the claims process. Meanwhile, the insured wants to reduce the amount of money they will owe in a settlement, with less incentive to finalize a settlement if they are not pleased with the amount.
Example of when the clause would come into action:
If a manufacturer is being sued for injuries sustained by consumers who used its product, their manufacturers liability policy requires the insurer to defend them in court. The insurer may realize that the defense process will be a drawn-out and that the consumer lawsuit may be finalized quickly by offering a settlement.
The manufacturer, however, may not be accepting of the settlement because it will cost them money out of pocket. This is where the hammer clause can be applied, to allow the insurer to drive the manufacturer into a settlement.
Sample Hammer Clause
Investopedia provides a good sample of this clause as a reference. A hammer clause could read something like this:
“We have the right and duty to defend any claim seeking damages, even if any of the allegations of the claim are groundless, false or fraudulent. We will investigate any such claim we deem appropriate. We will not settle any claim without your written consent, which shall not be unreasonably withheld. You and we agree to consult with each other to resolve any differences to such settlement.”
Hammer Clause in D&O Policies
For-profit or non-profit Directors & Officers (D&O) Liability Insurance also consider hammer clauses to reduce risk.
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