If you have been looking at directors’ and officers’ ( D&O ) liability insurance policies, you must have encountered the term ‘hammer clause’. It is important to understand what this means because it has financial implications for your claim settlement. This post examines the hammer clause to help you make the right choice when buying a D&O liability plan.
Key Takeaways
-
Core Function of the Hammer Clause: A hammer clause (also known as a “consent to settle” or “settlement cap” clause) allows an insurer to limit its liability if an executive rejects a proposed out-of-court settlement.
-
The Cost-Capping Mechanism: If a policyholder rejects a recommended settlement offer and continues litigation, the insurer’s liability is capped at the amount for which the claim could have been settled initially.
-
Full vs. Soft Hammer Variants: While a harsh (full) hammer clause leaves the policyholder 100% liable for excess legal fees and higher court awards, a soft (modified) hammer clause shares excess expenses (e.g., 70% paid by insurer, 30% by insured).
-
Reputational Defense vs. Financial Risk: Executives often resist early settlements to defend their professional reputation against false allegations, but a hammer clause shifts the financial burden of prolonged trials onto the company.
-
Leveraging Insurer Risk Expertise: While restrictive, settlement recommendations from insurers leverage their extensive litigation data to protect businesses from unpredictable trial outcomes and escalating legal fees.
What is the hammer clause?
An insurance provider usually includes a hammer clause in your directors’ & officers’ policy. It allows them to reduce the limit of their liability and protect their own interest. The hammer clause allows the insurer to propose an amount to settle a claim out of court and to avoid court proceedings. The clause stipulates that if the insured does not accept this settlement amount, the insurer can restrict claim payments. These restrictions can take the form of caps on the amount of money an insurer is liable to pay or exclusion of defense costs, etc.
The hammer clause is also referred to as the ‘consent to settle clause’ and ‘blackmail settlement clause’. This is because it is seen as a tactic that compels the consent of the insured for the terms of the insurer.
To understand how the clause works, consider an example. An insurance company recommends Rs 50 lakh as a settlement amount. However, the insured refused to settle the case. Eventually, at the end of court proceedings, the actual cost comes to Rs 55 lakh. Then, the insurer applies the hammer clause and is liable to pay only Rs 50 lakh.
So, a hammer clause is required in D&O (Directors and Officers) insurance to protect the insurer’s interests in settlement negotiations. It allows the insurer to limit its liability by giving the insured the option to accept a settlement offer or proceed with litigation at their own expense if they disagree with the proposed settlement.
Pros and cons of hammer clause
When purchasing a D&O liability policy, try and ensure that it does not have a hammer clause. Of course, this could increase the cost of insurance. However, it is better than the alternative, which would involve restrictions or caps on claim settlement amounts.
A modified hammer clause takes on some percentage of the defense cost. It might even take on 50% or 70% of the cost of the settled claim in excess of what it proposed initially. However, in the worst case, a harsh hammer clause negates even the defense cost and might only provide the settlement amount.
Often, a hammer clause may be considered a negative imposition on your policy. However, it helps to assess whether you need court proceedings or not. This is because businesses might not be able to assess litigation costs and procedures. But insurance companies have the expertise and experience to compute an appropriate settlement amount. Such a recommendation might help companies avoid hefty litigation or defense costs. Instead, they might be able to manage an out-of-court settlement with the help of the insurance company. A loss in court might also damage a company’s reputation and lead to financial crises.
Thus, it helps to study the advantages and disadvantages of a hammer clause before purchasing D&O liability insurance.
Summary Table: Operational Mechanics & Types of Hammer Clauses in D&O Policies
The relevance of a hammer clause in D&O insurance in the Indian context depends on the specific policy terms and conditions. While hammer clauses are commonly used in D&O insurance globally, their applicability and usage may vary among insurance providers operating in India. It is important for insured parties to review and understand their policy’s provisions regarding settlement negotiations and potential hammer clauses.
If you need assistance finding the right D&O insurance for your employees, SecureNow can help. Contact us at 96966 83999 or write to us at support@secuenow.in and share your coverage requirements.
Frequently Asked Questions (FAQs)
1. What is a “hammer clause” in a Directors and Officers (D&O) liability insurance policy?
A) A hammer clause-officially termed a “consent to settle” or “settlement cap” clause-is a policy provision that allows the insurer to limit its financial liability if the insured executive or company refuses to accept an out-of-court settlement offer recommended by the insurer.
2. How does a hammer clause affect legal defense costs during a lawsuit?
A) If an insured party rejects a settlement offer recommended by the carrier, a full hammer clause caps the insurer’s payout at the proposed settlement value. The insurer stops funding additional legal defense costs, attorney fees, or higher court judgments incurred after the date of rejection, leaving the remaining expenses to the policyholder.
3. What is the difference between a hard hammer clause and a soft hammer clause in D&O insurance?
A) Under a hard (full) hammer clause, the policyholder pays 100% of all legal expenses, court awards, and costs exceeding the rejected settlement offer. Under a soft (modified) hammer clause, the insurer agrees to share the excess costs with the policyholder according to a predetermined percentage, such as 70/30 or 50/50.
4. Why do insurance companies include consent to settle clauses in professional liability policies?
A) Insurers include consent to settle clauses to control escalating litigation costs and mitigate the risk of unpredictable, adverse jury verdicts or court judgments. It prevents policyholders from endlessly prolonging litigation at the insurer’s expense when a reasonable settlement is available.
5. Can a business remove or negotiate the hammer clause when purchasing D&O insurance?
A) Yes. Companies purchasing D&O insurance can negotiate with underwriters to delete the hammer clause entirely or replace a harsh full hammer clause with a soft (modified) hammer clause. Removing the clause increases the premium but provides total freedom to defend corporate and executive reputation in court.
About The Author
Rajesh
MBA Finance
With a wealth of expertise in the insurance realm, Rajesh is a distinguished writer specializing in articles focusing on directors and officers insurance for SecureNow. Boasting 9 years of experience in the industry, he profoundly understands the complexities surrounding directors and officers liability coverage. Their articles delve into the intricacies of D&O insurance, providing readers with invaluable insights into risk mitigation strategies and policy considerations. Renowned for their comprehensive knowledge and attention to detail, Rajesh is dedicated to delivering informative and engaging content that empowers individuals and businesses to navigate the complexities of insurance with confidence.
