Risk allocation

[edit] Introduction

The term risk can have a number of different meanings in the construction industry, relating to health and safety, project costs, time and so on. In any project, minimising risk is critical to avoid adverse situations such as:

• Physical harm to those involved,
• Unplanned costs
• Disputes
• Programme overruns.
• A failed project.

To avoid such scenarios, it is in the interest of all parties on a construction project to aim for risk minimisation, mitigation or elimination.

Risk allocation relates to determining who is responsible for dealing within risks. Normally, risk should be allocated to the party that is best able to manage it or the party best able to control or minimise the impact of the risk. And if in managing the risk also involves bearing its financial cost, there will be greater incentive to take measures to mitigate that risk.

For example, consultants may be best placed to manage design risks, whereas the contractor may be best placed to manage construction risks. The situation becomes more complex when there are unknowns, such as conditions below existing structures; items that have third party dependencies, such as planning permission (particularly on design and build projects); variation in costs over time; items for which responsibility is split between more than one party, and so on.

Investors will be particularly keen to minimise project risks, especially on large, time critical, or complex projects. But this cannot happen until the risks on a project are properly analysed and understood. This may involve developing a risk register, that identifies the likelihood, and severity of a risk, as well as management strategies and responsibility allocation.

For more information see: Risk register.

The Construction Playbook, Government Guidance on sourcing and contracting public works projects and programmes Version 1, produced by the Cabinet Office and published in December 2020 states: 'Inappropriate allocation of risk remains one of the main concerns of suppliers looking to do business with government. It is also one of the most frequent issues raised by the National Audit Office in their audits of government contracts.'

Risk allocation and pricing approaches, guidance note, published by the Government Commercial Function in May 2021 states: ‘Allocation and management of risk is central to all commercial contracts and is one of the core commercial principles informing the approach to contracting with third parties. Each party seeks to minimize its overall risk and maximize its reward, which creates an inherent tension between contracting parties. Government can manage risk by carefully negotiating provisions to transfer or share risk with suppliers. If a supplier is put in a position where they are managing an inappropriate balance of risk then the outcome is highly likely to be poor value for money (a high-risk premium will be loaded into the price), underperformance against the core contract objectives (as supplier focus increasingly shifts to cost cutting) and/or an onerous contract which could ultimately lead to its collapse.’

[edit] Public Private Partnerships (PPPs)

Public Private Partnerships (PPPs) tend to be used on large infrastructure projects where failure to achieve optimal risk allocation could be very serious. PPPs are a very broad range of partnership in which the public and private sectors collaborate for some mutual benefit. This may involve partnerships to deliver policies, services, buildings or infrastructure.

PPPs were first developed in the UK in the 1990s. The idea was that private sector companies could be more efficient at providing certain services than public authorities and so, compared to conventional delivery methods, PPP could deliver better value for money for taxpayers.

One of the key drivers for value for money in PPP delivery models was optimal risk allocation. Most long-term risks in a conventional delivery model are borne by the public partner, whether local or central government. In contrast, a PPP model allows the public partner to transfer liability to the private partner. In this way, government is relieved of shouldering the cost of those risks which it is least able to manage; this includes risks such as construction delays, cost overruns and even long-term maintenance.

Challenges involved with allocating risk in PPP include:

• Government may be better able to shoulder the risk: transferring it to a private agency may be costly and reduce value for money;
• It is difficult to predict what, if any, risks will be faced by the private partner over a 30-40-year maintenance period, and
• Although in principal allocating risk may seem straightforward, in reality it may be challenging.
• Private partners price the risk they are being required to accept, and this can result in PPP contracts becoming expensive in the long term.

For more information see: Public Private Partnerships

[edit] Related articles on Designing Buildings

• Build, own, operate and transfer (BOOT).
• Concession agreement.
• Construction contract.
• Design build finance transfer (DBFT).
• Design build operate (DBO).
• Design risk management.
• Flexibility in PPP Contracts: Best practices from countries where Abertis operates.
• Government Construction Strategy.
• Independent Client Advisers.
• Integrated Supply Team.
• PF2 (successor to PFI).
• Partnership.
• Private Finance Initiative.
• Risk.
• Risk management.
• Risk register.