Risk of pavement warranties to contractors

The federal and state Departments of Transportation are currently implementing warranties in highway construction projects with objectives to improve construction quality and encourage contractor innovation. The contractors react by increasing their bids to compensate for the additional risks that the warranties impose on their businesses. Risks have long been recognized and studied in the construction industry. However, a systematic study on risk of construction warranties basically does not exist. Many research efforts have been made to develop guidelines for implementing warranties and to evaluate their effectiveness. But all the studies are conducted from the owner's point of view. No guideline has been developed to guide contractors through the warranty process. Survey results indicate that most contractors are not familiar with warranties. The objective of this research is to define a concept of warranty risk and develop an approach to measure the contractor's business risk exposure to pavement warranties. This research is conducted from the contractor's perspective and begins with a review of the highway construction business. The risk of warranties to the contractor is defined as the probability that actual warranty period repair costs will exceed the estimated repair costs. Three factors for warranty risk are identified to be the uncertainty in repair work quantities, unexpected price escalation, and timing of repair. An investigation of historical pavement condition survey data is conducted to analyze the uncertainty of pavement performance after construction. Life distribution models are fitted using the performance data to model the time for each type of distress to occur. Uncertainty in future price escalation is analyzed using the historical highway construction cost index. The Box-Jenkins procedure is followed to build a time series model for assessing future price uncertainty. The Monte Carlo simulation approach is adopted to integrate all the models and produce a probability distribution for warranty risk. Value at Risk (VaR) is used as a measure of warranty risk. A real case study is conducted to demonstrate and validate the simulation approach.