**4. Non-insurance risk transfer: contractual transfer embedded within other contracts**

The contract between the owner and the general contractor (or the contractor and the subcontractors) specifies the terms and conditions, details of construction, material, deadlines for completion and many other project specific details. The contract also identifies and allocates risk. Some risks that might be borne by one party can be transferred by mutual agreement to another party in the contract. Here we consider several risk transfer mechanisms available to the two parties signing the master construction contract that can be embedded within the master contract.

#### **4.1 Risk transfer as part of subcontractor agreements**

The decision as to who bears the risk in a construction project should generally worked out contractually. Risk created by a subcontractor or its employees can still come back to affect the contractor through the legal doctrine of *respondeat superior* and the existence of vicarious liability of the contractor (the liability of an employer or supervisor for liability generated by their employees). Often contracts are written between the contractor and subcontractor in such a manner as to make sure the risks created by a subcontract do not adversely affect the contractor. There are several important techniques to transferring risks contractually, and we discuss these below.

#### *4.1.1 The contractor as an additional on subcontractor's insurance*

An insurance contract is a legal contract between the insured and the insurer that agrees to pay specific amounts for claims filed within the policy period that satisfy the terms of the policy. A liability insurance policy such as the CGL policy, for example, will pay any liability claim amount (damages) that meets the conditions of the contract plus litigation costs up to the specified policy limits. Since the policy is a contract between the insurer and the insured, only the insured can file a claim against the policy. Thus, for example, if a contractor hires a subcontractor who causes physical damage, bodily injury or liability expense related to the construction project, only the subcontractor can file a claim on their insurance policy. Since filing of claims can make subsequent experience rated insurance purchases more expensive, the subcontractor may be reluctant to file a claim. A way around this is for the contractor to have written into their general construction contract with the subcontractor that they (the contractor) be listed as an additional insured on the subcontractor's insurance policy. This gives them equal status to talk with the subcontractor's insurer, and the contractor now has the ability to file claims against the subcontractor's policy.

If there is a claim the contractor has against the subcontractor that would trigger coverage by the subcontractor's insurance policy, the contractors can give permission for their own insurer to deal directly with the subcontractor's insurer, as they are a party to both contracts. By using the additional insured route to the subcontractor's

**45**

*Different Market Methods for Transferring Financial Risks in Construction*

adverse claim experience does not go on the contractor's claim record.

pays the costs in excess of the payment under the contractor's policy.

listing the contractor as an additional insured.

be recommended by the contractor' insurance broker [19].

insurance policy, the contractor can have the requisite damages and defense costs paid without drawing upon the policy limits of any other policy they might have. This also saves the contractor money on experience rated insurance policies, as the

It is also desirable that the contractor have written into their contract with the subcontractor that they be listed as having primary (as opposed to excess) additional insured status on the subcontractor's policy. Primary insured status means that the subcontractor's policy becomes the primary policy (pays first) instead of the contractor's own policy when a claim is filed, and it will pay up to the policy limits of the subcontractor before tapping any of the contractor's own insurance policies. The contractor's policies are then secondary insurance and pay whatever is left on the claim above the primary insurance policy's limits. Transferring claim costs to the subcontractor's policy helps control the contractor costs and allows them to retain their own policy coverage unused. If the contractor were listed as an additional insured on an excess basis, then the contractor's own policy becomes primary (and pays first up to policy limits) and the subcontractor's policy becomes excess and only

Many contractors write into their original agreement that they be continued as an additional insured for as long as possible since claims may arise long after the subcontractor leaves the worksite. The contractor can mandate they obtain a Certificate of Insurance from the subcontractor that shows coverages as well as

Several different forms and endorsements exist for listing the contractor as an additional insured on the subcontractor's policy. The most favorable risk transfer (for the contractor) is to have additional insured status with an endorsement that includes both work in progress and completed work (an ongoing operations endorsement and a completed operations endorsement). These endorsements can

*4.1.2 Owner and contractor controlled insurance programs and wrap-up insurance*

Every construction project contains multiple subprojects and multiple sources of potential risk of losses. The larger the project, the more subcontractors there are on the project, the more varied, complex, and potentially overlapping are the risk and potential losses. In smaller or traditional construction projects, each subcontractor takes care of their own risks through their own insurance, and the contractor requires a hold harmless agreement and to be listed as an additional insured. With a large-scale project, (e.g., \$50–100 million) there are savings by having all contractors or subs covered under a single policy. Because of the potential interactions of different subcontractors, there can be duplicative coverage for some risks, and disagreement (and litigation) among subcontractors (and their insurers) as to fault. Subcontractors have their own insurer giving the potential for litigation among insureds as to who pays first. There can also be lack of uniformity of policy limits, conditions, terms and conditions specified by each insurer. Finally, the owner should be listed as an additional insured on all relevant policies (e.g., contractor and sub-contractors), which may create costly duplicative coverage of owner's risks. A solution to this situation is for one party to obtain insurance policies that covers multiple other parties working on the construction project. One insurance policy covers the entire project instead of each of the multitude of subcontractors each with their own insurance policy covering just their piece. This arrangement to have one insurance policy cover the entire project is a wrap-up insurance program, as all subcontractors' risks are "wrapped up" into a single policy. The goal of a wrap-up program is to reduce total insurance costs for the project while affecting consistent

*DOI: http://dx.doi.org/10.5772/intechopen.84748*

#### *Different Market Methods for Transferring Financial Risks in Construction DOI: http://dx.doi.org/10.5772/intechopen.84748*

*Risk Management in Construction Projects*

ply chain or logistical failure [18].

**other contracts**

supplier or it could cover all suppliers depending on the terms of the contract. Coverage under these policies is triggered by interruption to contractor due to sup-

worksite that cause losses and interruptions to the contractor.

**4.1 Risk transfer as part of subcontractor agreements**

*4.1.1 The contractor as an additional on subcontractor's insurance*

tor now has the ability to file claims against the subcontractor's policy.

If there is a claim the contractor has against the subcontractor that would trigger coverage by the subcontractor's insurance policy, the contractors can give permission for their own insurer to deal directly with the subcontractor's insurer, as they are a party to both contracts. By using the additional insured route to the subcontractor's

It should be noted that Contingent Business Interruption Insurance is different from regular Business Interruption (BI) Insurance. CBI covers the risk of damage (loss) to the contractor due to an incident at a supplier's location. On the other hand, regular BI Insurance addresses the risk of losses arising at the contractor's

**4. Non-insurance risk transfer: contractual transfer embedded within** 

The contract between the owner and the general contractor (or the contractor and the subcontractors) specifies the terms and conditions, details of construction, material, deadlines for completion and many other project specific details. The contract also identifies and allocates risk. Some risks that might be borne by one party can be transferred by mutual agreement to another party in the contract. Here we consider several risk transfer mechanisms available to the two parties signing the master construction contract that can be embedded within the master contract.

The decision as to who bears the risk in a construction project should generally worked out contractually. Risk created by a subcontractor or its employees can still come back to affect the contractor through the legal doctrine of *respondeat superior* and the existence of vicarious liability of the contractor (the liability of an employer or supervisor for liability generated by their employees). Often contracts are written between the contractor and subcontractor in such a manner as to make sure the risks created by a subcontract do not adversely affect the contractor. There are several important techniques to transferring risks contractually, and we discuss these below.

An insurance contract is a legal contract between the insured and the insurer that agrees to pay specific amounts for claims filed within the policy period that satisfy the terms of the policy. A liability insurance policy such as the CGL policy, for example, will pay any liability claim amount (damages) that meets the conditions of the contract plus litigation costs up to the specified policy limits. Since the policy is a contract between the insurer and the insured, only the insured can file a claim against the policy. Thus, for example, if a contractor hires a subcontractor who causes physical damage, bodily injury or liability expense related to the construction project, only the subcontractor can file a claim on their insurance policy. Since filing of claims can make subsequent experience rated insurance purchases more expensive, the subcontractor may be reluctant to file a claim. A way around this is for the contractor to have written into their general construction contract with the subcontractor that they (the contractor) be listed as an additional insured on the subcontractor's insurance policy. This gives them equal status to talk with the subcontractor's insurer, and the contrac-

**44**

insurance policy, the contractor can have the requisite damages and defense costs paid without drawing upon the policy limits of any other policy they might have. This also saves the contractor money on experience rated insurance policies, as the adverse claim experience does not go on the contractor's claim record.

It is also desirable that the contractor have written into their contract with the subcontractor that they be listed as having primary (as opposed to excess) additional insured status on the subcontractor's policy. Primary insured status means that the subcontractor's policy becomes the primary policy (pays first) instead of the contractor's own policy when a claim is filed, and it will pay up to the policy limits of the subcontractor before tapping any of the contractor's own insurance policies. The contractor's policies are then secondary insurance and pay whatever is left on the claim above the primary insurance policy's limits. Transferring claim costs to the subcontractor's policy helps control the contractor costs and allows them to retain their own policy coverage unused. If the contractor were listed as an additional insured on an excess basis, then the contractor's own policy becomes primary (and pays first up to policy limits) and the subcontractor's policy becomes excess and only pays the costs in excess of the payment under the contractor's policy.

Many contractors write into their original agreement that they be continued as an additional insured for as long as possible since claims may arise long after the subcontractor leaves the worksite. The contractor can mandate they obtain a Certificate of Insurance from the subcontractor that shows coverages as well as listing the contractor as an additional insured.

Several different forms and endorsements exist for listing the contractor as an additional insured on the subcontractor's policy. The most favorable risk transfer (for the contractor) is to have additional insured status with an endorsement that includes both work in progress and completed work (an ongoing operations endorsement and a completed operations endorsement). These endorsements can be recommended by the contractor' insurance broker [19].

#### *4.1.2 Owner and contractor controlled insurance programs and wrap-up insurance*

Every construction project contains multiple subprojects and multiple sources of potential risk of losses. The larger the project, the more subcontractors there are on the project, the more varied, complex, and potentially overlapping are the risk and potential losses. In smaller or traditional construction projects, each subcontractor takes care of their own risks through their own insurance, and the contractor requires a hold harmless agreement and to be listed as an additional insured. With a large-scale project, (e.g., \$50–100 million) there are savings by having all contractors or subs covered under a single policy. Because of the potential interactions of different subcontractors, there can be duplicative coverage for some risks, and disagreement (and litigation) among subcontractors (and their insurers) as to fault. Subcontractors have their own insurer giving the potential for litigation among insureds as to who pays first. There can also be lack of uniformity of policy limits, conditions, terms and conditions specified by each insurer. Finally, the owner should be listed as an additional insured on all relevant policies (e.g., contractor and sub-contractors), which may create costly duplicative coverage of owner's risks.

A solution to this situation is for one party to obtain insurance policies that covers multiple other parties working on the construction project. One insurance policy covers the entire project instead of each of the multitude of subcontractors each with their own insurance policy covering just their piece. This arrangement to have one insurance policy cover the entire project is a wrap-up insurance program, as all subcontractors' risks are "wrapped up" into a single policy. The goal of a wrap-up program is to reduce total insurance costs for the project while affecting consistent

coverage. If the owner is the lead party who arranges for the single insurance policy that all contractors and subcontractors subscribe to, the arrangement is an Owner Controlled Insurance Program (OCIP). If the general contractor is the lead party with subcontractors as subscribers, the arrangement is a Contractor Controlled Insurance Program (CCIP). A number of large contractors are now considering wrap-up insurance programs, and CCIPs are much more common today than in the past [8].

There are several advantages of a wrap-up insurance program (either OCIP or CCIP). First, it provides uniformity of coverage with a single insurer. This eliminates duplicative coverage and differences in conditions and limits. It eliminates costly legal bickering between the subcontractors' insurers over who has responsibility of a claim, which can eat into the policy limits of the coverage. It allows for more advantageous "economies of scale" in negotiating with the insurer over price. All these factors can reduce total premiums. Subcontractors pay their "share" of the premium and do not get project insurance on their own.

Centralized loss control and safety policies can be affected by using the wrapup plan, making for uniform loss control incentives. Importantly, the wrap-up program can complicate the bidding process as the use or non-use of the wrap-up arrangement can greatly affect each subcontractors' insurance related costs. For effective bidding, subcontractors must know their insurance costs, thus, the creation and details of the wrap-up arrangement must be explicitly determined before bidding and project commencement.

The goal of the OCIP or CCIP is to save insurance costs so it usually only includes coverages for which there would be cost savings by having the individual policies wrapped up into a single policy. Typically, these include workers' compensation, CGL, builders' risk, and sometimes umbrella insurance coverage. Other coverages like commercial automobile or professional liability do not offer the potential cost savings and are not generally included in the wrap-up program but rather continue coverage by individual subcontractors [4].

#### **4.2 Hold harmless and indemnification agreements**

A hold harmless agreement is a contractual agreement between two parties that specifies how the risk of liability arising during construction will be distributed. The contracting parties to the hold harmless contract agree among themselves, before any loss occurs, on how to split the costs of a risk realization. Usually hold harmless agreements are embedded clauses within the general construction contract and they shift the risk from one party (who originally holds the risk) to another party. From an economic efficiency perspective, this transfer might be done in order to place the financial responsibility with the party that has best control over the risk, hence creating an enhanced financial incentive to control risk by the party that best has the ability to control the risk. Alternatively, the transfer of risk might place the risk with the party that has a comparative economic advantage in risk bearing so that the cost of risk is lessened [4].

The two parties are the" indemnitor" (the one who agrees to indemnify or hold harmless) and the "indemnitee" (the one who is originally potentially liable to pay but who has transferred this risk to the indemnitor and can no longer be harmed by the financial burden). Illustrative examples include having the owner as the indemnitee and the general contractor as the indemnitor, or it could be a contractor as the indemnitee and subcontractor as indemnitor.

As an illustration of the incentive effects, an electrical subcontractor has best control over how the wiring in a construction project is performed. Faulty wiring however, could cause a financial loss for the contractor, such as if a third party was injured and sued the contractor. If the contractor had the subcontractor sign a hold

**47**

*Different Market Methods for Transferring Financial Risks in Construction*

harmless agreement, then the subcontractor has agreed to pay for any harm to the contractor caused by subcontractor's work (within the terms of the hold harmless agreement). The financial consequences of the risk of faulty wiring would be transferred to the party best able to ensure there is no faulty wiring. This hold harmless and indemnification clause ensures subcontractors monitor their own work, as they

The type or form of hold harmless/indemnification agreement determines the degree to which the liability associated with the indemnitee's negligence is shifted to the indemnitor. There are three common forms of indemnity (hold harmless) agreements: (1) a broad form, (2) an intermediate form, and (3) a limited or

First, the broad form transfers the most incurred risk (financial responsibility) from the contractor (indemnitee) to the subcontractor (indemnitor). With this broad form agreement, the subcontractor agrees to take on all related liability for accidents whether it be due to their own negligence, negligence by the contractor, or a combination of negligence on the part of both. Due to its broad scope, the subcontractors must usually get an additional insurance policy on top of their own liability policy. Note also that since the subcontractor with this type hold harmless form has agreed to take on the contractor's liability, even that which had nothing to do with the subcontractor; there is an adverse incentive for safety created for the contractor to take care and spend money on safety in the workplace. Therefore, some jurisdic-

The second intermediate type of hold harmless agreement has the subcontractor (indemnitor) assume responsibility for all loss costs except those arising solely from the contractor's (indemnitee's) negligence. This is the most common hold harmless agreement type. If both the subcontractor (indemnitor) and the contractor (indemnitee) are partially negligence the subcontractor is responsible for all liability. The third limited form hold harmless agreement holds the subcontractor (indemnitor) responsible only for their part of the liability and the contractor (indemnitee) is responsible for his or her part. This is a comparative fault form, as determination must be made as to what percentage of the liability was the fault of

It should be noted that the party agreeing to assume the liability of another under a hold harmless agreement might, but does not automatically, have recourse to their CGL policy to cover their contractually assumed liability. The 2013 CGL policy has a "contractual liability exclusion" that eliminates an assumption of such risk within the liability section of the CGL unless it is for a liability that the insured would have had even without having signed a hold harmless agreement, or unless it was for a liability assumed in a contract or agreement that is an "insured contract." The meaning of this last term continues to be litigated, and it behooves the contractor to consult their broker for what parts (if any) of the hold harmless agreement can be covered by the CGL. Court rulings have differed by state [21]. Many conclude that the hold harmless agreement is an "insured contract" and hence is excluded from this policy exclusion (and therefore is included in the CGL coverage).

Like insurance, surety bonds exist to ensure that a construction project is completed within the contract's terms and conditions. Most surety bonds are underwritten by sub-divisions of insurers, and like insurance, surety bonds are regulated at the state level in the USA by the state's Department of Insurance. Surety bonds are not insurance, however, but rather provide a guaranty that the obligations of the

*DOI: http://dx.doi.org/10.5772/intechopen.84748*

bear the consequences of their losses.

tions have declared the broad form illegal.

the subcontractor and what was due to the contractor [20].

**5. Surety bonds for construction projects**

comparative fault form [4, 20].

#### *Different Market Methods for Transferring Financial Risks in Construction DOI: http://dx.doi.org/10.5772/intechopen.84748*

*Risk Management in Construction Projects*

coverage. If the owner is the lead party who arranges for the single insurance policy that all contractors and subcontractors subscribe to, the arrangement is an Owner Controlled Insurance Program (OCIP). If the general contractor is the lead party with subcontractors as subscribers, the arrangement is a Contractor Controlled Insurance Program (CCIP). A number of large contractors are now considering wrap-up insurance programs, and CCIPs are much more common today than in the past [8].

There are several advantages of a wrap-up insurance program (either OCIP or CCIP). First, it provides uniformity of coverage with a single insurer. This eliminates duplicative coverage and differences in conditions and limits. It eliminates costly legal bickering between the subcontractors' insurers over who has responsibility of a claim, which can eat into the policy limits of the coverage. It allows for more advantageous "economies of scale" in negotiating with the insurer over price. All these factors can reduce total premiums. Subcontractors pay their "share" of the

Centralized loss control and safety policies can be affected by using the wrapup plan, making for uniform loss control incentives. Importantly, the wrap-up program can complicate the bidding process as the use or non-use of the wrap-up arrangement can greatly affect each subcontractors' insurance related costs. For effective bidding, subcontractors must know their insurance costs, thus, the creation and details of the wrap-up arrangement must be explicitly determined before

The goal of the OCIP or CCIP is to save insurance costs so it usually only includes coverages for which there would be cost savings by having the individual policies wrapped up into a single policy. Typically, these include workers' compensation, CGL, builders' risk, and sometimes umbrella insurance coverage. Other coverages like commercial automobile or professional liability do not offer the potential cost savings and are not generally included in the wrap-up program but rather continue

A hold harmless agreement is a contractual agreement between two parties that specifies how the risk of liability arising during construction will be distributed. The contracting parties to the hold harmless contract agree among themselves, before any loss occurs, on how to split the costs of a risk realization. Usually hold harmless agreements are embedded clauses within the general construction contract and they shift the risk from one party (who originally holds the risk) to another party. From an economic efficiency perspective, this transfer might be done in order to place the financial responsibility with the party that has best control over the risk, hence creating an enhanced financial incentive to control risk by the party that best has the ability to control the risk. Alternatively, the transfer of risk might place the risk with the party that has a comparative economic advantage in risk

The two parties are the" indemnitor" (the one who agrees to indemnify or hold harmless) and the "indemnitee" (the one who is originally potentially liable to pay but who has transferred this risk to the indemnitor and can no longer be harmed by the financial burden). Illustrative examples include having the owner as the indemnitee and the general contractor as the indemnitor, or it could be a contractor as the

As an illustration of the incentive effects, an electrical subcontractor has best control over how the wiring in a construction project is performed. Faulty wiring however, could cause a financial loss for the contractor, such as if a third party was injured and sued the contractor. If the contractor had the subcontractor sign a hold

premium and do not get project insurance on their own.

bidding and project commencement.

coverage by individual subcontractors [4].

bearing so that the cost of risk is lessened [4].

indemnitee and subcontractor as indemnitor.

**4.2 Hold harmless and indemnification agreements**

**46**

harmless agreement, then the subcontractor has agreed to pay for any harm to the contractor caused by subcontractor's work (within the terms of the hold harmless agreement). The financial consequences of the risk of faulty wiring would be transferred to the party best able to ensure there is no faulty wiring. This hold harmless and indemnification clause ensures subcontractors monitor their own work, as they bear the consequences of their losses.

The type or form of hold harmless/indemnification agreement determines the degree to which the liability associated with the indemnitee's negligence is shifted to the indemnitor. There are three common forms of indemnity (hold harmless) agreements: (1) a broad form, (2) an intermediate form, and (3) a limited or comparative fault form [4, 20].

First, the broad form transfers the most incurred risk (financial responsibility) from the contractor (indemnitee) to the subcontractor (indemnitor). With this broad form agreement, the subcontractor agrees to take on all related liability for accidents whether it be due to their own negligence, negligence by the contractor, or a combination of negligence on the part of both. Due to its broad scope, the subcontractors must usually get an additional insurance policy on top of their own liability policy. Note also that since the subcontractor with this type hold harmless form has agreed to take on the contractor's liability, even that which had nothing to do with the subcontractor; there is an adverse incentive for safety created for the contractor to take care and spend money on safety in the workplace. Therefore, some jurisdictions have declared the broad form illegal.

The second intermediate type of hold harmless agreement has the subcontractor (indemnitor) assume responsibility for all loss costs except those arising solely from the contractor's (indemnitee's) negligence. This is the most common hold harmless agreement type. If both the subcontractor (indemnitor) and the contractor (indemnitee) are partially negligence the subcontractor is responsible for all liability.

The third limited form hold harmless agreement holds the subcontractor (indemnitor) responsible only for their part of the liability and the contractor (indemnitee) is responsible for his or her part. This is a comparative fault form, as determination must be made as to what percentage of the liability was the fault of the subcontractor and what was due to the contractor [20].

It should be noted that the party agreeing to assume the liability of another under a hold harmless agreement might, but does not automatically, have recourse to their CGL policy to cover their contractually assumed liability. The 2013 CGL policy has a "contractual liability exclusion" that eliminates an assumption of such risk within the liability section of the CGL unless it is for a liability that the insured would have had even without having signed a hold harmless agreement, or unless it was for a liability assumed in a contract or agreement that is an "insured contract." The meaning of this last term continues to be litigated, and it behooves the contractor to consult their broker for what parts (if any) of the hold harmless agreement can be covered by the CGL. Court rulings have differed by state [21]. Many conclude that the hold harmless agreement is an "insured contract" and hence is excluded from this policy exclusion (and therefore is included in the CGL coverage).

### **5. Surety bonds for construction projects**

Like insurance, surety bonds exist to ensure that a construction project is completed within the contract's terms and conditions. Most surety bonds are underwritten by sub-divisions of insurers, and like insurance, surety bonds are regulated at the state level in the USA by the state's Department of Insurance. Surety bonds are not insurance, however, but rather provide a guaranty that the obligations of the

contractor will be fulfilled. The Surety (the entity writing the bond) can assist the contractor if the contractor experiences cash flow problems. If the contractor fails to perform or is held in default of the contract, or abandons the project, the Surety may replace the contractor to get the project completed.

Unlike insurance, written to cover unexpected fortuitous events that affect the project and that indemnifies the insured and provides legal defense of the insured under the policy, a surety bond is written to cover the contractor's obligation to the owner under the contract and does not provide any legal defense for the contractor. An insurance contract has a specific period for coverage and is renewable whereas a surety bond is generally project specific and lasts throughout the project. If an insurer makes a payment on behalf of the contractor, the contractor is not expected to reimburse the insurer, whereas if a surety bond provider makes payments on behalf of the contractor, the contractor must pay them back. Because the underwriting of the bond involves contractor prequalification based on their construction experience and financial strength, the bond is usually underwritten with the expectation of no loss. When used in construction, surety bonds are called Contract Surety Bonds [8].

Unlike an insurance contract, which is between two parties (the insurer and insured), the surety bond involves three parties: the Obligee (project owner or contract beneficiary), the Surety (who writes the bond and promises performance of the contract), and the Principal (contractor who contracted to construct according to the contract).

Three types of Contract Surety Bonds are most relevant in construction. These are (1) the "bid bond" which protects the Obligee should the contractor be awarded the contract and then either does not sign the contract or does not provide the called-for payment or performance bonds, (2) the "payment bond" that guarantees that the contractor will pay workers, suppliers, and sub-contractors, and (3) the "performance bond" that protects the Obligee from loss should the contractor fail to perform on the construction project according to contract. A Surety assures the project is completed according to contract [8].

Surety bonds are very important for handling the financial consequences of certain risks in the construction industry since many entities require a surety bond from the contractor or sub-contractors as a condition of awarding the contract. For example, general contractors may require their subcontractors to provide surety bonds to protect the contractor. In the public sector, statutory requirements by federal, state and local governments require contractor bonding to ensure the lowest bidder can actually perform on the contract and that suppliers and subcontractors will be paid and taxpayer money be well spent. In the private sector, lending institutions may require surety bonds (and might even become a dual obligee on the surety bond) to protect their investment. Private owners, especially on large projects, may require the contractor provide a surety bond to guarantee the quality of the contractor (since they are pre-qualified as discussed previously) and to make sure their project gets accomplished according to plan in the event of contractor default of failure.

#### **6. Emerging market technologies affecting construction risk**

There are many emerging risks dues to world dynamics and risks in the market. Construction managers will likely have to respond to these in their risk management processes or pay the consequences. Some insurance providers already have products to address these. Through the use of insurance providers, such as Lloyds of London, construction managers can negotiate new insurance products that

**49**

the risk.

**7. Conclusion**

*Different Market Methods for Transferring Financial Risks in Construction*

relatively unfamiliar to construction risk management [22–24].

management attention before the risks are devastating.

on housing construction using 3D printing [26].

designs, and to detect any errors or inconsistencies [30].

managers to recognize and deal with these risks.

meet their specific emerging risk management needs or choose to self-insure. This section is forward facing to identify some emerging risks that demand construction

The construction industry is one of the least automated industries, relying heavily on human labor. There are, however, different types of construction robots now poised to revolutionize parts of construction. The use of construction robots can increase efficiency and decrease cost, but also can create risks and uncertainties

One potentially disruptive technology is 3D-printing that can build even large buildings on demand. A robotic arm controls a 3D-printer and this 3D printer produces an entire building (or component parts needed for construction). This technology has been used for canals and bridges, with a 3D printed canal built in Netherlands in 2014, and the first ever-3D printed pedestrian bridge built in Spain

Robots may dramatically improve the speed and quality of construction work [22–24]. It was announced recently that Sunconomy, a USA construction company, received permits to build its first 3D printed manufactured house in Lago Vista, Texas [25]. WinSun, a Chinese construction company, expects up to a 50% savings

All forms of construction robots could fundamentally change risks, from risks associated with injuries, to project completion time, to supply chains [27]. However, two areas of liability exposure may arise: products liability and intellectual property

Contractors using 3D printing should check their CGL policy as many have exclusions for cyber related risk and may exclude liabilities associated with embedded software errors that cause product defect loss when using 3D printing. Contractors should consider getting a version of products liability insurance to cover these losses. Insurance risk transfer issues associated with this emerging technology are discussed in [28]. Demolition robots are another robot that, while slower than demolition crews, are safer and cheaper [29] but create liability.

Emerging AI based applications can be very beneficial to construction. These include: AI innovations providing enhanced visual processing using videos of worksites to help identify safety hazards, drones, high tech sensors and other enhanced visual processing to automate tracking of project progress against plans, as well as 3D models from data captured by drones to measure progress against original

In spite of these and other benefits of AI and tech innovations, they do create liability transfer risks still not well identified or addressed. These insurance liability transfer risks are very complex and the party responsible for AI and innovation failures causing damages have yet to be legally decided [31]. Cyber liability exclusions in the CGL may cause lack of coverage issues and it is important for construction

There are many risks in construction necessitating decisions to avoid, retain or transfer an identified risk (The A-R-T of Risk Management) that ideally should be made in the planning phase before project start. This chapter delineated characteristics of construction risk and focused on ways to transfer financial risk to the insurance market, to other stakeholders, to retain or to avoid that part of the business creating

*DOI: http://dx.doi.org/10.5772/intechopen.84748*

in December 2016 [24].

violations (the 3D plans used).

#### *Different Market Methods for Transferring Financial Risks in Construction DOI: http://dx.doi.org/10.5772/intechopen.84748*

*Risk Management in Construction Projects*

Surety Bonds [8].

ing to the contract).

project is completed according to contract [8].

may replace the contractor to get the project completed.

contractor will be fulfilled. The Surety (the entity writing the bond) can assist the contractor if the contractor experiences cash flow problems. If the contractor fails to perform or is held in default of the contract, or abandons the project, the Surety

Unlike insurance, written to cover unexpected fortuitous events that affect the project and that indemnifies the insured and provides legal defense of the insured under the policy, a surety bond is written to cover the contractor's obligation to the owner under the contract and does not provide any legal defense for the contractor. An insurance contract has a specific period for coverage and is renewable whereas a surety bond is generally project specific and lasts throughout the project. If an insurer makes a payment on behalf of the contractor, the contractor is not expected to reimburse the insurer, whereas if a surety bond provider makes payments on behalf of the contractor, the contractor must pay them back. Because the underwriting of the bond involves contractor prequalification based on their construction experience and financial strength, the bond is usually underwritten with the expectation of no loss. When used in construction, surety bonds are called Contract

Unlike an insurance contract, which is between two parties (the insurer and insured), the surety bond involves three parties: the Obligee (project owner or contract beneficiary), the Surety (who writes the bond and promises performance of the contract), and the Principal (contractor who contracted to construct accord-

Three types of Contract Surety Bonds are most relevant in construction. These are (1) the "bid bond" which protects the Obligee should the contractor be awarded the contract and then either does not sign the contract or does not provide the called-for payment or performance bonds, (2) the "payment bond" that guarantees that the contractor will pay workers, suppliers, and sub-contractors, and (3) the "performance bond" that protects the Obligee from loss should the contractor fail to perform on the construction project according to contract. A Surety assures the

Surety bonds are very important for handling the financial consequences of certain risks in the construction industry since many entities require a surety bond from the contractor or sub-contractors as a condition of awarding the contract. For example, general contractors may require their subcontractors to provide surety bonds to protect the contractor. In the public sector, statutory requirements by federal, state and local governments require contractor bonding to ensure the lowest bidder can actually perform on the contract and that suppliers and subcontractors will be paid and taxpayer money be well spent. In the private sector, lending institutions may require surety bonds (and might even become a dual obligee on the surety bond) to protect their investment. Private owners, especially on large projects, may require the contractor provide a surety bond to guarantee the quality of the contractor (since they are pre-qualified as discussed previously) and to make sure their project gets accomplished according to plan in the event of contractor default of failure.

**6. Emerging market technologies affecting construction risk**

There are many emerging risks dues to world dynamics and risks in the market. Construction managers will likely have to respond to these in their risk management processes or pay the consequences. Some insurance providers already have products to address these. Through the use of insurance providers, such as Lloyds of London, construction managers can negotiate new insurance products that

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meet their specific emerging risk management needs or choose to self-insure. This section is forward facing to identify some emerging risks that demand construction management attention before the risks are devastating.

The construction industry is one of the least automated industries, relying heavily on human labor. There are, however, different types of construction robots now poised to revolutionize parts of construction. The use of construction robots can increase efficiency and decrease cost, but also can create risks and uncertainties relatively unfamiliar to construction risk management [22–24].

One potentially disruptive technology is 3D-printing that can build even large buildings on demand. A robotic arm controls a 3D-printer and this 3D printer produces an entire building (or component parts needed for construction). This technology has been used for canals and bridges, with a 3D printed canal built in Netherlands in 2014, and the first ever-3D printed pedestrian bridge built in Spain in December 2016 [24].

Robots may dramatically improve the speed and quality of construction work [22–24]. It was announced recently that Sunconomy, a USA construction company, received permits to build its first 3D printed manufactured house in Lago Vista, Texas [25]. WinSun, a Chinese construction company, expects up to a 50% savings on housing construction using 3D printing [26].

All forms of construction robots could fundamentally change risks, from risks associated with injuries, to project completion time, to supply chains [27]. However, two areas of liability exposure may arise: products liability and intellectual property violations (the 3D plans used).

Contractors using 3D printing should check their CGL policy as many have exclusions for cyber related risk and may exclude liabilities associated with embedded software errors that cause product defect loss when using 3D printing. Contractors should consider getting a version of products liability insurance to cover these losses. Insurance risk transfer issues associated with this emerging technology are discussed in [28]. Demolition robots are another robot that, while slower than demolition crews, are safer and cheaper [29] but create liability.

Emerging AI based applications can be very beneficial to construction. These include: AI innovations providing enhanced visual processing using videos of worksites to help identify safety hazards, drones, high tech sensors and other enhanced visual processing to automate tracking of project progress against plans, as well as 3D models from data captured by drones to measure progress against original designs, and to detect any errors or inconsistencies [30].

In spite of these and other benefits of AI and tech innovations, they do create liability transfer risks still not well identified or addressed. These insurance liability transfer risks are very complex and the party responsible for AI and innovation failures causing damages have yet to be legally decided [31]. Cyber liability exclusions in the CGL may cause lack of coverage issues and it is important for construction managers to recognize and deal with these risks.

#### **7. Conclusion**

There are many risks in construction necessitating decisions to avoid, retain or transfer an identified risk (The A-R-T of Risk Management) that ideally should be made in the planning phase before project start. This chapter delineated characteristics of construction risk and focused on ways to transfer financial risk to the insurance market, to other stakeholders, to retain or to avoid that part of the business creating the risk.

A contractor's goal is to minimize the cost of risk, so alternative risk transfer methods were discussed, from well-established ones to emerging ones. Builders can contractually transfer risks to involved others or clients (e.g., through hold harmless agreements) or to insurance companies. The marketplace is dynamic, and transfer options for construction risks are continually evolving.

This chapter looked forward and discussed emerging technologies that will be creating new risks to anticipate (e.g., the advent of 3D printing, robotics, and AI). Technological advancements will always present new risk challenges.

Finally, issues of sustainability (the ability to have low environmental impact) and resilience (the ability to bounce back from unexpected or catastrophic events) will become increasingly important for construction risk managers. This is partially due to climate change, increasing catastrophic events, and the consequential regulatory changes likely to spur new and challenging building codes. These are among other currently unknown and, as yet unaddressed risks are important for the construction manager to anticipate.
