Risk

5.47 Risk management is defined as a structured approach to managing risks that are identified and assessed when designing an intervention or that materialise later in its lifecycle.

5.48 The public sector's risk exposure arises as a consequence of public policy decisions. Public sector organisations responsible for an intervention cannot opt out of certain risks and achieve risk reduction through 'cherry picking' (as insurance companies may choose to do when refusing cover). The option of managing a balanced risk portfolio is also not usually available (as investment funds may do).

5.49 To optimise social value, risk must consciously and proportionately be managed. Good risk- management practice in appraisal, monitoring and evaluation involves:

identifying possible risks in advance and putting mechanisms in place to minimise the likelihood they materialise with adverse effects. The appraisal should include an assessment of how specific risks may be avoided, minimised or managed.

including the costs of risk avoidance, transfer and mitigation. A risk register should be created during the development of an intervention (see Annex 5) and maintained through implementation. It should be owned by those responsible for operational delivery.

considering how and by whom key risks might be managed. This is this an important part of assessing the long-list and provides important inputs into the design of a procurement process, risk allocation and risk sharing in commercial contractual arrangements. If a procurement process is involved this should be re-examined as a proposal develops, including when contract bids are assessed.

ensuring risk is borne by the organisation that is best placed to monitor and manage it, and that this responsibility is clearly agreed with appropriate controls to mitigate adverse consequences if risks materialise.

monitoring of risk and optimism bias which should be undertaken by all public bodies as part of their monitoring and evaluation processes.

having decision making processes supported by a framework of risk analysis and evaluation, ensuring they are underpinned by good oversight and accountability.

5.50 As the short-list appraisal is developed, risks and risk costs should be identified and the optimism bias allowance included at the outset of the appraisal should be reduced in accordance with the Green Book guidance (see Annex 5). Box 11 shows an example of applying optimism bias.

5.51 Risk costs are the costs if risks materialise and of avoiding, transferring or mitigating risks. If risks materialise, there will be associated costs and these should be quantified on an expected value basis. Multiplying the expected likelihood of a risk materialising by its estimated cost can be used to derive an expected value. This requires objectively-based estimates of the percentage likelihood of a risk occurring. Low probability high impact risks should be noted in the risk register to make the decision maker aware. Effective risk costing will be supported if organisations put in place sophisticated risk assessment processes.

5.52 Risks with low probability but high impact need to be considered seriously by policy makers. In addition to ensuring these risks are part of the risk register, Senior Responsible Officers (SROs) need to actively manage and minimise these risks both before and during implementation. Real options analysis (see Annex 5 for a worked example) provides a technique to explore whether additional flexibility can be added in the project design phase and utilised later when further information becomes available. It is particularly useful for projects that exhibit significant uncertainty or are difficult to reverse following initial investment (eg. where future climate change impacts are uncertain).

Box 11. Optimism Bias Case Study