Chapter 14. Risk and Insurance in Construction – Construction Project Management: Theory and Practice

14

Risk and Insurance in Construction

Introduction, risk, risk identification process, risk analysis and evaluation process, response management process (risk treatment strategies), insurance in construction industry, common examples of business and project risk, risks faced by Indian construction companies assessing international projects

14.1 INTRODUCTION

Risk management is at the core of any business or organization, and construction industry and construction companies are no exception to this. This is central to any business regardless of size, activity, or sector. Construction companies can lose substantial sums of money as a result of failure to identify and evaluate risk in time. Companies may even forego their opportunity to take advantage of potentially beneficial opportunities arising in the course of their activities if risks are not recognized in good time. Risk management is, therefore, as much about looking ahead to identify further opportunities as it is about avoiding or mitigating losses.

It is often claimed that formal risk management does not begin until the first actual risk assessment has taken place. Risks are rarely ignored when initial plans are made; however, it is very rare to identify all the risks systematically during the initial stages of planning projects. It is well known that managers and their teams generally know what could go wrong and what worthwhile opportunities might occur. Without the benefit of systematic risk analysis, however, it is not always possible for them to exploit their knowledge to the full. Even when an analysis is undertaken, a team will not always maintain and update it equally; sometimes, when risks are foreseen, they are dismissed on the grounds that ‘it couldn’t happen here’. Thus, through all the phases of a construction project, risk assessment must be adopted as part of a continuous review process. By doing so, the many risks to the business originating out of construction projects can be identified and managed.

The benefits of systematic risk identification and risk management include:

  • more realistic business and project planning;
  • actions being implemented in time to be effective;
  • greater certainty of achieving business goals and project objectives;
  • appreciation of, and readiness to exploit, all beneficial opportunities;
  • improved loss control;
  • improved control of project and business costs;

Figure 14.1 A simplified risk management process

  • increased flexibility as a result of understanding all options and their associated risks;
  • greater control over innovation and business development; and
  • fewer costly surprises through effective and transparent contingency planning.

In this chapter, we discuss the process for identifying, assessing and controlling risk within a broad framework. The main features of this process in a simplified form are illustrated in Figure 14.1. The risk management process described here can be applied to each aspect of business activity and at each level of decision-making.

For a construction organization, projects are the principal means by which a business moves forward. In order to manage risk effectively, the business, project, or sub-project goals need to be dearly identified. This is because it is only in relation to an organization’s or an individual’s specified goals that risk arises. Confusion over project objectives is itself a major cause of project failure.

Identification of stakeholders is also an important part in clarifying goals and assessing risk. Unless the stakeholders are identified and understood at an early stage, the true extent of the management task and the source of much risk can go unrecognized. Identifying stakeholders also helps define the relationship between the business and its environment, and the context in which its projects will be carried out. Though it may seem easy, not all stakeholders are easily recognizable. There can be many organizations with influence and vested interests than is readily acknowledged. In order to achieve ‘viewpoint-oriented’ planning, different stakeholders must be identified and taken into account.

14.2 RISK

In literature, the word ‘risk’ is used to convey different meanings and is synonymously used with terms such as ‘hazard’ and ‘uncertainty’. The researchers in this area do not follow a uniform and consistent definition. Although the term ‘risk’ has downsides (losses or damages) as well as upsides (profits or gains), more often it is assumed to convey the negative notion only.

Risk in this book follows the definition adopted by Al-Bahar and Crandall (1990), who define it as the exposure to the chance of occurrence of uncertainty. Uncertainty here represents the probability that an event will occur. Accordingly, the risk is assumed to be a function of uncertainty of an event and the likely loss or gain (note) from the event.

As pointed out earlier, modern construction projects are increasingly becoming complex, thereby giving rise to uncertainty at every stage of the project. The risk management process is not systematically performed in construction projects by most of the project stakeholders. Application of certain ‘rules of thumb’ based on the experience and judgement of stakeholders is most common in the context of construction projects. Unfortunately, risk management in construction projects is assumed to be no more than insurance management where the objective is to find the optimal insurance coverage for insurable risks. As we shall see shortly, risk management is much more than just ‘insurances’.

Risk management according to Al-Bahar and Crandall (1990) is a formal, orderly process for systematically identifying, analysing and responding to risk events throughout the life of a project to obtain the optimum or acceptable degree of risk elimination or control. The different processes of risk management are discussed briefly in the following paragraphs.

14.3 RISK IDENTIFICATION PROCESS

Risk identification is the process of identifying all potential sources of project risks and their likely consequences, besides finding out the causes of those risks. Al-Bahar and Crandall (1990) define risk identification process as ‘the process of systematically and continuously identifying, categorizing, and assessing the initial significance of risks associated with a construction project.’

As mentioned earlier, risks arise on account of uncertainties and, thus, risk identification aims to identify where the uncertainties exist. Some of the methods used for risk identification are—(1) brainstorming, (2) interviews, (3) questionnaires, (4) availing services of specialists, and (5) past experience.

The identification of risks should be done with a positive approach, and here, the objectives should be to identify not only the risks that present threat but also the presence of opportunities coupled with such threats. The identification of risk should begin early to have maximum impact on the project.

As shown in Figure 14.2, there are six steps involved in the risk identification process. The following sections will discuss each step separately.

14.3.1 Preliminary Checklist

Preparation of a preliminary checklist is the first and the most important step towards identification of risks. The checklist includes all the risks that may affect project quality, performance, productivity and economy of construction. Brainstorming and questionnaire survey along with past experience help in preparing the preliminary checklist. Some companies have a standard template to prepare the checklist.

14.3.2 Risk Events Consequences Scenario

After the preparation of checklist, the consequences for each of the risks identified are defined. The consequences could be in the form of economic gains or losses, injury to the personnel involved with the work, physical damage, and time- and cost-related savings/overrun. These consequences are tried to be brought to a common scale, preferably in monetary terms.

Figure 14.2 Risk identification process

14.3.3 Risk Mapping

Risk mapping is performed next. Risk map is a two-dimensional plot between probability of occurrence of the uncertainty and its potential severity. Risk map shows Iso-risk curves that are useful for a manager to understand the relative importance of each potential risk. Iso-risk curves contain points of equivalent risk, though there may be differences in probability values and potential severity (see Figure 14.3).

14.3.4 Risk Classification

After the risk mapping, risks are classified under categories. Though several researchers tried different means of classifying risk, the classification proposed by Al-Bahar and Crandall (1990) is reported here. The classification is based on the nature and the potential impact of the risk, and has six broad categories:

  • Acts of God such as flood and earthquake
  • Physical damage such as damage to structure, worker, equipment, etc.
  • Financial- and economic-related such as inflation and exchange-rate fluctuation

Figure 14.3 Risk mapping

  • Political- and environment-related such as changes in laws and regulations, and war and civil disorder
  • Design-related such as incomplete design scope and defective design
  • Construction-related such as labour productivity and different site conditions

14.3.5 Risk Category Summary Sheet

Preparation of risk category summary sheet is the last step in risk identification process. The objective of preparing the summary sheet is to involve all the participants in the project management team. The involvement of all the participants is important, as it would not be prudent to delegate the responsibility of judging the risk to a single person. In the risk category summary sheet, each risk event is listed and described, and their interaction is studied collectively by the project management team.

14.4 RISK ANALYSIS AND EVALUATION PROCESS

Risk analysis is the systematic use of available information to characterise the risks, determine how often the specified events could occur, and judge the magnitude of their likely sequence (BS 31100:2008). On the other hand, risk evaluation is the process to decide risk management priorities by evaluating and comparing the level of risk against predetermined standards, target risk levels, or other criteria.

It is not enough to identify risk. From the risk-mapping exercise, some of the risks identified are considered by project management to be more significant and selected for further analysis. What is needed now is to determine their significance quantitatively, through probabilistic analysis, before the response management stage.

The risk analysis and evaluation process is the vital link between systematic identification of risks and rational management of the significant ones. It forms the foundation for decision-making between different management strategies. With respect to this text, risk analysis and evaluation is defined as ‘a process which incorporates uncertainty in a quantitative manner, using probability theory, to evaluate the potential impact of risk.’ Figure 14.4 is a schematic representation of the various components of the process. The following sections will discuss each component separately.

There could be a number of risks associated with a project. There is no point attempting to concentrate on each one of them as the time and effort spent on them may not be commensurate with the returns. Risk mapping establishes the relative importance of different risks in qualitative terms. Now, the important and significant risks are analysed further to decide on the appropriate mitigation strategy.

14.4.1 Data Collection

Collecting data relevant to a given type of risk is an important and intricate step in the risk analysis and evaluation process. Although some contractors do keep data as the work progresses, most of the time it may not be in a structured form and, hence, difficult to put in use. One has to then rely on assessment based on experts’ opinion. The data so gathered are put in a proper format to draw appropriate conclusions.

Figure 14.4 Risk analysis and evaluation process

14.4.2 Modelling Uncertainty

This step is aimed to quantify the likelihood of occurrence and potential consequences based on all available information about the risk under consideration (Al-Bahar and Crandall 1990). The likelihood of occurrence of a risk event is measured in terms of probability values based on past data, intuition and expert opinion. The potential consequences of the risk are measured in monetary terms.

14.4.3 Evaluation of Potential Impact of Risk

This is the next step after the uncertainties have been modelled quantitatively. The evaluation of the potential impact of a risk is important in order to get an overall picture of different risks associated with the project. Some of the tools used for such evaluation are—expected value, Monte Carlo simulation, and influence diagram.

14.5 RESPONSE MANAGEMENT PROCESS (RISK TREATMENT STRATEGIES)

After evaluating the risks based on their financial impact, appropriate risk treatment strategies are formulated. The objectives of risk management strategies are to remove the potential impact as far as possible and to increase the control of risk. Some of the risk treatment strategies within the framework of risk management are shown in Figure 14.5 and discussed in subsequent sections.

14.5.1 Risk Avoidance

Risk avoidance is a fairly common strategy. By avoiding risks, construction companies know that the loss or gain associated with a given risk will not be encountered by them. For example, if a construction company perceives that tunnelling projects are associated with a lot of risks, they would not venture into such projects. Obviously, this also means that the company will not be able to reap the large gains associated with such projects.

14.5.2 Loss Reduction and Risk Prevention

The objective of loss reduction and risk prevention is to reduce the probability of a risk and to reduce the financial severity of the risk should the risk occur. For example, if it were known that theft is a problem in a given locality, the construction company would try to build in security-related costs in their bid. The loss reduction and risk prevention also has a bearing on the insurance premium that the insurer charges from the insured. For example, a company with a low level of loss reduction and a risk prevention programme will be charged a higher premium by the insurer, compared to a company with a high level of loss reduction and a risk prevention programme in place.

Figure 14.5 Risk treatment strategies

14.5.3 Risk Retention and Assumption

Risk retention and assumption is the assumed value of the financial impact of risk. It could be of planned or unplanned type. While planned risk retention and assumption means that a conscious effort has been made to estimate the financial impact of the risk involved in the project, in unplanned risk retention and assumption the construction company may not recognize the existence of risk. Thus, in the latter case, the construction company unconsciously assumes the loss that could occur (Al-Bahar and Crandall 1990). In the unplanned category, one can also envisage a situation wherein the construction company has underestimated the magnitude of the financial impact of a given risk.

14.5.4 Risk Transfer (Non-insurance or Contractual Transfer)

Risk transfer is the transferring of risk by the construction company to the other project participants such as subcontractor, vendor, or specialist contractors. In risk transfer, the construction company enters into a contractual arrangement with subcontractors, vendors, or specialist contractors. The basic principle is that the party who is more capable or better placed to maintain control should be able to take risk. For example, if the project involves construction of pile foundation, a specialist contractor specializing in piling works would be in a better position to bear the risk. Risk transfer is different from insurance in the sense that the risk is not being transferred to an insurance agency; rather, it is being transferred to the specialist who has adequate historical data and is in a better position to evaluate and undertake the risk.

14.5.5 Insurance

Insurance is a device by means of which the risks of two or more persons or firms are combined through actual or promised contributions to a fund out of which claimants are paid. Insurance is a contractual relationship that exists when one party, for a consideration, agrees to reimburse another for loss caused by designated contingencies.

The first party is called the insurer or underwriter; the second, the insured or policyholder; the contract is the insurance policy; the legal consideration is the premium; the loss of life or property in question is the exposure; and the contingency is the happening of the insured event.

Considering the importance that construction organizations attach to insurance as a means to manage risk, it is discussed separately in the following sections.

14.6 INSURANCE IN CONSTRUCTION INDUSTRY

In the construction industry, insurance is one of the most important ways to tackle risk. In fact, insurance is considered as a synonym for risk management in the industry. The majority of construction companies rely on insurance policies for different risk scenarios. They purchase a number of insurance policies depending on the project and contractual requirement. While selecting a given type of policy, a company considers the severity of potential risk, the probability of occurrence of the risk, and the available risk mitigation measures it has under its disposal.

14.6.1 Fundamental Principles of Insurance

The fundamental features of the principles of insurance are given in Table 14.1.

 

Table 14.1 Fundamental features of the principles of insurance

1.

Insurable interest

(a) There must be life, property, or financial interest capable of being covered.
b) Such life, property, etc. must be the subject matter of insurance.
c) The insured must be in a legally recognized relationship with the subject matter of insurance, in consequence of which the insured may benefit from its continued safety or the absence of liability, or may be prejudiced by its damage or destruction or the creation of liability.

2.

Utmost good faith

Insurance contracts are contracts of ‘utmost good faith’. They are based upon mutual trust and confidence between the insured and the insurer. The proposer has a legal duty to voluntarily disclose all material facts that he knows and also what he ought to know.

3.

Indemnity

Indemnity means ‘compensation for loss or injury sustained’. It means to make good the loss or damage subject to sum insured, or more simply, ‘an exact financial compensation.’

4

Subrogation

This is the transfer of right and remedies of the insured to the insurer, who has indemnified the loss.

5.

Proximate cause

The active efficient cause that sets in motion a train of events that bring about a result, without the intervention of any force started and working actively from a new and independent source.

6.

Consideration

In insurance contract, payment of premium is the consideration from the insured, and promise to indemnify is the consideration from the insurer. The contract does not come into existence unless the premium is paid.

7.

Average

Average means under-insurance, liability being limited to that proportion of the loss or sum insured bears to the value at risk.

8.

Contribution

Contribution is the ‘right of an insurer who has paid a loss under a policy to recover a proportionate amount from other insurers liable for loss.’ If an insured has two or more policies on the same subject matter, he cannot recover his loss from all, as this would be more than his actual loss.

14.6.2 Insurance Policies for a Typical Construction Organization

Some commonly used insurance policies in the context of a large construction organization are given in Table 14.2.

 

Table 14.2 Insurance policies commonly taken by a typical construction organization

S. No. Policy name Brief explanation

1.

Fire insurance

Policy ‘A’ or ‘B’ covering offices, main depots, transit houses, etc. Fire policy ‘C’ covering job sites.

2.

Workmen’s compensation insurance

To take care of the legal liability of the employer towards the employees under W.C. Act due to accident.

3.

Group personal accident policy

For providing compensation to the employees who meet with accident resulting in fatal or non-fatal injuries.

4.

Group mediclaim policies

To take care of medical expenses necessitated due to hospitalization and domiciliary hospitalization on account of accidents/sickness/disease.

5.

Overseas mediclaim policy

To take care of medical expenses incurred due to sickness/accident necessitating treatment abroad.

6.

Cash insurance (cash-in-transit/safe)

For covering loss of cash while it is in transit or in safe.

7.

Fidelity guarantee

For loss caused to the employer due to infidelity of the employees who are responsible for dealing with cash or stores.

8.

Motor insurance

For covering the vehicles (viz., motorcycles/scooters, private cars/jeeps, commercial vehicles) against accidental damage and third-party liability. Goods-carrying vehicles against own damage and liability.

9.

Machinery breakdown policy

For covering loss or damage to plant and machinery due to accidental failure caused by electrical or mechanical breakdown.

10.

Marine insurance

For covering loss or damage to materials, stores and spares, plant, machinery, etc. during transit.

11.

Contractor’s plant and machinery insurance (CPM)

For plant and machinery that are essentially used at project sites.

12.

Contractor’s all-risk insurance (CAR)

For covering mainly civil jobs.

13.

Erection all risk/storage-cum-erection insurance

For covering mechanical and electrical jobs.

14.

Marine-cum-erection insurance

This is an all-risk policy covering civil, mechanical and electrical jobs with extension of marine/transit risk cover.

15.

Electronic equipments insurance

To have all-risk protection for loss or damage to computers.

16.

Public liability insurance

For legal liability of the owner in respect of fatal/non-fatal injury caused to third-party personnel or damage to third-party property arising out of accident for which insured is held liable under law.

17.

Burglary/theft insurance

The policy covers materials such as temporary structures at site, stores material, spares, tools, etc. located at different project sites in the country.

18.

Group savings-linked insurance scheme

Covering all permanent employees.

19.

Baggage insurance

Covers accompanied baggage of the insured during travel against the risks of loss, damage by accident, fire, theft, etc.

14.6.3 Project Insurance

An element of risk is inherent in all types of engineering projects. It is ever-present in the world of commerce and industry, be it during construction or during operational stage. The insurance policies may be taken by the owner as well as the contractor. An owner organization may go in for policies such as marine-cum-erection (including third-party liability), delayed start-up (advance loss of profit), and so on. The contracting organization may go in for policies such as:

  • Construction plant and equipment insurance
  • Employer’s liability/workmen’s compensation
  • Marine vessels policy
  • Motor vehicles policy
  • Cash insurance and temporary properties of employers as well as of contractor

Some important and commonly applicable insurance policies are discussed briefly in the following paragraphs.

14.6.4 Marine-cum-Erection Insurance

The policy covers the contract works and equipment while in transit and during construction/erection at site, during testing and commissioning, and also during the defects liability period. Besides, the policy also covers damage to the surrounding property and liability to third parties.

For goods in transit, the policy covers all risks of physical loss or damage, including war and strike, riots and civil commotion. However, the policy does not cover loss or damage due to—insufficient or inadequate packing; inherent defects; unseaworthiness of vessels; financial default of vessel owners; radioactive contamination; and consequential losses caused by delay.

During construction and erection, the policy covers all risks of physical loss or damage to the project works, including environment perils, location perils, handling perils and negligent acts. Some examples of each of these perils are given below:

Environment perils—storm, flood, earthquake, etc.

Location perils—fire, lightning, theft and burglary, etc.

Handling perils—collision, impact, etc.

Negligent acts—carelessness, negligence, faults in erection, malicious act, etc.

The policy during construction and erection excludes war risks; normal wear and tear; rust, corrosion and erosion; cessation of work; wilful acts or wilful negligence; and consequential (financial) losses.

During the defects liability period, the policy covers contractor’s liability for the damage caused by contractor on site during regular maintenance, as well as the damage caused by faults in erection on site. The exclusions during defects liability period are in respect of gradual pollution; damage to project works; the insured’s own employees; the vehicles licensed for road use; and marine vessels or aircraft.

14.6.5 Contractor’s All-risk Insurance (CAR Insurance)

This engineering policy offers protection against loss or damage to the contract work. There is also a provision to extend cover against any third-party claims while executing the project. All civil engineering works, from a small residential building to a huge bridge, are susceptible to damage from a wide range of causes including fire, explosion, flood, storm, impact and internal defects. Exposure to such damage commences at the time of first delivery of the materials to the contract site and continues to exist till completion of the work. Even after completion of the work, there is exposure especially during the maintenance period, after the civil engineering work is handed over to the owner/client. The contract usually describes the responsibilities of the contractor for loss or damage during the period of the contract and the subsequent maintenance period. The CAR policy can provide the contractor with a comprehensive insurance coverage.

This insurance cover is useful for (a) all civil engineering works including massive dams, bridges, tunnels and docks, (b) residential and office buildings,(c) water treatment plants, canals and roads, and (d) airports, factories, etc.

The policy covers loss or damage to the subject matter from any unforeseen or accidental cause that is not specifically excluded under the policy. Some of the more important causes of loss indemnified under a CAR policy are:

  1. Fire, lightning, explosion, impact, aircraft damage
  2. Flood, inundation, storm, cyclone, hurricane, etc.
  3. Earthquake, subsidence, rockslide and landslide
  4. Theft, burglary, riot and strike damage

Some general exclusions in this policy are nuclear perils; war group perils; and wilful act or gross negligence on the part of the insured. Specific exclusions of the policy include deductible excess; faulty design; inventory losses; defective material; bad workmanship; wear and tear, deterioration, normal atmospheric conditions, rusts, and scratching of painted or polished surfaces; cost of rectification or errors unless resulting in physical damage; and loss or damage to vehicles used on the road or waterborne or airborne craft/vehicles.

The period of insurance commences from the first unloading of the property at the contractor’s site and expires on the date specified. The cover also ceases for that part of the insured contract work taken over by the principal prior to the expiry date.

The sum insured will be the total of the estimates of possible outlay or outgo under the following heads—contract price; materials or items supplied by the principal; any additional items not included in contract price and materials supplied by the principal; landed cost of imported items as at construction site; construction plant and machinery (restricted to five per cent of the contract value); clearance and removal of debris; insured’s own surrounding property; extra charges for overtime, express freight, etc.; increased replacement value for contract price and materials supplied by the principal; and third-party liability.

The policy is also applicable during the maintenance period, usually 12 months after the completed work is handed over. However, the liability under this is restricted to loss or damage caused by the insured in the course of obligatory maintenance under the contract.

The additional cover such as clearance and removal of debris, construction plant and machinery, surrounding property, third-party liability and escalation may be provided in the policy depending on the insured’s requirement.

14.6.6 Marine/Transit Insurance

Marine insurance may be defined as ‘an agreement whereby the insurer undertakes to indemnify the insured against marine losses, incidental to marine adventure.’ The common modes of marine transit are sea, rail/road, air and registered post. The standard types of perils include—inland transit (rail and road); fire; lightning; collision; overturning; derailment; theft; non-delivery; and breakage.

The various types of policies listed under marine/transit insurance are:

  1. Specific policies: These are policies issued for a particular shipment. As and when a shipment is made, the insured approach insurers and take out a policy insuring that particular shipment only.
  2. Open covers: These are agreements between the insured and the insurers to cover all shipments/dispatches during the agreed period of insurance, which is normally one year. Open policy is normally issued for inland transit and open cover for overseas shipments.
  3. Cover note: These are issued by insurers when a policy cannot be issued for want of important details like name of the vessel, bill of lading number and date, RR/LR/AWB number and date, etc. These are valid for a particular period only and should be replaced by policies when dispatch particulars are obtained.
  4. Certificate of insurance: This is normally issued when specific policies are not required to be issued under open policies, mainly to comply with bank stipulations.

14.6.7 Fire Policy

This policy covers factories, depots and stores. The risks covered under the policy are—fire/lightning; explosion/implosion; aircraft damages; riot/strike/malicious and terrorism damages; impact damages; storm/cyclone/typhoon/hurricane/tornado/flood and inundation; landslide/subsidence including rockslide; bursting and/or overflowing of water tanks apparatus and pipes; missile-testing operation; leakage from automatic sprinkler; and bushfire. The policy may have an additional cover for spontaneous combustion, earthquake, debris removal, etc.

14.6.8 Plant and Machinery Insurance

This is a comprehensive policy covering unforeseen and sudden physical damage to the property deployed/used at various locations/projects anywhere in the country. The types of cover are applicable for the following:

  1. Material damage: This covers equipments of all types, including earth-moving equipment, all types of cranes, pumps (including concrete pumps), concrete mixers, welding machines, compressor, DG sets, batching plants, transformers, drilling rigs, piling hammer, hot mix plant, concrete pavers, truck-mounted boom placers, formwork materials and scaffolding materials.
  2. Third-party liability: Under this, the insurance company indemnifies the insured against the legal liability for accidental loss or damage caused to the property of other persons and against the legal liability for fatal or non-fatal injury to any person other than employees.
  3. Increased cost of working: The insurance company indemnifies additional costs incurred by the insured, to ensure continued operation with substitute equipment, subject to limit specified.
  4. Inland transit: This insurance covers all risk of loss or damage to the subject matter. Transit insurance starts from the time the goods leave the warehouse/store until delivery to the final destination.

The indemnity limit varies depending on the type of cover.

14.6.9 Liquidity Damages Insurance

In general, under the provisions of construction agreements, the contractor is responsible to the owner for delay and/or under-performance of the project caused by technological failure or fault on the part of the contractor (including his subcontractors and suppliers). In such circumstances, the contractor is obliged to pay liquidated damages to the owner in amounts that should equate to the financial obligations of the owner to the project lenders. Cover for such damages is available to the contractor by way of liquidated damages insurance, which is designed to protect the contractor for liability assumed under contract for the payment of liquidated damages to the owner for late completion and/or performance shortfall, following errors and omissions on the part of the contractor, subcontractors and/or suppliers in connection with the work to be performed under the terms of the construction agreement. Such work could cover the engineering, design, procurement, construction and commissioning of the project.

14.6.10 Professional Indemnity Policy

The need for this policy is felt by construction companies that offer design and consultancy services. Besides, some of the contract conditions these days stipulate insurance policy to cover legal liability arising out of design defects. The policy offers an indemnity limit of Rs. 100 crore covering various locations in the country.

14.7 COMMON EXAMPLES OF BUSINESS AND PROJECT RISK

Some of the common project risks identified in BS 31100:2008 are given in Box 14.1. The list though is not comprehensive.

14.8 RISKS FACED BY INDIAN CONSTRUCTION COMPANIES ASSESSING INTERNATIONAL PROJECTS

The construction industry is a high-risk and low profit-margin industry. In the area of international construction, the risks are much more due to the political, legal, financial and cultural complexities involved. The Indian construction industry has only two companies that figure in the list of ‘Top 225 International Contractors 2006’ published by Engineering News Record (ENR) in August 2006, and India’s market share of US$2.15 billion (Exim Bank 2006) is just 0.05 per cent of the estimated US$3–4 trillion international construction market, according to Economic Times Intelligence Group (ETIG 2005). In India, there is a lack of international experience but the opportunities for growth for companies willing to enter the international arena are enormous. The domestic construction industry is growing at a rapid pace, due to very high demand for housing and increase in spending on infrastructure. The Indian construction industry contributes substantially to the GDP (about 6 per cent), while its contribution to exports is small (2.13 per cent). Indian companies are expanding rapidly and will soon need to look to the international market for further growth, and also for acquiring the latest technology. The Indian industry is labour-intensive and the application of latest technologies for construction is seen mainly in projects of national importance. These factors would have an influence on the Indian companies’ attitude towards addressing the risks in the international construction market. In this section, we view the risks from the Indian perspective.

Box 14.1 Common examples of business and project risk

14.8.1 Risks in International Construction

International construction projects are more complex due to conditions such as multiple ownership, elaborate financial provisions and different political ideologies, and thereby contain higher risks as compared to domestic market (Han et al. 2005). Wang (2004) has carried out a detailed analysis of international construction risks. Twenty-eight critical risks associated with international construction projects in developing countries have been identified, categorized into three (country, market and project) hierarchy levels, and their criticality evaluated and ranked. The top ten critical risks are—approval and permit, change in law, justice reinforcement, credit worthiness of local entities, political instability, cost overrun, corruption, inflation and interest rates, government policies, and government influence on disputes. The influence relationship among the risks in the three risk hierarchy levels has also been identified and confirmed. The risks at country level are more critical than those at market level, while the latter are more critical than those at project level. In addition, the risks at higher hierarchy level have dominating impacts on the risks at lower level. For the identified risks, the researcher has also provided and evaluated some practical mitigation measures.

Following case study approach, Bing and Tiong (1999) have proposed a risk management model for international construction joint ventures (JVs). The risk management process consists of three typical phases—(1) identification, (2) analysis and (3) treatment. The researchers have further identified a set of 25 risk factors applicable to international construction joint ventures. Bing et al. (1999) have grouped these risk factors into three main groups—(1) internal; (2) project specific; and (3) external. They examine the most effective mitigating measures adopted by construction professionals in managing these risks for their construction projects in East Asia. Based on an international survey of contractors, it has been found that the most critical risk factors exist in the financial aspects of JVs, government policies, economic conditions and project relationship. Turnbaugh (2005) provides guidelines to identify and quantify possible risk elements to the project, and then outline potential risk mitigation and control measures. Ten major areas of risk and a summary of potential risk elements and indicators as well as preferred risk responses have been identified.

In addition to identifying and evaluating the risk factors in general, some researchers have also tried to explore a particular factor in international construction risk scenario. For example, Kapila (2001) has stressed the financial risk factors associated with international construction ventures. He further examines the most effective mitigation measures adopted by construction professionals in managing these risks for their construction projects, and suggests strategies to minimize foreign-exchange risk and to better manage foreign-exchange dealings. Stallworthy and Kharbanda (1983) have emphasised project financing and rated it above technological excellence in export project development. Ashley and Bonner (1987) have studied the political risks in international construction.

Han et al. (2005) describe findings from experiments done to investigate the risk attitude and bid-decision behaviour in the selection of international projects. The participants demonstrated either weak risk seeking in profit situations or strong risk seeking towards loss situations when choosing between conflicting options of risky opportunities and sure payoffs. On the other hand, another experimental test attempting to investigate bid behaviour when making a realistic bid or no-bid situation in a complicated international construction project reveals the prevailing risk aversion. Further, they find the experimental supports for some of the errors and biases due to risk attitude that commonly exists in bid decisions in this area.

Hastak and Shaked (2000) have recommended an international construction risk assessment model (ICRAM-1) that assists the user in evaluating the potential risk involved in expanding operations in an international market by analysing risk at the macro (or country environment), market and project levels. They have discussed some of the existing models for country risk assessment, and further presented potential risk indicators at the macro, market and project levels. ICRAM-1 provides a structured approach for evaluating the risk indicators involved in an international construction operation and is designed to examine a specific project in a foreign country. It can be used as a tool to quantify the risk involved in an international construction investment as one of the preliminary steps in project evaluation.

It may be concluded that the researchers investigating the risk aspects in international construction have worked primarily in the areas of risk identification, classification, analysis, evaluation through risk assessment models, and developing the strategy for risk mitigation. Researchers have also focused their attention on studying the bid/no-bid situation, the attitude of contractors in selection of international project, and the entry strategy for foreign construction markets.

Based on the literature review and the views of experts, a list of risk factors applicable in international construction, referred to in the study as R1, R2,…R14, have been identified. They are summarized in Table 14.3.

 

Table 14.3 Summary of risk factors

REFERENCES

 

1. Al-Bahar, J.F. and Crandall, K.C., 1990, ‘Systematic risk management in construction projects’, ASCE Journal of Construction Engineering and Management, 116(3), pp. 533–546.

2. Ashley, D. B. and Bonner, J.J., 1987, ‘Political risks in international construction’, Journal of Construction Engineering and Management, ASCE, 113(3), pp. 447–467.

3. Bing, L. and Tiong, R.L.K., 1999, ‘Risk management model for international construction joint ventures’, Journal of Construction Engineering and Management, ASCE, 125(5), pp. 377–384.

4. BS 31100:2008 British Standard on Risk management: Code of practice.

5. Devaya, M.N., 2007, ‘Study of construction export potential of Indian construction industry’, Masters thesis, Department of Civil Engineering, Indian Institute of Technology, Delhi.

6. Han, S.H., Diekmann, J.E. and Ock, J.H., 2005, ‘Contractors risk attitudes in the selection of international construction projects’, Journal of Construction Engineering and Management, ASCE, 27(4), pp. 283–292.

7. Hastak, M. and Shaked, A., 2000, ‘ICRAM-1: Model for International Construction Risk Assessment’, Journal of Management in Engineering, ASCE, 16(1), pp. 59–69.

8. Kapila, P. and Hendrickson, C., 2001, ‘Exchange rate management in international construction ventures’, ASCE Journal of Management in Engineering, 17(4), pp. 186–191.

9. Stallworthy, E.A. and Kharbanda, O.P., 1983, International Construction, Gower Publishing Company Ltd, England.

10. Turnbaugh, L., 2005, ‘Risk management in large capital projects’, Journal of Professional Issues in Engineering Education and Practice, ASCE, October 2005, pp. 275–280.

11. Wang, S. Q., 2004, ‘Risk management framework for construction projects in developing countries’, Construction Management and Economics, 22(3), pp. 237–252.

REVIEW QUESTIONS
  1. State whether True or False:
    1. Realistic business and project planning, and cost saving are some of the benefits of systematic risk management.
    2. Risk management is a formal and orderly process for systematically identifying, analysing and responding to risk events throughout the life of a project.
    3. Risk identification process is the process of systematically and continuously identifying, categorizing and assessing the initial significance of risks associated with a construction project.
    4. For a construction organization, projects are the principal means by which a business moves forward.
    5. Identification of stakeholders is not an important part in clarifying goals and assessing risk.
    6. Iso-risk curves are used for risk identification and mapping.
    7. Risk analysis and evaluation process includes data collection, modelling of uncertainty, and evaluation of potential impact of risk.
    8. Risk treatment strategies are risk avoidance, loss reduction and risk prevention, risk retention and assumption, risk transfer, and insurance.
    9. The three broad types of risk factors are internal, project-specific and external.
    10. Brainstorming and interviews are some of the methods for risk identification.
  2. Match the following:

    (1) What is at risk and why?

    (a) risk analysis

    (2) What (and where) are the risks?

    (b) risk treatment

    (3) What is known about them?

    (c) risk identification

    (4) How important are they?

    (d) context (business/projects)

    (5) What should be done about them?

    (e) risk evaluation

  3. Arrange the following risk identification process in sequence—(a) risk classification, (b) defining consequences for each risk in checklist, (c) risk category summary-sheet preparation, (d) preliminary checklist, (e) risk mapping.
  4. What are the benefits of systematic risk identification and risk management?
  5. What are the different steps involved in risk management process?
  6. What is meant by risk?
  7. Discuss the importance of insurance in risk management.
  8. Discuss different risk treatment strategies.
  9. Discuss some important insurance policies prevalent in construction industry.
  10. Discuss the importance of risk analysis and risk evaluation.
  11. What is the right method of responding to any risk in a construction project? Give examples of (a) risk avoidance, (b) risk reduction, (c) risk transfer and (d) risk sharing.
  12. Can you share and transfer the risk simultaneously?
  13. What are the techniques used to identify the risk in a new project.
  14. Large infrastructure projects such as airports and highways face many known and unknown risks at various stages of project execution. Using an example of a highway project, explain these risks for all the phases.
  15. How do you handle unknown types of risks that may arise during the execution of a construction project?
  16. What are the areas in construction project risks where insurance is possible?
  17. Can manmade risks be always covered by insurance?
  18. Comment on a project insurance policy by referring to general provisions, specific provisions and exclusions in a CAR policy.
  19. Write short notes on the risks in international contracts.