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 on your claim settlement. This post examines the hammer clause to help you make the right choice when buying a D&O liability plan.
What is the hammer clause?
An insurance provider usually includes a hammer clause in your D&O 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 defence cost, 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 refuses 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.
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 defence 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 defence 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 defence 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.