6.4  Identify all material risks and quantify consequences of risk

Once all material risks have been identified, the procurement team will need to assess and quantify the possible consequences of each risk eventuating, including the effect of any timing issues. This requires a thorough understanding of all areas of the project.

There should be an attempt to value all material risks, even those that at first appear difficult to quantify. Nevertheless, a flexible approach to the number of risks and the valuation methods used is required. Primary effort should go into valuing the more important risks (the Pareto or 80/20 rule). Where there is insufficient data to value a risk, commonsense approximations may be used. However, if a risk cannot be sensibly quantified, its exclusion from the PSC should be noted and become part of the qualitative assessment.

The project team should also make a preliminary assessment of the relationships between the identified risks. Risks that are not mutually independent should be noted as potentially correlated with other risks.

The project team should also identify the risks that it expects will be retained by the public sector and those that may be transferred or shared. Each material risk should be identifiable in the risk-adjusted costing in the financial model for the PSC.

Assessing the timing of the cash flows associated with each risk is particularly important for two reasons. First, the impact of inflation needs to be considered. Second, different risks typically have a different cost/time profile over the term of a project. For example, the financial impact of construction risks are generally limited to the pre-completion period and the early years of the project; operating, demand or maintenance risks are relevant over the entire term of the project (following completion); residual value risk is limited to the end of the term of the project or to an assumed disposal date.

The consequence of risk measures the difference between the base cost (or revenue) in the Raw PSC and the expected outcome if the risk eventuates. As noted in Section 3, the Raw PSC should not include any value for project risks that may directly affect cash flows, such as contingencies.

A specific issue that needs to be considered is the consequence of insurance in terms of mitigating risks to the project. Further information on this is provided in Section 7.3.