What it means
The clause exists because insurer and insured do not always want the same outcome. An insurer looking at the numbers may want to pay the claimant and close the file, while the policyholder may want to fight on to protect a reputation or a professional record.
The clause resolves that standoff on the insurer's terms. When it is invoked the insurer hands over the amount of the proposed settlement plus the defence costs incurred up to that point.
The policy then effectively ends for that claim, and the policyholder continues the case with its own money. Any award above the settlement figure, and every dollar of further legal cost, falls on the insured.
It is a cousin of the consent to settle provision and of the so-called hammer clause, and the three are often confused. A consent clause requires the insured's agreement before settling, a hammer clause makes the insured pay a share of anything above a refused settlement, and a buyout clause pays a fixed sum and withdraws entirely.
For a buyer of insurance this is one of the clauses most worth reading before signing. Professional firms, company directors and medical practices are the most exposed, because for them the reputational cost of settling can far exceed the money at stake.
Negotiating the clause out, or capping the insured's share, is a normal part of broking a liability policy. The practical defence is to have the conversation early rather than at the point of conflict.
Agreeing with the insurer in advance how claims of this type will be handled, and recording that agreement in writing, avoids a nasty surprise at the worst possible moment.
In practice
Real-world examples.
Example
An architecture practice is accused of a design fault on a school building. The insurer values the claim at $250,000 and wants to settle, the practice refuses because it is bidding for public work and cannot show a settled negligence claim, and the insurer buys out its obligation for $250,000 plus costs to date.
Example
A directors and officers policy covers a board facing a shareholder claim. The insurer offers to settle, two directors want their names cleared, and the buyout clause transfers the decision and the funding to them personally, which changes their appetite for the fight immediately.
Example
A broker reviewing a medical group's cover spots a buyout clause with no cap. She negotiates an amendment requiring the group's written agreement before the clause can be used, and the premium rises by $6,000 a year, which the partners accept as the price of keeping control.
Formula
Calculation
Cost to the policyholder = (final award + defence costs incurred after the buyout) - (settlement amount paid by the insurer + defence costs paid up to the buyout)
A consultancy faces a professional negligence claim. The insurer wants to settle at $400,000, the firm refuses because it believes an admission would damage its standing with regulators, and the insurer invokes the buyout settlement clause. It pays the firm the $400,000 settlement figure plus the $60,000 of defence costs already incurred, a total of $460,000, and withdraws from the case. The matter runs for another year, the court awards the claimant $750,000 and the firm spends a further $150,000 on lawyers, so the total outcome is 750,000 + 150,000 = $900,000. The firm's own cost is 900,000 - 460,000 = $440,000, which is the price of having chosen to fight on.Case study
Seen in the real world.
Varden and Hale Surveyors is an illustrative, fictional firm of commercial property surveyors. A client sued over a valuation used to support a $9,000,000 loan, claiming the figure had been overstated by $1,100,000.
The insurer assessed the claim and proposed settling at $350,000 without an admission of liability. The partners objected, because the lead surveyor was due to give expert evidence in other matters and a settlement would be raised against him in every future case. The insurer invoked the buyout settlement clause, paid $350,000 plus $45,000 of costs to date, and closed its file.
The firm fought on for eighteen months, won on the central valuation point, and still spent $210,000 on its defence. It was better off than it would have been had it lost, but it ended up about $215,000 worse off in cash than if it had accepted the settlement. The illustrative lesson is that the clause converts a reputational judgement into a direct financial bet by the policyholder.
Watch out
Common mistakes.
- Assuming the insurer must have the policyholder's consent before settling or withdrawing, when a buyout clause is written precisely to remove that requirement.
- Reading only the policy limit and the premium at renewal, and never reading how claims decisions are allocated between insurer and insured.
- Refusing a recommended settlement on principle without first modelling what losing the case would cost once cover has been bought out.
Questions
People also ask.
Is a buyout settlement clause the same as a hammer clause?
No, a hammer clause leaves cover in place but makes the insured share any excess above the refused settlement, while a buyout clause ends the insurer's involvement for a fixed payment.
Can the clause be negotiated away?
Often it can, either by removing it, by requiring the insured's written consent before it is used, or by capping the insured's share of any excess, usually at a higher premium.
What should a finance director do when an insurer signals it may invoke the clause?
Get an independent estimate of the likely award and the further legal costs, then compare that total with the settlement on offer before letting reputation drive the decision.
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