Nailing Down That Hammer Clause

On the job site, a hammer is a pretty durable tool. But in the world of insurance hammers come in several different forms, mean different things according to the policy they relate to, and far from durable, they can be your worst nightmare.

Professional Liability

When dealing with Professional Liability (E&O) coverage, a hammer clause is language in your insurance policy that allows the insurance company to force you, the insured, to settle a claim. Some people call hammer clauses “blackmail” clauses as the power resides with the insurer and the policyholder has no say in the matter.

How it works is that the insurer places a cap on the amount of indemnification it is willing to provide. If the insured doesn’t agreement with this assessment it may be responsible for its own defense costs, something that typically is paid for by the insurer. And therein lies the rub.

The insurance company doesn’t want to drag out the settlement process as legal and claims adjuster fees will only grow larger over time. Moreover, it does not want to bear the risk of the claim being resolved in court. The insured, on the other hand, is concerned with the amount of money it may be responsible to pay so it has less of an incentive to finalize the settlement if not to its liking.

One method to prevent this situation is for the insured’s policy to contain a Buyout Settlement Clause. This removes the insurer from any further responsibility for defending the claim once the insured rejects the proposed settlement. The insurer will payout to the insured the amount it deems appropriate to the claim, and the insured is thereafter on its own to settle the claim and pay for its own defense. If the ultimate cost of the claim is less than the amount paid out by the insurer, the insured keeps the difference. Alternatively, if the final settlement is greater than the amount paid by the insurer then it is the responsibility of the insured to make up the difference.

A variation on this scenario introduces a Consent to Settle option that ensures that the insurer, not the insured, is responsible for some or most of the litigation costs even after the insured refuses a settlement recommendation. This is sometimes referred to as a “soft” hammer clause.

Construction

In the world of construction, a hammer clause is an entirely different animal. Particularly in New York, a hammer clause is related to the General Contractor's (GC) insurance. It is an exclusionary form added to the GC's policy to restrict or eliminate coverage because of the insurance of its subcontractors. Sometimes, a contractor’s hammer clause is referred to as a Sub-Warranty.

Having a hammer clause isn’t ideal because it puts all the responsibility on the GC to make certain its subcontractors have the coverage required by the GC’s policy. This requirement forces the GC to maintain good risk transfer and document review practices. Effectively, the GC could be put at risk of its insurer not paying claims if the subcontractor does not comply with the insurer’s regulations contained in the GC’s policy.

A typical hammer clause in a commercial general liability policy might read as follows:

This insurance does not apply to any claim, “suit”, demand or loss that alleges “bodily injury” to any “worker” that in any way, in whole or in part, arises out of, relates to or results from operations or work performed on your behalf by a subcontractor, unless such subcontractor:

1. Has in force insurance at the time of such injury or damage a Commercial General Liability insurance policy that:
   • Names you as an additional insured;
   • Provides an each-occurrence limit of liability equal to or greater than $1,000,000; and
   • Provides coverage for you for such claim, “suit”, demand or loss;
2. Has agreed in writing to defend, indemnify and hold harmless the Named Insured and any other insured under the policy for any claim or “suit” for “bodily injury” to any “worker” arising out of the work performed by such subcontractor, to the fullest extent allowed by law.

As there are very few GCs that do not use subcontractors the issue of hammer clauses is central to management of the GC’s risk exposure. Although excellent risk transfer and management are key, the following steps should be taken:

1. Always require subcontractors to include the GC as an additional insured on their policies and to provide proof (a certificate of insurance is not enough, always request a copy of the endorsement - better yet, get the entire policy!).
2. Create detailed contracts that clearly lay out the insurance requirements subcontractors must fulfill in order to do business.
3. Don’t go for the cheapest policy. Explore other options that may be a little more expensive but have less coverage restrictions.

The bottom line on all this is not to get hammered with hammers. They are used by insurers to reduce premiums and limit their own exposure, but the insured can often be left learning too little too late they are facing financial catastrophe.

Be certain you work with insurance professionals fully versed in these complex matters and that those managing GC / subcontractor risk transfer are fully qualified to make the calls that could determine the fate of your business.

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