Critical Coverage Concept - The Hammer Clause (6/26/08 Knowledge Knugget)

Last week we talked about the Consent to Settle clause wherein carriers agree to not settle any claim without the insured's consent. When the carriers make that provision, they frequently (but not always) qualify it by adding what's called "the hammer clause". The hammer clause provides that the carrier requires the insured's consent to settle, but if the carrier negotiates a potential settlement that it likes, and the insured does *not* consent......then the insured is responsible for all defense costs thereafter, and if the settlement exceeds the initial negotiated potential settlement, the insured is also responsible for the additional settlement amounts. As you can imagine, the spectre of having to pay ongoing litigation costs, and the potential of being responsible for hundreds of thousands of dollars of damages has a chilling effect on the insured's desire to continue litigation without the carrier's support. In this soft market, many carriers are providing what is called a "velvet hammer" or a "softened hammer". This is seen most often in D&O and EPL forms, but can occur in others. A velvet hammer is a compromise where the carrier provides some amount of defense and/or indemnity after the insured refuses a recommended settlement offer. The carrier's participation usually is around 70% to 80% of continuing defense and eventual settlement costs, and the provision requires that the insured bear the remaining amount itself (no insurance allowed!). If the market continues to soften, we can expect to see this provision eek into other classes of business as well. Some carriers provide additional motivation for the insured to accept the first settlement proposal. This motivation generally comes in the form of a reduction of the deductible, sometimes up to 50%.