Contractors’ Claims Insurance: A Risk Retention Approach

Abstract

The negative effects of claims and disputes have serious negative impacts on contracting parties, their projects, the construction industry as a whole, and consequently on the nation’s economy. This paper explores a method for mitigating the negative effects associated with contractors’ claims and disputes using a risk retention approach. This method can help contractors in getting early relief from the financial and economic burdens of construction claims. To meet the goals and objectives of this study, the writers have: (1) investigated the feasibility of pricing insurance premiums using the options pricing theory; (2) explored the applicability of modeling the options pricing theory using Monte Carlo simulation; (3) set up the principles required for optimal design of a risk retention group for construction claims; and (4) tested the possible impact of the newly developed risk retention group using historic data of 10,193 construction projects spanning over 12 different California districts. Pursuant to this study, it was verified that construction claims satisfy the required principles for insurance. Also, based on the used testing framework, the developed risk retention group for construction claims has been proved a success from the insured and insurer sides. It is the writers’ hope that this study will lay the basis for a leading risk management technique that could be extended over the nation for the benefit of relieving the negative consequences associated with lengthy claims and disputes resolution in the construction industry.