TRANSFERRING RISK
11 Box 4.3 describes the general types of risk a project manager is likely to encounter.4
12 Risk assessment will inform an overall view of the viability of an option, i.e. whether its risk-adjusted benefits exceed its risk-adjusted costs, or whether (in the case of uncertainty) the costs of a possible adverse outcome are so great that precautionary action needs to be introduced to obtain a cost-effective solution.
BOX 4.3: GENERAL TYPES OF RISK
Availability risk | The risk that the quantum of the service provided is less than that required under a contract. |
Business risk | The risk that an organisation cannot meet its business imperatives. |
Construction risk | The risk that the construction of physical assets is not completed on time, to budget and to specification. |
Decant risk | The risk arising in accommodation projects relating to the need to decant staff/ clients from one site to another. |
Demand risk | The risk that demand for a service does not match the levels planned, projected or assumed. As the demand for a service may be partially controllable by the public body concerned, the risk to the public sector may be less than that perceived by the private sector. |
Design risk | The risk that design cannot deliver the services at the required performance or quality standards. |
Economic risk | Where the project outcomes are sensitive to economic influences. For example, where actual inflation differs from assumed inflation rates. |
Environment risk | Where the nature of the project has a major impact on its adjacent area and there is a strong likelihood of objection from the general public. |
Funding risk | Where project delays or changes in scope occur as a result of the availability of funding. |
Legislative risk | The risk that changes in legislation increase costs. This can be sub-divided into general risks such as changes in corporate tax rates and specific ones which may affect a particular project. |
Maintenance risk | The risk that the costs of keeping the assets in good condition vary from budget. |
Occupancy risk | The risk that a property will remain untenanted - a form of demand risk. |
Operational risk | The risk that operating costs vary from budget, that performance standards slip or that service cannot be provided. |
Planning risk | The risk that the implementation of a project fails to adhere to the terms of planning permission or that detailed planning cannot be obtained, or if obtained, can only be implemented at costs greater than in the original budget. |
Policy risk | The risk of changes of policy direction not involving legislation. |
Procurement risk | Where a contractor is engaged, risk can arise from the contract between the two parties, the capabilities of the contractor, and when a dispute occurs. |
Project intelligence risk | Where the quality of initial project intelligence (eg preliminary site investigation) is likely to impact on the likelihood of unforeseen problems occurring. |
Reputational Risk | The risk that there, will be an undermining of customer/ media perception of the organisations ability to fulfil its business requirements e.g. adverse publicity concerning an operational problem. |
Residual Value risk | The risk relating to the uncertainty of the value of physical assets at the end of the contract. |
Technology risk | The risk that changes in technology result in services being provided using non-optimal technology. |
Volume risk | The risk that actual usage of the service varies from the level forecast. |
13 When faced with significant risks, a public body should consider transferring part or all of it to the private sector. The governing principle is that risk should be allocated to whichever party from the public or private sector is best placed to manage it. The optimal allocation of risk, rather than maximising risk transfer, is the objective, and is vital to ensuring that the best solution is found. Accordingly, the degree to which risk is transferred depends upon the specific proposal being appraised.
14 Successful negotiation of risk transfer requires a clear understanding by the procuring authority of the risks presented by a proposal, the broad impact that these risks may have on the suppliers' incentives and financing costs, and the limits to risk transfer which might still be considered for value for money.
15 Where the private sector has clear ownership, responsibility and control, it should be encouraged to take all of those risks it can manage more effectively than the procuring authority. If the public body seeks to reserve many of the responsibilities and controls that go hand-in-hand with service delivery and yet still seek to transfer significant risk, there is a danger that the private sector will increase its prices.
16 Appropriate transfer of risk generates incentives for the private sector to supply timely cost effective and more innovative solutions. As a general rule, PFI schemes should transfer risks to the private sector when the supplier is better able to influence the outcome than the procuring authority. Risks to be considered include:
❑ Design and construction risk: to cost and/ or time;
❑ Technology and obsolescence risks;
❑ Commissioning and operating risks, including maintenance;
❑ Regulation and similar risks (including taxation, planning permission);
❑ Demand (or volume/ usage) risks;
❑ Residual value risk; and
❑ Project financing risk.
17 A risk allocation table can be a useful tool to identify the bearer of each risk relevant to a proposal. An example of this is set out in Box 4.4.
BOX 4.4: EXAMPLE OF RISK ALLOCATION TABLE
Scale | Bearer | Key Issues | ||
Purchaser | Provider | |||
Obsolescence | Low |
|
| Assets require low levels of technology |
Demand Risk | Med |
|
| … |
Design risk | High |
|
| … |
Residual Value | Low |
|
| … |
3rd party revenues | Low |
|
| … |
Regulatory change | High |
|
| … |
etc. | … |
|
| … |
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4 See OGC website: http://www.ogc.gov.uk/