The fundamental objective of risk allocation is that the benefit to the agency of risk transfer exceeds the cost of transfer. This is achieved by transferring risks to the party or parties that are best able to manage them and are therefore likely to price these risks competitively.
An iterative approach should be taken to risk allocation, by initially grouping risks in three basic categories:
■ retained risks, being those risks that will always reside with the public sector, such as policy or regulatory risk;
■ transferable risks that may be assigned to the private sector; and
■ negotiable risks that may be retained by the public sector or transferred to the private sector through negotiation.
The initial risk allocation provides the project team with a preliminary indication that there are sufficient, material transferable risks that can deliver a value for money outcome. For the majority of projects, there will be a number of transferable risks that are not negotiable, meaning that value for money cannot be achieved unless these risks are passed to the private sector.
Distinguishing between retained and transferable risks at an early stage also allows project team to identify those retained risks that should not be passed to the private sector. If the private sector is compelled to accept risks that it may not be able to manage, it is highly likely that the cost of transferring those risks will exceed the benefit to the agency of transferring the risk. This will erode value for money and in the extreme case may lead to the failure of the project.
Risks should be prioritised prior to allocation, to ensure that the project team focuses on the transferable risks that may have a major impact on project costs and benefits, and may require extensive negotiation with the private supplier. Low cost/low probability risks are unlikely to materially affect the PSC and can be given a correspondingly low priority.
The overall profile of risk transfer is likely to change as the project progresses. It is vitally important that these changes are recorded in the risk matrix and updated in the PSC.