Applying Insurance Pricing Theory for Pricing ADR as an Insurance Product

As litigation is recognized as a costly and time-consuming method to resolve disputes, alternative dispute resolution (ADR) techniques are being adopted in construction projects to help handle disputes in a more effective way. However, there are potential costs related to ADR implementation as it requires expenditures to cover the expenses incurred by the owner's/contractor's employees and third party neutrals. Normally those costs are determined during the project planning phase prior to the actual occurrence of disputes. In this paper, the possibility of pricing ADR as an insurance product will be explored. It is similar to the concept of "premium" in insurance industry, although it may be structured more like a self-insurance program. The objective is to provide project participants with an economic advantage by investing a certain amount of premium in the beginning of the project in exchange for compensation from the insurance company in the uncertain event of an unknown ADR cost that may be incurred during the construction phase. Insurance pricing theory's underwriting concepts will be utilized to develop similar concepts in ADR pricing. A conceptual model will be presented to perform the ratemaking process by drawing an analogy from health insurance. An example of a construction project is used to illustrate the mathematical calculations required to determine the premium of the proposed ADR techniques.