Spotlight on Risk

By Bill Beck, WorleyParsons

Risk and uncertainty are inherent to the construction industry and carry with them a potential for time, resource, and monetary loss. These risks are divided among the project participants in various ways depending upon contract format and language. The Body of Knowledge of the Construction Industry Institute (CII) provides members with important research on risk management procedures. (See Knowledge Area 10 – Risk Management.)

Identification and measurement of risks must be an included element of pre-bid planning by the contractor. Failure to do so is equivalent to overlooking direct work items included in the contract. Because there are so many risks to a nearly infinite number of combinations, it is essential that the contractor uses a structured, practical approach for the evaluation. Several sophisticated commercial computer software programs are now available to facilitate this analysis. Given the large amount of money spent on risk management and insurance in the construction industry, greater use of risk management information systems (RMIS) would help risk managers to make better informed risk retention and transfer decisions.

Accepting risk and providing contingency to cover it is only one form of risk control. Others include risk avoidance, risk sharing, risk reduction, risk transfer, insurance and risk containment. It appears that there is a tendency for owners to transfer risk to contractors and then require the contractor to purchase insurance. This may not be the most cost effective method of risk financing in many cases. While every risk carries with it the potential for a loss, this loss is not assured and there may be a potential for gain. Thus, risk containment efforts must be directed toward both preventing losses and taking advantage of any gain potential. An efficient allocation of risk transfers risk to the party that can bear that risk at the lowest cost (the least-cost risk bearer), while equity considerations call for risk to be shifted to the party that controls the loss exposure. By balancing these sometimes conflicting goals, the total cost of risk for a project can be minimized, other things being equal.

CII’s research stresses the importance of the risk management phases (identification – measurement – management). Each phase is necessary to the analysis to provide optimum results. In addition, the sequencing should start with the identification and end with proper management. The process should be continuous throughout the project, for conditions are susceptible to change and the amount of information increases as the project progresses. Below you will find description of each risk management phase.

  • Identifying the Risk: The risk identification phase is designed to determine the nature and source of risks, and thus provide a list of risky elements. Without initially identifying potential project risks a risk analysis would not exist. There would be nothing to measure and thus, nothing to manage.

    There appear to be three major sources for identifying risk: experience, insight, and historical data. As a combination of the three, the best method of identifying risks would be modifying historical data (if available) by human insight and experience. The risk characteristics that are of major concern are: 1) the severity of loss, and 2) the frequency of loss.
  • Measuring the Risk: Phase two of a risk analysis is the measuring of the identified risks. It is in this phase that one attempts to quantify the frequency and severity based on the variability of inputs. The method of measurement presented in this report dealt in terms of the risk element’s cost.

    The attributes of the various risk measurement techniques which are important to consider during selection are:
    1. The type of risk which is best modeled by the technique.
    2. The kind of output which is provided to the decision-maker.
    3. The types of model and data required by the technique.
    4. The ability of the technique to handle complexity and correlations among the variables.
    Many different techniques are available to measure risk, each has an appropriate niche. It requires some skill and knowledge to successfully match the capability of the tool to the requirements of the decision. The important elements of the decision are 1) the perceived seriousness of the risk, 2) the complexity of the situation and 3) the availability of the required expertise.
  • Managing the Risk: As the final phase of a risk analysis, the management of identified and measured risks is the point where considered decisions are needed. These decisions begin at conception and continue through plant start-up and beyond. And these decisions will have to be made to control the risks in the project scope, cost, contracts, quality, and resources. Contingency plans were discussed as a means of managing risks. Five alternatives are presented in this report which may be used to help control risks. These are: elimination, reduction, transfer, sharing, and retaining uninsured. With the initial control in the hands of the owner, it is his choice as to who controls particular risks. Yet, the decision maker should be cognizant of who can best control the risk, and who is in the best position to accept it.

The risk management process should be continuous throughout the project, for conditions are susceptible to change and the amount of information increases as the project progresses. For additional information on this topic, please refer to the CII Body of Knowledge, Knowledge Area 10 – Risk Management, to see the complete list of CII research publications on risk.

Date posted: September 3, 2015