Construction Risks: Single versus Portfolio Insurance

Abstract

Risks and uncertainties are naturally inherent in the construction industry and negatively affect contracting parties and executed projects. This paper explores the possibility of insuring against construction risks, which are beyond the control of contractors and not covered by surety policies, through single and portfolio insurance strategies. Accordingly, the writers programmed Iman and Conover’s bootstrapping method for inducing correlations using Microsoft Excel and consequently, developed a technique for pricing insurance premiums as an exotic option using Monte Carlo simulation. The aforementioned methodology was applied on a data set of five defined risks that were collected from small, medium, and large scale projects in California. Pursuant to this study, the calculated premiums for insuring against the defined risks are in line with the premiums available in market for other insurance policies. Moreover, the estimated premium for the proposed portfolio insurance product is more advantageous to contractors in both risk coverage and cost because it is well below the estimated premiums for single insurance products covering individual risks. It is foreseen that this research could open horizons for new construction related insurance products, which would significantly contribute to the efficiency of the risk management process in the construction industry.