Completion delay risk management: A dynamic risk insurance approach

In the construction of an infrastructure project, completion delay is one of the major risks to the financial outlook of an infrastructure project under construction. During the construction phase, if the project is delayed, project managers can take specific actions to shorten the duration of certain activities on the critical path in order to restore the project to its original schedule. However, not all management actions to shorten the duration of activities are cost-effective: the cost of reducing some activities' duration may exceed the savings. Risk that project managers cannot economically reduce through management feedback reactions should instead be transferred to third parties such as insurance companies that have risk pooling capacity. In this paper, we present a novel way of managing completion delay risk through "dynamic risk insurance" by combining a technique known as the envelope method with a stochastic-based Monte Carlo method. Two important features of this implementation of dynamic completion risk insurance are (1) a stochastic risk premium between the contractor and the surety over the course of construction and (2) evolution of the risk premium as a function of management feedback reaction. Finally, two illustrative examples, a BOT road and a commercial building, demonstrate how the proposed model may be applied in practice. The new model of dynamic risk insurance presented in this paper may improve risk management practice in large-scale construction projects that are loaded with uncertainty.