What is a 'Buyout Settlement Clause'

A buyout settlement clause is an insurance contract provision allowing the insured party to refuse a settlement offer proposed by the insurer and the claimant.

When an insurance company underwrites a new policy, it agrees to defend the interests of the policyholder against claims from third-parties. This is referred to as indemnification. If an individual or business files a claim against the insured’s policy, the insurance company collects the relevant information to the claim, and typically handles the legal expenses associated with defending the policyholder in court.

Often, the insurer seeks a settlement with the claimant to avoid the courts making a decision on the amount of damages awarded. The insured doesn't always agree with the terms or amount of the settlement, and sometimes elects to reject it.

BREAKING DOWN 'Buyout Settlement Clause'

A buyout settlement clause removes the insurer from having any further responsibility for defending against claims once respective insured parties rejects them. In this instance, the insurer “buys out” policyholders by providing the amount of their negotiated claim settlements. 

At this point, the insured becomes responsible for their own defense, including all legal fees incurred after rejecting the claim. Policyholders benefit from this option if they fight the claim and settle for less than the amount of the buyout. If this occurs, the policyholder keeps the difference between any ultimate settlement and the amount paid to them in the buyout. However, if the cost of defense exceeds the settlement amount, policyholders pay for those extra expenses out of pocket.

Why Policyholders May Opt for a Buyout

In many cases, policyholders want to settle cases against them quickly. A quick settlement allows the policyholder to reduce any expenses associated with working on the case. For some business, a quick settlement reduces the possibility that a drawn-out negotiation damages the business’ reputation.

In some cases, however, the policyholder won't approve of the terms of the settlement, perhaps believing the claim lacks merit. In this case, agreeing to any settlement amounts to an admission of wrongdoing. Rejecting the claim puts the interests of the policyholder at odds with the desire of the insurer to reduce the cost of defending against a claim.

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