Insurance as a Risk Management Tool for ADR Implementation in Construction Disputes
Publication: Journal of Construction Engineering and Management
Volume 138, Issue 1
Abstract
Nowadays, along with the inherent intricacy and magnitude of large-scale construction projects come increasingly complex disputes. Because most projects operate on tight budgets, alternative dispute-resolution (ADR) techniques such as negotiation, mediation, and arbitration are being widely adopted in large-scale construction projects to help handle disputes in more effective and cost-saving ways. However, the risk of incurring uncertain ADR-implementation costs in the dispute-resolution process has become an important issue. The traditional self-insured approach of simply retaining all risks is no longer considered economical. One way to reduce the potential for variations in the dispute-resolution budget is to price ADR techniques as an insurance product, which allows project participants to transfer the risk of incurring unexpectedly high ADR-implementation costs to the insurance company. Despite this advantage, many factors are preventing project participants from investing in ADR-implementation insurance. This paper proposes a model on how to use ADR-implementation insurance as a risk management tool for construction dispute resolution. It first investigates the possibility of using insurance for ADR-implementation and then uses subjective loss to represent the risk-averse attitude of project participants and quantify the effect of ADR-implementation costs in monetary terms. Event-tree analysis (ETA) is used to simulate different dispute-resolution processes and determine the probability mass function of ADR-implementation costs by drawing analogies from seismic risk insurance. These probabilities are employed to calculate the expected ADR-implementation costs and to derive the insurance premium. Finally, the gross premium is compared to project participants’ subjective loss to help them determine whether purchasing ADR-implementation insurance is necessary. At the end, a numerical example is presented to illustrate the application of the methodology.
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Acknowledgments
The writers would like to acknowledge the financial support for this research received from the National Science Foundation Award No. NSFCMMI-0700415. The writers would also like to thank Mr. Robert F. Conger of the Tillinghast business of Towers Perrin for his extremely helpful comments on previous drafts of this article. Any opinions, findings, conclusions, or recommendations expressed in this paper are those of the writers and do not necessarily reflect the views of the National Science Foundation or the individuals mentioned here.
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Information
Published In
Journal of Construction Engineering and Management
Volume 138 • Issue 1 • January 2012
Pages: 14 - 21
Copyright
© 2012 American Society of Civil Engineers.
History
Received: Dec 6, 2010
Accepted: Mar 30, 2011
Published online: Mar 31, 2011
Published in print: Jan 1, 2012
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