What is Hammer Clause?
How does it work in contracts or insurance policies?
What are the essential elements you should know!
In this article, I will break down the notion of Hammer Clause so you know all there is to know about it!
Keep reading as I have gathered exactly the information that you need!
Let’s define “hammer clauses” and see how they are used in contracts!
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Let’s get started!
What Is A Hammer Clause
A hammer clause, also known as the consent to settle clause, is a contractual provision giving the right to an insurance company to request that an insured settle a claim at a certain price.
The reason why it’s called a “hammer” clause is that the insurance company is given important legal rights to “force” the insured to settle a certain claim or legal matter exposing the insurance company to a payout.
In the same way that a hammer forces a nail in place, the hammer clause forces the insurance company’s will onto the insured to settle a claim.
Very often, you’ll find a hammer clause in professional liability insurance policies.
Since a professional liability claim involves allegations that a professional failed in his or her professional duties, did not respect professional norms, or there was malpractice of some kind, the targetted professional will want to defend his or her reputation by going all the way.
However, the insurance company may not believe that going all the way will result in the best financial outcome for it as its main objective is to pay the least amount of money for the claim.
That’s when the hammer clause professional liability becomes useful for the insurer to force the insured to take a settlement offer.
The “hammer clause” can be referred to in different ways:
- Consent to settle clause
- Consent to settle loss clause
- Consent to settlement clause
- Claim settlement clause
- Settlement cap provision
- Blackmail clause
When an insurance company or someone refers to any of the above clause names, they are generally referring to the hammer clause.
Hammer Clause Definition
How do you define the hammer clause?
According to Investopedia, a hammer clause is defined as follows:
A hammer clause is an insurance policy clause that allows an insurer to compel the insured to settle a claim.
In other words, a hammer clause is a legal provision in a contract or insurance policy where the insurance provider can force the insured to settle a claim.
The reason why insurance company’s include a hammer clause in their insurance policy (generally directors and officers insurance policy or error’s and omissions policy) is to limit costs and risk of loss.
The different types of costs and expenses the insurance company attempts to avoid are the following:
- Lawyer fees
- Adjuster fees
- Agent fees
- Interpreter fees
- Mediator fees
- Court fees
- Administration fees
- Risk of loss due to the claim
Hammer Clause Insurance
How does the insurance clause work in insurance?
A hammer provision is a useful contractual tool allowing insurance companies to settle a claim or a lawsuit even when the insured does not share the same views.
Typically, if a claim or lawsuit is filed triggering an insured’s insurance policy, the insurance company will have a duty to indemnify the insured for the claim to the extent it is eligible under the policy.
In many cases, the insurance company will have to settle the insured’s loss, pay the legal fees, pay for the claim adjuster’s fees, and more.
If the insurance company and insured both agree at what price to settle a claim, then the hammer clause will never get triggered.
However, if the insurance company believes that the case should be settled at a certain price but the insured wishes to legally move forward, it may happen that the insurance company will resort to the use of the insurance hammer clause to force the insured to settle or assume the risk of loss.
By using the hammer clause, the insurance company will require that the insured settle the matter at a certain price.
However, if the insured refuses to settle and moves forward with the lawsuit, it will be at its own risk of having to pay an amount over and above the insurance company’s settlement proposal and assuming the legal costs to continue the case.
As you can see, the fact that an insurance company can limit its exposure and force the insured to assume the risk of a claim provides significant leverage to the insurance company in compelling the insured to settle a claim.
Coinsurance Hammer Clauses
What is a coinsurance hammer clause?
According to the International Risk Management Institute, coinsurance hammer clause is defined as:
A provision [that] provides for a sharing of defense and indemnity costs (between the insured and the insurer) incurred after the insured refuses to consent to a settlement proposed by an insurer
Depending on the wording of the “hammer” clause, an insurance company may calibrate the level of risk it may want to take with the insured (this risk-sharing is called the coinsurance hammer clause).
The coinsurance hammer clause can be of different terms, such as:
- 0/100 risk share (hard hammer clause)
- 80/20 risk share (soft hammer clause)
- 50/50 risk share (mild hammer clause)
- 100/0 risk share
In the first instance, the insurance company will not take share any risk with the insured (the insurance company will have 0% liability after the initial settlement offer and the insured will have 100% liability).
Then you have an 80/20 split where the insurance company will take 80% of the liability after the initial settlement offer and the insured will take 20% (this is a soft hammer clause as the insurance company will still cover a large portion of liability and defense costs going forward).
Next, you have the 50/50 coinsurance hammer clause where each of the parties will assume half of the liability and costs following the insurance company’s settlement proposal.
Finally, you have a 100/0 risk share where, in substance, the insurance company remains on the hook for 100% of the liability even after it makes an initial settlement offer and the insured refuses.
Hammer Clause Example
Let’s look at a concrete example of a hammer clause used by an insurance company to better illustrate the notion.
Imagine that a service provider is insured for $5,000,000 for its errors and omissions (or professional liability).
Imagine also that a client lodges a claim against the service provider for $1,000,000 resulting from damages it caused due to its error.
The claim goes to court and the insurance company is required to not only pay for the insured’s loss but also the legal fees.
The insurance company believes that the total legal fees of the case may amount to $1,500,000 and the litigation may take three to four years to finalize.
As such, to avoid having to pay $1,500,000 in legal fees and $1,000,000 of a potential loss, it informs the insured that it wishes to settle the matter for $750,000.
However, the service provider (the insured) does not believe that it committed any wrongdoing resulting in any payout and wishes that the insurance company defend its case all the way to trial and get a full acquittal.
The service provider’s main objective is to maintain a clean reputation and have no claim or lawsuit against it showing that it had to pay for a professional error.
The insurance company’s main objective is to pay the least amount of money and avoid a total exposure of $2,500,000.
In this case, the insurance company triggers the settlement clause to force the insured to settle the matter at $750,000 otherwise if it incurs any losses above that amount or further legal fees, the insured will be held directly responsible to pay for it.
Since the service provider may get exposed to a potential loss of $1,750,000, it may reconsider its decision and choose to settle the case at $750,000.
Hammer Provision Takeaways
So there you have it folks!
What does a hammer clause mean?
How does it work?
Essentially, a hammer clause is a legal provision allowing an insurer to limit the amount of money it may have to pay in the context of a claim or a lawsuit should the insured refuse to settle the claim.
In other words, when there’s a claim filed against an insured, the insurance company may place a cap on the total amount of indemnification it will be willing to pay to cover the insured’s losses.
If the insured does not accept the insurance company’s settlement offer or settlement value, it will be held accountable for any additional defense cost and liability resulting from the claim.
In substance, the hammer clause forces the insured to settle a claim by shifting the risk of loss and costs onto it for any further legal proceedings or losses following the insurer’s indemnification proposal.
When dealing with a hammer clause, the insurer will achieve its objective of avoiding lengthy legal disputes, high legal defense costs, and limiting exposure to liability whereas the insured can limit out-of-pocket settlement fees and costs.
You may see hammer provisions in D&O insurance, professional liability insurance, E&O insurance, or similar policies more often than others.
Just keep in mind that with a “hammer provision”, an insurance company can put a cap on the total amount of money it will pay to cover your liability and pay for your defense costs.
I hope this article helped you better understand the notion of the consent to settle close in insurance policies.
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Hammer Clause (Consent To Settle Clause)
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