Defense Contractor Stability Pool: Converting Termination Risk into Insurable Protection 

A Practitioner Recommendation for Mobilizing Private Capital
by Andrew Hersh

BENS brings practitioner perspectives from the business community to the nation’s most pressing security challenges. Through our Mobilizing Private Capital campaign, we’re translating that understanding into action. 

As the threat environment grows more complex and appropriations remain unpredictable, senior national security leaders are intensifying efforts to attract private investment. The challenge now is helping the rest of the ecosystem keep pace, ensuring that capital markets, industry, and the broader bureaucracy understand the shift, build the necessary connections, and adapt their practices to accelerate it. 

This campaign meets that challenge through a series of member-led recommendations. This recommendation comes from Andrew Hersh, National Security Leader at Newfront Insurance, Chairman of Governance Risk Global, and Founder and former CEO of Sigma7 Risk. Andrew is an innovator in the field of Risk Management, having founded the largest independent global risk services business and having built several insurance brokerage businesses with a focus on protecting national critical infrastructure. He has advised the Department of Energy, the Federal Emergency Management Agency, and the Department of Defense on governance, supply chain risk, and on the privatization of operations and catastrophic risk insurance pools. With nearly 30 years addressing complex risk challenges, he is a thought leader on how private insurance capital can be best leveraged to achieve national resilience, in securing critical supply chains, and to facilitate private capital investments across these sectors. He believes that risk pooling mechanisms – proven in commercial and non-defense infrastructure – could lower the risk profile for defense contractors and unlock private investment. 

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Establish a Public-Private Partnership (P3) Defense Contractor Stability Pool (DCSP), an industry‑funded, privately managed risk pool that transfers the risk of termination‑for‑convenience (T4C) exposure that FAR Part 49 does not fully compensate. This would convert sovereign contract uncertainty into priced, transferable risk, mobilizing private capital to expand defense production capacity. While we acknowledge that “insurance” is almost entirely constrained to accidental and fortuitous loss, we are using the term broadly throughout this document to refer to transferable risk.

The mechanism advances only if validation confirms: (1) termination uncertainty is a top constraint on lending, (2) loss patterns support sustainable pooling, and (3) government backstop can be structured to avoid Federal Credit Reform Act (FCRA) subsidy scoring.

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The Opportunity  

Mid‑tier contractors – roughly $50M–$500M in revenue – hold real Department of Defense (DoD) demand, but face high borrowing costs or outright denials because lenders cannot price sovereign contract uncertainty. Collective risk mechanisms in other sectors, Federal Housing Administration mortgage insurance, terrorism insurance in the United Kingdom known as Pool Re, and Owner‑Controlled Insurance Programs (OCIPs) in construction demonstrate that risks viewed as “uninsurable” can become investable when losses are defined, pooled, and backstopped. 

How the Pool Would Work 

Coverage structure: The DCSP would cover specific, uncompensated losses from T4C, the residual risk exposure that FAR Part 49 either explicitly excludes or leaves to subjective determination. Coverage would use clear, objective triggers and exclusions to limit moral hazard through either: 

• Traditional indemnity insurance covering documented extra-expenses directly related to the canceled project and its business impact, such as unrecovered capital investments, contract-specific tooling, and working capital stress during settlement. This approach makes contractors whole for actual incurred losses. 
• Parametric trigger structure (an insurance-linked security) where contract cancellation triggers a predetermined fixed payment to the contractor regardless of actual documented losses. The parametric approach expedites payment without requiring extensive loss documentation, making tooling and facility investments effectively “cash-equivalent” collateral for lenders. Unlike indemnity insurance, this capital markets instrument could include compensation for lost expected profits on unexecuted work. 

Financing and backstop: Premiums would be priced actuarially based on historical dollars-canceled rather than count of terminations; the pool is funded by contractor premiums. Government provides a catastrophic backstop structured as senior secured debt with super-priority repayment rights, subject to clear repayment terms with potential interest, making the backstop cost-neutral or revenue-positive over time. Private reinsurers and capital markets should participate to reduce the government backstop burden, which will also be reduced as capital reserves grow over time. As with any insurance company, the DCSP will be able to invest its float capital subject to government and regulatory rules, generating investment income that contributes to long-term sustainability. 

Why This Matters 

If T4C exposure can be priced and pooled, lenders can underwrite on conventional credit fundamentals – execution, collateral, cash flows – instead of worst‑case sovereign shocks. The expected effect is lower cost of capital and greater availability of growth debt for facility build‑outs, tooling, and workforce, precisely where DoD needs surge capacity. 

Economic benefits extend beyond contractors: Contract cancellations trigger economic losses that reduce corporate and payroll tax revenue back to government. While insurance premiums may represent 1-2% of covered contract values, the government gains investment income from capital reserves, tax revenue protection from economic stabilization, and avoidance of emergency appropriations for distressed defense suppliers. Over time, a well-managed pool could become revenue-neutral or positive for government while materially expanding defense industrial capacity. 

Why insurance pooling over alternatives? Expanded Defense Production Act (DPA) Title III direct loans require program-by-program appropriations and do not address systemic risk perception across the lending community. Cost-plus contracting reduces contractor risk but doesn’t unlock private capital for facility investment. Pooling, where actuarially viable, creates a self-sustaining mechanism that transfers risk and scales across programs without repeated appropriations battles. 

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The Challenge 

What FAR 49 leaves uncertain 

FAR Part 49 provides substantial protection to contractors through allowable cost reimbursement through FAR Part 31, reasonable profit on work performed and preparations made through FAR 49.202, and partial payments during settlement through FAR 49.112-1 – up to 100% for completed items and approved subcontract settlements, and up to 90% for termination inventory and other allowable costs. 

However, FAR 49 explicitly excludes certain categories and leaves others to subjective determination, creating a residual risk exposure that lenders cannot price. This residual risk, though smaller than total contract value, is what makes defense contracts difficult collateral for private lenders. The DCSP targets only this gap: 

1. Consequential damages and certain cost recoveries face subjective determinations. FAR 49.201 calls for “fair compensation” determined by the Termination Contracting Officer (TCO) using “business judgment, as distinguished from strict accounting principles.” What constitutes fair compensation for unamortized capital and specialized tooling made post-award for multi-year production may not be fully recovered when termination occurs early in contract performance. 

2. Subcontractor penalties may or may not be allowable depending on FAR Part 31 cost principles and how subcontracts were structured. 

3. Working capital gaps persist despite partial payments. The 10% not advanced on certain costs, plus settlement expenses, which do not receive partial payments, plus 6-12 month settlement timelines create cash flow stress – particularly for smaller firms without deep credit lines. 

4. Subjective determinations of what costs are “reasonable” and what profit is “fair” under FAR 49.202’s nine-factor test create uncertainty that lenders cannot price. FAR 49.202 also explicitly excludes anticipatory profits, while traditional indemnity insurance cannot cover speculative profits, parametric insurance-linked security structures could address expected returns on capital. 

The inability to insure or price this residual sovereign termination uncertainty degrades collateral value and drives lenders to demand prohibitive rates or decline the exposure entirely. 

NOTE: DCSP does not replace FAR 49. It insures the residual risks that FAR 49 either explicitly excludes or leaves to subjective determination. The goal is to convert sovereign uncertainty into priced, insurable risk, making defense contracts viable collateral for private lending. 

Actuarial Uncertainty 

Pooling requires dollar‑weighted loss data by fiscal year, agency, appropriation, contract type, and phase. If cancellations are infrequent but highly correlated during fiscal stress such as sequestration‑like periods, capital reserves may be depleted in a black-swan event and the government backstop may be triggered. To stand up a P3 insurance pool, it must acknowledge and be prepared for a black-swan event. Today, the necessary data to determine the spread and magnitude of risk exists across DoD/DCMA/Comptroller systems but are not analyzed for this purpose. 

Critical risk: Termination decisions are policy choices, not random events. In a year like 2025, where the government engineered widespread spending reductions through its DOGE program, risk that previously appeared distributed could breach the capital reserves in the pool. 

Moral Hazard and Governance 

Because government decisions trigger claims, design must avoid dulling program discipline. Coverage must exclude terminations for cause such as contractor non-performance, use narrow and objective triggers, and structure premium differentials to internalize cancellation costs. Governance must be independent of program offices while remaining accountable to Congress, the U.S. Department of the Treasury, and participating firms. 

Budget Optics and Scoring 

Contractors will pass premiums into bids, with DoD effectively paying 1–2% more on covered programs. That surcharge is justifiable only if the mechanism unlocks materially more private investment and accelerates capacity than alternative tools, and if the government realizes offsetting benefits through investment income, tax revenue stabilization, and reduced emergency appropriations. 

Critical barrier: Under the Federal Credit Reform Act (FCRA), if the government backstop has expected net cost (premium revenue < expected claims + admin costs), the Congressional Budget Office (CBO) will score subsidy cost upfront as budget authority. Phase 1 must pre-clear a backstop structure with the CBO and Office of Management and Budget that qualifies it as revolving credit; not a credit subsidy. A proposed approach for addressing this barrier is for government to collect risk-based premiums for the backstop itself – making it actuarially neutral. Or structures the backstop as senior secured debt with super-priority repayment rights above all other pool obligations. Without favorable CBO scoring, political viability is zero. 

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The Path Forward

A staged approach with hard decision gates ensures we only scale if the economics, insurability, and market behavior check out. 

Phase 1: Validate Economics, Insurability, and Legal Path 

Answer the fundamental questions: 
Does termination uncertainty actually constrain defense lending? Lender and contractor surveys must establish whether this ranks as a top-tier constraint and whether coverage would materially change lending behavior. 

Are loss patterns insurable? Historical termination data must show whether losses are distributed enough to support pooling or too concentrated in fiscal stress periods. If terminations spike during budget cuts and continuing resolutions, correlation breaks pooling economics. 

What premiums are sustainable? Analysis will determine whether viable premiums align with comparable risk pools (terrorism insurance, construction OCIPs), or whether DoD termination patterns make pooling uneconomical. Any premium estimates prior to this analysis are speculative. 

Will reinsurers engage? Major reinsurers must review preliminary data and risk models to assess whether they would consider providing capacity. Reinsurer willingness to participate, even conditionally, is the market’s verdict on insurability. Without sophisticated reinsurance capital validating the risk model, pooling lacks credibility. 

What is the legal and budget path? Identify whether existing authorities (DPA Title III) can be adapted or whether new legislation is required. CBO scoring methodology is make-or-break. If CBO scores the government backstop as a subsidy cost rather than revolving credit, political viability drops sharply. Phase 1 must pre-clear scoring treatment with OMB/CBO before advancing. 

How do we ensure large prime participation? Large prime participation is essential for pool diversification and adequate capitalization, but incentives are not yet identified. Phase 1 must propose credible mechanisms or acknowledge the pool cannot achieve necessary scale. 

Decision Gate A — Proceed only if validation confirms: 

• Termination uncertainty is a top-tier lending constraint with material rate impact potential 
• Loss patterns support sustainable pooling (not excessively concentrated in fiscal stress) 
• Major reinsurers express conditional interest in the risk structure 
• A viable statutory and appropriations path exists with acceptable CBO scoring 
• A credible mechanism for large prime participation has been identified 

If validation fails, publish findings and stop. Understanding why pooling doesn’t work helps direct future efforts toward constraints that actually bind. 

Phase 2: Design & Controlled Pilot 

Test whether coverage changes behavior: 
Design the pool architecture, triggers, exclusions, limits, premium methodology, capital model, claims governance, and government backstop structure. 

Run a controlled pilot targeting capital‑constrained mid‑tier contractors first (munitions, shipbuilding supply chains, uncrewed systems). Require binding lender commitments contingent on coverage to ensure we’re measuring real behavior change, not hypothetical interest. 

Engage credit rating agencies to assess whether coverage receives favorable treatment in credit analysis – critical for institutional lenders who face risk-weighted capital requirements. 

Measure outcomes that matter: 

• Do borrowing costs actually decline for firms with coverage? 
• Do firms that were previously denied capital gain access? 
• Does capital flow to facility investment and tooling, not just cheaper refinancing? 
• Does coverage translate to measurable capacity expansion—new production lines, increased throughput, faster surge response? 

Decision Gate B — Scale only if pilot demonstrates clear behavior change and industrial capacity gains. Terminate if evidence shows other constraints dominate (cost/pricing data, performance risk, payment lags) or if coverage doesn’t materially expand access to capital. 

Phase 3: Scale with Guardrails 

Expand eligibility to additional sectors while implementing large prime participation requirements to ensure pool depth and risk diversification. Lock in reinsurance panels and adjust pricing based on observed experience. Establish independent governance with actuarial oversight and public performance dashboards. 

The ultimate test: Does DoD get more industrial capacity per dollar spent on premiums than alternative uses of that budget? If not, sunset the program. Measurement must focus on industrial outcomes, production lines stood up, throughput increases, surge capacity improvements, not just financial engineering metrics. 

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Conclusion 

The DCSP is not a blanket subsidy or a claim that “this is proven.” It is a disciplined test of whether a targeted, pooled insurance mechanism can convert sovereign contract uncertainty into a priced, investable risk. And in doing so, mobilize private capital to expand production capacity. 

The proposal is deliberately conditional: advance if the data, reinsurers, lenders, and law align. Stop if they do not. Findings should be published at each decision gate, regardless of outcome, including negative results that redirect effort toward true binding constraints. That is the right standard for serious practitioners. 

Success is measured not by financial engineering elegance, but by whether the mechanism delivers measurable industrial capacity expansion at favorable return on investment. If validated, DCSP becomes a scalable tool in the mobilizing private capital portfolio. If not, the rigorous validation process will yield hard evidence to guide future capital mobilization efforts. 

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