Promoting the Sustainability of Relational Contracting through Addressing Third Party Insurance Obstacles

Abstract

Despite the recent development of various integrated project-delivery (IPD) contracts in the United States, relational contracting is still in its infancy. This is attributed to various cultural and organizational paradigms that have been governing the industry for many years and will not change easily. Another significant obstacle as of right now, though, is that no insurance policies or products cover multiparty agreements. In other words, the contracting team as a whole is not yet covered from third party claims. Meanwhile, the no-blame or no-suit culture extends among the core associated stakeholders to relational contracts—the very same parties that are not collectively insured against third party claims. To this end, there is an explicit lack of consistency among relational contract agreements in treating risk and insurance issues. This paper proposes, studies, and analyzes how risk-retention groups (RRGs) can be used to provide the required insurance coverage against third party claims under relational contracts. The utilized methodology comprised five interdependent steps in which the author (1) studied the principles to calculate insurance premiums; (2) investigated the feasibility of using the options theory for insurance pricing; (3) explored application of Monte Carlo simulation on option-based insurance; (4) set up the principles required for optimal design of a risk-retention group for third party claims under a relational contract; and (5) hypothetically verified, tested, and discussed the possible impact of the newly developed concept using a historic data set of 10,193 construction projects. The proposed approach proved its success from both the insured and insurer sides. With the hopeful application of RRGs under IPD contracts and the resolution of other cultural and organizational paradigms, relational contracting could, over time, attain its required impact and penetration within the construction industry.