Consent to Settle: The Hammer Clause Explained

AUGUST 19, 2024

Among the numerous features in professional liability insurance policies, a “hammer clause” is a notable component that impacts how settlements are managed between the insurer and the insured. This provision aims to control litigation costs by influencing the decision-making process regarding the acceptance of settlement offers.

Understanding the implications of a hammer clause is crucial for professionals to effectively navigate their insurance coverage and legal strategies.

What is a Hammer Clause?

A "hammer clause" in legal terms, particularly in the context of professional liability insurance, is a provision in an insurance policy that gives the insurance company some control over the settlement of claims. Specifically, it allows the insurer to press the insured party to accept a proposed settlement of a claim.

Here’s how it works:

1. Settlement Proposal: If the insurer receives a settlement offer from a third party that it considers reasonable, it can invoke the hammer clause.
2. Notification to the Insured: The insurer notifies the insured of the settlement offer and recommends acceptance.
3. Choice to Accept: The insured has the choice to accept the settlement or refuse it.
4. Financial Consequences of Refusal: If the insured refuses the settlement recommended by the insurer, the hammer clause typically limits the insurer’s liability to the amount for which the claim could have been settled, plus defense costs incurred up to the point of the settlement offer. This means any additional costs or damages awarded beyond the refused settlement amount might have to be covered by the insured out of pocket.

The purpose of a hammer clause is to control the costs that the insurer might incur from a prolonged legal defense or from a potentially larger judgment or settlement in the future. It also places a significant decision-making power in the hands of the insurer while giving the insured an important, sometimes tough decision regarding the management of the claim.

Giving Insurers Too Much Control?

After learning the basic role and function of hammer clauses when dealing with liability claims, a common question sometimes comes in the form of “is my insurance company out to get me?

The answer is no. The primary intent behind a hammer clause is not adversarial; rather, it is a risk management tool used by insurance companies to control the costs associated with litigation and claim settlements. Here are some important points to consider about the rationale behind a hammer clause:

• Cost Control: Insurance companies use hammer clauses to encourage the settlement of claims in a cost-effective and timely manner. This can help prevent the costs and uncertainties of prolonged litigation.
• Efficient Claims Resolution: By promoting reasonable settlements, hammer clauses can lead to more efficient resolution of claims, which can be beneficial to both the insurer and the insured. It helps avoid the unpredictability and often higher costs associated with taking a case to trial.
• Shared Decision Making: While it may seem that a hammer clause restricts the insured’s choices, it also involves them in the decision-making process by requiring their consent to settle. This gives the insured a significant say in the matter, even though there are financial implications to consider if they choose to decline a recommended settlement.
• Alignment of Interests: In many cases, the interests of the insurer and the insured are aligned in terms of resolving claims quickly and economically. The hammer clause is a tool to facilitate this mutual interest, albeit with the insurer having a form of leverage to encourage settlement.
• Mitigating Risk of Over-Insurance: Sometimes, insured parties may be tempted to "over-insure" or increase their coverage limits unnecessarily. A hammer clause can act as a deterrent against this by making the insured partly responsible for the decision to go to trial, which could result in costs exceeding the policy limits.

What Control Does the Insured Have When Dealing With a Hammer Clause?

Under a hammer clause, the insured retains a degree of control, though it is somewhat constrained. Here are the key aspects of control the insured has when dealing with a hammer clause:

• Decision to Accept or Reject Settlement: The primary control the insured has is the ability to accept or reject the settlement offer recommended by the insurer. This decision allows the insured to weigh the merits of the settlement against the potential risks and costs of continuing the litigation.
• Negotiation Leverage: In some cases, the existence of a hammer clause might provide the insured with leverage to negotiate with the insurer on the terms of the settlement. For example, the insured might argue for a higher settlement amount that the insurer might consider acceptable to avoid protracted litigation.
• Consultation and Advice: The insured can consult with their own legal advisors to evaluate the reasonableness and implications of the settlement offer. This is crucial in ensuring that their decision is informed and aligns with their best interests.
• Counterproposals: Depending on the policy terms and the relationship with the insurer, the insured might have the opportunity to make counterproposals to adjust the settlement in ways that might be more favorable or acceptable to them.

Despite these controls, the decision-making process under a hammer clause can be challenging for the insured. Rejecting a recommended settlement exposes them to the risk of having to cover any additional damages and legal costs beyond the proposed settlement amount themselves, if the eventual outcome is less favorable.

Is a Policy With a Hammer Clause Right for Your Firm?

Deciding whether a liability insurance policy with a hammer clause is suitable for your risk profile and professional needs involves a thoughtful analysis of various factors. Here’s how you can determine if such a policy fits your requirements:

1. Understand Your Risk Exposure: Evaluate the nature of your professional activities and the risks associated with them. Consider how often you might face claims and the typical severity of these claims. If you are in a high-risk profession where claims are potentially costly and frequent, you may want to have more control over settlement decisions.
2. Assess the Hammer Clause Terms: Look closely at the specific terms of the hammer clause. Understand the limits it sets on your decision-making and the financial implications if you choose to reject a settlement offer. Consider whether these terms are reasonable given your professional risk.
3. Financial Capacity to Cover Excess Costs: Consider your financial ability to handle costs that exceed the settlement amount proposed by the insurer. If rejecting a settlement offer could lead to significantly higher costs that you must cover, ensure you are financially prepared for that possibility.
4. Consult with Legal and Insurance Advisors: Speak with legal and insurance professionals who can provide insight into how such clauses have affected others in your profession. They can offer guidance based on experience and familiarity with industry-specific risks.
5. Compare Policy Options: Look at different liability insurance policies from various insurers to see if they all include hammer clauses, and how the terms differ. Some insurers might offer policies without hammer clauses or with more favorable terms, albeit possibly at a higher premium.
6. Consider Your Comfort with the Insurer's Decision-Making: Reflect on how much trust you place in your insurer's judgment to recommend reasonable settlements. Your comfort level with giving up some control over settlement decisions in exchange for potentially lower premiums and shared risk management is crucial.
7. Review Past Claims Experiences: If you have a history of claims, consider how those were handled and whether you were satisfied with the outcomes. This can inform how much autonomy you want in future claim settlements.
8. Risk Tolerance: Finally, align the decision with your overall risk tolerance. If you are risk-averse and prefer to minimize potential out-of-pocket expenses, a policy with a hammer clause might be more appealing if it offers lower premiums and the clause's conditions are acceptable to you.

By carefully weighing these factors and how they align with your professional and financial situation, you can make a well-informed decision about whether a liability insurance policy with a hammer clause is appropriate for you. An experienced insurance underwriter can help you find the appropriate coverage and limits to meet your risk exposure, risk tolerance, and financial constraints.