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INVESTIGATING THE EFFECTIVENESS OF INSURANCE AS RISK MANAGEMENT TOOL IN CONSTRUCTION INDUSTRY

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ABSTRACT

The nature of construction business is risk versed. Most forms of construction contract recognized the use of insurance as risk management tool. Few studies however, evaluates its effectiveness as risk management tool. This study investigated the efficacy of insurance in curbing risks in construction project delivery. The objectives were to identify insurable risks in construction project delivery, identify prevalent insurance policies in the construction industry, and to determine their level of use. Survey questionnaire were administered to 220 targets in the clients, contractors, and consultants organisations and insurance companies in Akwa Ibom state. Data analysis involved descriptive statistics and Relative Important Index. The findings revealed the five most significant insurable risks in the construction industry as injury to person, injury to property and heavy rain, fire, poor construction method and poor site management practices. Further findings revealed the most significant insurance policies in the construction industry are bid bond, contractors all risks insurance, performance bond, motor insurance and third party insurance. The level of use of these insurance policies is however very low and their effectiveness deemed adequate to address construction risks. To promote increased adoption of insurance in construction risk management, awareness of the benefits must be propagated to the common domain.

CHAPTER ONE

INTRODUCTION

1.1                Background to the Study

No construction project is risk free. Every construction project, large or small, involves risks with varying impact. The construction industry is subject to more risk and uncertainty than many other industries (Flanagan and Norman, 1993). The process of taking a project from initial investment appraisal to completion, and into use, is complex. It requires a multitude of people with different skills and interests and the co-ordination of a wide range of disparate, yet interrelated activities. Such complexity moreover, is compounded by many external, uncontrollable factors. Risk may hinder the successful completion of a project by causing time and budget over-run, and/or quality default.

Construction insurance is used as a collective term to describe various types of policies to protect construction works, erection and operation of machinery. Traditionally, it is assumed to be only limited to the construction stage. However, the project is a whole life process, which includes a feasibility study, a call for tender and evaluation of tenders, an award of contract, construction and erection phases, and a take-over and maintenance period. Many researchers (Palmer, 1996; Bunni, 2003) discussed all possible insurance policies during the whole project process to build an overall picture of construction insurance.

The Oxford Advanced Learner‟s Dictionary (1995) defines risk as the “chance of failure or the possibility of meeting danger or of suffering harm or loss”. In construction projects, a risk may be defined as the likelihood of a detrimental event occurring to the project. Since the objectives of construction projects are usually stated as targets established for function, cost, time and quality, the most important risk in construction is failure to meet these targets. Within the scope of management and decision theory, research in construction and project risk management began in 1960‟s (Guilin, 2004). Risk management is defined as a set of methods and activities designed to reduce the disturbances occurring during project delivery (Skorupka, 2003). It can also be defined as the structured set of processes aimed at identifying, analyzing and responding to project risks. It includes maximizing the results of positive events and minimizing the consequences of negative events (PMBOK Guide, 2000). According to Gray (2000), risk management is a proactive approach rather than reactive. It is preventive process designed to ensure that surprises are reduced and negative consequences associated with the undesirable events are minimized. Successful management of project risk gives the project manager better control over the future and can significantly improve chances of reaching project objectives on time, within budget and meeting required technical (functional) performance.

Insurance is a risk transfer technique of passing the responsibility of risks to another party. Risks can be transfer either through contracting or by insurance which changes an uncertain exposure to certain cost. Transferring risk does not necessarily reduce the effect the risk would have or the likelihood of its occurrence but only passes the responsibility to another party. From the legal viewpoint, insurance allocates the risks to which the project is exposed, between the parties. Dickson (1983) highlighted insurance as a risk transfer mechanism that the insured transfer from a state of uncertainty to a state of certainty at the certain cost of the insurance premium. It is a cost-smoothing mechanism, in which contractors exchange a regular known annual premium for an unknown potential loss. This study investigates the appropriateness of insurance as a risk management tool in the construction industry.

Construction insurance is a practice of exchanging a contingent claim for a fixed payment to protect the interests of parties involved in a construction project. Construction insurance is a major method of managing risks in the construction industry. Its primary function is to transfer certain risks from clients, contractors, subcontractors and other parties involved in the construction project to insurers to provide contingent funding in time of difficulty. Construction insurance plays an increasingly important role in guaranteeing the success of projects, with insurers sharing losses resulting from natural disasters and other contingencies. Insurance is, of course, only one means of managing risks associated with projects. It needs to be put into context and understood that not every risk can be insured against, insured against adequately or insured for a price that is acceptable. As stated in the statement of problem, construction insurance does not receive the attention it deserves as a result of lack of proper risks management practices in the construction industry. The research sought to identify insurable risks and the types of insurance typically involved in the Nigerian construction industry. The study is expected to contribute in raising the awareness of the insurable risks and policies which project participants are exposed to, in construction contracts. It provides a tool for decision-making in contract formation especially in insurance policies.

1.2       Statement of the Problem

The provision of insurance is generally considered important and indeed in the event of a major loss, the insurance may be the only viable means of repaying financiers or ensuring that the Project is back on track. However paradoxically, rarely does insurance receive the attention it deserves, either within the overall context of the deal or in the detail of the interrelationship between the drafting of the construction contracts. Also practitioners sometimes do not have a clear understanding of risk allocation and the strategy of risk management through insurance. This can result in claim difficulties which can consequently affect the project in diverse ways, such as increase in project cost, completion time of the project as well as quality.

It is important to understand the extent of the insurance contract before contractual terms are finalized to avoid circumstances where risks have been assumed based on the wrong assumptions of a party's ability to obtain particular insurance at a commercially acceptable price (or at all). This is of particular concern in the current climate where insurance premiums are higher; policies contain many limitations and exclusions.

1.3        Research Questions

The following research questions are set-out to guide the study:

·         What are the insurable risks in construction project delivery?

·         What types of insurance policies can be used in the construction industry for effective risks management?

·         What is the level of use of identified insurance policies in the construction industry?

1.4          Aim and Objectives of the Study

The main aim of the research was to conduct an investigation into how insurance is used as a risk transfer tool in the Nigerian construction industry with a view to improving insurance uptake. The objectives of the study include to:

·         identify the most insurable risks typically involved in the construction project delivery;

·          assess the types of insurance policies commonly used in the construction industry;

·         determine the level of use of identified insurance policies in the construction industry

1.7            Scope of the Research

The study focused on insurance as a risk management tool for the construction industry in Akwa Ibom State. The construction industry in Akwa Ibom State have witnessed various complex high risk projects in the last Six years including Pile Jack Underground Drainage Systems and many other five star projects. It is limited to insurance companies, contractors within the state capital and public sector clients mainly Ministry of Works and Ministry of Housing and Urban Renewal. 

1.8              Organisation of the Research

The research was organised in Five (5) Chapters. Chapter one provided the introduction and background to the problem. This was followed by a review of literature on risk management and construction insurance in the second chapters. The third chapter highlighted the research methodology and data collection method. Analysis of the research results was discussed in chapter four while conclusions and recommendations were captured in chapter five.

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