When a business faces a liability claim, the complexities of layered insurance policies that come with primary and excess policies can complicate a resolution. One critical tool that comes into play in these situations is the hammer clause and its enforcement through a hammer letter. Understanding how these mechanisms work is important for policyholders.
A hammer clause is a provision found in many excess liability policies. It allows an insurer in the excess layer to settle a claim when it believes settlement is in everyone’s best interest. If the underlying carrier or insured refuses to settle and the case proceeds to trial, the clause can limit or eliminate the excess insurer’s responsibility for any additional amounts awarded beyond the proposed settlement.
A hammer letter typically occurs in complex claims involving multiple layers of insurance coverage, particularly when both primary and excess insurers are implicated. In such cases, every insurer in the tower must independently investigate the claim and determine whether its policy is potentially triggered. Excess policies generally include provisions stating that coverage will not apply unless the underlying limit of insurance or self-insured retention is fully exhausted.
Disputes can occur when primary and excess insurers do not agree on the potential exposure of a claim on the insured. These disagreements often extend to the strategy for defending or settling the claim, with differing views on how to limit or avoid liability. A hammer letter is commonly issued by an excess insurer when it believes the claim should be settled within the limits of the underlying policy and it wants to pressure the primary carrier to do so. This typically happens when the potential trial judgment is projected to be significantly higher than the proposed settlement, making early resolution a means to control financial risk for all parties in the insurance tower.
For example, if a plaintiff offers to settle for $3 million but the primary carrier (whose limit is $1 million) and the insured refuse, the excess carrier (with coverage above that $1 million) may issue a hammer letter. If the case goes to trial and results in a $5 million judgment, the insured and/or underlying carrier could be responsible for the $2 million difference.
Most insureds are aware of their limits and coverage, but fewer understand how the layers interact when litigation escalates. Hammer clauses can significantly affect how a claim is resolved and who ultimately pays. In some cases, insureds may push to continue defending a claim, not realizing that a hammer clause can leave them responsible for verdicts that exceed a rejected settlement.
While some experienced risk managers or large corporate insureds may be familiar with hammer clauses, many businesses encounter them for the first time only during a contentious claim process. That’s why proactive education is key.
Choosing to settle early, especially when advised to do so in a hammer letter, can provide long-term benefits for insureds.
Receiving a hammer letter doesn’t mean the claim is over; it’s a call to action. Insureds should take several strategic steps when one is issued:
Hammer clauses and hammer letters are powerful tools used by insurers to protect themselves from unnecessary exposure and encourage timely resolution of claims. For insureds, understanding how and when they’re used is essential to managing large claims effectively, avoiding unwanted financial surprises, and protecting the company’s long-term insurability.
Lauren Tice, Esq.
Senior Vice President
South Regional Claims Leader
