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Article Excerpt
Introduction
Construction is one of the most dangerous and risky occupations. Insurance is a keystone to eliminate most of the financial threats in construction business (Clough, Sears & Sears, 2005). Bunni, (2003) identified five types of insurance that are available for contractors for different risk nature: contractors' all risk insurance, general liability insurance, worker's compensation insurance, motor insurance, and marine transport insurance. Contractors' all risk insurance covers physical losses or damage to works, plant, equipment and materials during the course of construction that result from crises such as natural disasters, fire/explosion or collapse. General liability insurance indemnifies the contractor in respect of legal liability for damages to a third party or their property due to a project. Under the workers' compensation system, cost of all injuries/fatalities to workers resulting from construction activities should be borne by the contractor, irrespective of fault. Worker's compensation insurance (WCI) is purchased to transfer this financial risk to a professional insurer. Motor insurance provides liability coverage for over-the-road hazards for self-propelled motor vehicles used for the sole purpose of providing mobility of construction equipment. In international construction, marine transport insurance is required to protect from any losses resulting from ship crises when travelling by sea.
Out of these five classes of insurance, the significance of the WCI in construction is overwhelming because the construction industry is well known for poor safety performance globally. The construction industry in the US accounted for only 5% of the US's workforce but claimed a disproportionate 20% of all occupational fatalities (National Safety Council, 1997). In the UK, construction accounted for 31% of all work-related deaths in 2002/03 (Haslam, Hide, Gibb, Gyi, Pavitt, Atkinson & Duff, 2005). On average, 49 construction workers have been killed at work each year in Australia (Fraser, 2007). The Singapore construction industry accounted for 29% of the total number of industrial workers, but accounted for 40% of worksite accidents (Chua & Goh, 2004). Hence, the workers' compensation insurance (WCI) has been recognised as an imperative for construction by legislation in most countries to safeguard the interests of injured workers as well as to ease the contractors' financial burden of compensating. On the other hand, insurance companies issuing WCI for construction projects are forced to assume abundant financial risks. This implies that construction WCI is a critical part in the entire portfolio of any insurer's business, which entails rigorous attention for risk assessment and premium rating.
Experience modification rating (EMR) technique is commonly used in many countries for WCI premium rating. Nevertheless, many researchers have criticised EMR as being ineffective for construction applications. A detailed account on EMR and its shortcomings is available in Hoonakker, Loushine, Carayon, Kallman, Kapp and Smith, (2005). Insurance companies in many countries use their own models, notwithstanding EMR, but these are ineffective and lead to detremental losses for insurers. In the Singapore insurance industry, for example, WCI premiums are traditionally computed by applying a rate on the wage roll of construction projects. There has been a collective agreement among general insurers that the preferable WCI premium rate for construction projects is 1% of the wage roll. This rate is merely a benchmark. Individual insurers set competitive rates around the benchmark considering the market condition. However, no strong theory supports this benchmark norm and effective framework is therefore lacking for insurers to undertake structured risk and market analyses. In the face of keen competition, underwriters tend to compromise the risk analysis due to the lack of a well-balanced framework. This causes riskier projects being covered by insurers at lower premiums, which ultimately result in adverse loss ratios. The industry statistics for year 2006 of the General Insurance Association of Singapore reinforced that despite WCI being the third largest class of insurance in Singapore; it achieved poor underwriting results over the years, which is mainly due to unrealistic pricing. It continued to struggle in 2005 with an underwriting loss of S$7 million in the first half of 2005 compared to the same period in 2004, when it lost S$1 million. The incurred loss ratio has climbed from 72% to 80% (GIA, 2006). Hence, there is an intense need for re-engineering the WCI premium formula for construction projects. The objectives of this paper are to:
1. Identify the critical variables that influence WCI premiums for construction projects; and
2. Develop a premium computation model.
Premium-rating Variables for Construction WCI
In insurance, unlike other industries, the cost of the production is unknown when the contract is sold, and it will be unknown until the policy expires. Therefore, the pricing for insurance must be based on predictions of losses, expenses and incomes in the future. Under WCI, the commitment of an insurer is extremely broad; there are no exclusions or maximum limits on the insurer's liability (Vaughan & Vaughan, 1996). Setting an appropriate cost for some future contingency of unpredictable timing, frequency and size requires the estimates of future claims, investment income, administrative expenses, profit and tax. In addition, the price can profoundly influence the volume of the business attracted (Booth, Chadburn, Cooper, Haberman & James, 1999). Hence, WCI premium rating is a critical management function for any insurer, which should decide premiums that are high enough to cover all the future costs, yet low enough to beat the market competition. The premium rating is regarded as a two-stage process (Booth et al., 1999):
1. The costing exercise--this is a scientific method that calculates the cost of future claims from the insured risk and all associated expenses.
2. The pricing exercise--this is a commercial adjustment to technical costs that considers broader corporate and market factors.
Predicting Future Claims in Construction WCI
The scientific approach to determine the cost of future claims of a WCI policy entails an assessment of project and contractor-related variables. Under the project-related variables, the following were identified by various authors:
* Worrall and Buttler, (1988) noted that the wage roll, project duration and the expected workers' compensation liability per...
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