- Project plans
- Project activities
- Legislation and standards
- Industry context
Last edited 01 Sep 2020
Types of risk in construction projects
Even if a contract is silent on a particular risk, that risk will still lie with one party or the other. Wherever risk is shifted from one party to the other, there should be a counterbalancing change in price. Any discussion about whether or not a particular risk should be included in the price is a discussion of policy, not of ‘fairness’, ‘morality’ or ‘justice’.
Generally, risk is best allocated to the party best prepared for managing them.
 Types of risk in construction projects
The first category of risk is often referred to as 'pure and particular risk'. It includes damage to persons and property (such as fire, storm, water, collapse, subsidence, vibration, etc.). Contract conditions often make it a contractual obligation to take out insurance cover against these risks.
The second category is 'fundamental risk'. This includes external factors such as: damage due to war, nuclear pollution, supersonic shock waves, government policy on taxes, labour, safety or other laws; malicious damage; and industrial disputes. Such incidents are all the subject of statutory liability and no insurance cover is normally available or needed.
The third category, often referred to as 'speculative risk', is something which can be apportioned in advance as agreed by the parties to the contract. This may include losses in time and money, which result from unexpected ground conditions, exceptionally adverse weather, unforeseeable shortages of labour or materials, and other similar matters beyond the control of the parties.
There are also risks of losses of time and money due to: delays and disputes (possession of site, late supply of information, inefficient execution of work, etc.); poor direction, supervision or communication; delays in payment; and delay in resolving disputes.
- Identify the risk.
- Analyse the risk in terms of likely frequency of occurrence and severity of impact.
- Respond to the risk: make risks explicit so that decisions can be taken as to who should bear them.
- Contractual clauses are intended to transfer risks.
- When laying-off risks, weigh up the frequency of occurrence against the level of premium paid for the transfer.
- It can be unwise to pass a risk that is difficult to assess to the contractor as they may either increase their prices, or disregard it when preparing their bid and then find they are in difficulty later.
- The client may carry highly unpredictable and poorly defined risks as the alternative might be to unacceptably inflate tenders.
- Redefine the project.
- Clarification of responsibilities, remuneration, and expenditure at the beginning of the project to help avoid problems.
- Most standard form contracts insist on certain types of insurance, such as; insurance against fire, professional indemnity insurance, and so on.
- Either none of the project team considers the risk, or they consider the risk and decided that they already lie with those who could best control them.
- Fixed price: items paid for based on the contractor’s predetermined estimate
- Cost reimbursement: items paid for based on what the contractor spends in executing the work.
 Balance of risk for different forms of contract.
There is a single point of responsibility with the contractor for both the design of the project and operations on site. As such, most of the risk lies with the contractor, particularly where the contract is let on a lump sum basis. However, risk is increasingly transferred back to the employer as more preparatory design work is carried out before the contract is let. It is important to agree who accepts the risk for obtaining permissions such as planning permission and building requlations approval.
With traditional lump-sum contracts, the intention is that there should be a fair balance of risk between the parties. The employer is responsible for procuring the design and the contractor for undertaking the operations on site (although this is complicated when nominated sub-contractors and suppliers are included).
The balance can be adjusted as required, but the greater the risk assigned to the contractor, the higher the tender figure is likely to be. The risk to the employer is lessened by the contract being let on a lump-sum basis, although in reality, no price is 'fixed'. See fixed price contract for more information.
In management contracting the balance of risk lies with the employer. Separate works contracts are let, and the employer may continue to develop the design during construction, hence there may be little certainty about cost or time. However, the risk of delays and defects are associated with the responsibility for the works contracts. In some cases the management contractor may absorb this risk and with a resulting increase in price, although this may compromise their 'impartiality'.
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