Government can allocate most risks to the private sector, provided the cost of their allocation is adequate, and the private party is able to diversify its portfolio to manage the consequences of the risks. An efficient market exists in the management of risks, with private parties keen to assume risks in return for a premium.
An important question for government to address is whether the risk premium it is paying to transfer the risk represents value for money or whether, in some cases, assuming the risk itself might prove a more cost-efficient option.
The theory of optimal risk allocation suggests that it is unwise for a party to allocate a risk that is predominantly within their control to a third party who will be unable to adequately manage the risk. The risk is only accepted by the third party at a costly premium, which in turn diminishes the likelihood of achieving a value for money outcome. Conversely, if a risk can be appropriately managed and mitigated by a third party, it should not attract a costly high-risk premium. This creates an incentive for risk transfer.
The development of the public private partnership business case provides insight into risk valuation to ensure government is not charged an excessive risk premium. It is designed to assist in optimising value for money in risk allocation by determining when a risk would best be assumed by government.