The key factors in assessing a risk are:
• the likelihood (probability) of its occurrence
• the size (impact) of its consequences if it does occur.
The likelihood of a risk occurring often affects and is affected by how risks are allocated. Allocating a risk optimally, (to the party best able to control its occurrence and consequences), reduces the likelihood of the risk eventuating by giving the party an incentive to prevent its occurrence. That party is also likely to be in the best position to access information about the likelihood of the risk materialising and can therefore establish a realistic premium.
Likelihood and consequences are combined to produce a level of risk that may be determined using statistical analysis and calculations. Alternatively, where no past data is available, subjective estimates may be made which reflect the degree of belief that a particular event or outcome will occur. To avoid subjective bias, the best available sources of information and analytical techniques should be used in estimating consequences and likelihood of risk. Appropriate sources of information may include the following:
• past records
• relevant experience
• industry practise and experience
• published literature
• test marketing and market research
• experiments and prototypes
• economic, engineering or other models
• specialist and expert judgements.
Investigative techniques may include:
• structured interviews and consultations with experts
• use of multi-disciplinary groups of experts
• individual evaluations using questionnaires
• use of computer and other modelling tools
• use of fault trees and event trees.
Whenever possible, the confidence placed on estimates of levels of risk should be included.
The materiality of the risk should dictate the level of analysis undertaken. A risk that is extremely unlikely to occur and with only potentially minor consequences is unlikely to be of great concern. Conversely, a risk that is likely to eventuate with significant consequences would be of major concern.
When estimating consequences of risk, attention should be paid not only to the potential costs of restoring the project to expectation (i.e., to comply with the project agreement) but also to the cost of any mitigation options, including reallocation to an insurer.