Effective risk management and transfer for infrastructure projects

Brian Denney, head of Infrastructure at Arthur J Gallagher Construction offers advice on how to protect yourself on major projects.

Brian Denney, Arthur J Gallagher

The effective management of risk can be one of the most significant factors in the success or failure of complex infrastructure projects. Where risk can be managed with clarity within the terms of the contractual framework, projects are generally completed successfully. 

Conversely, projects can encounter major problems because risks were not properly identified or the allocation of known as well as unforeseen risks was not clearly defined. 

The well recognised principle that a risk should be allocated to the party that can best manage the risk is not necessarily appropriate for infrastructure projects where there are multiple stakeholders, each of whom can influence the occurrence and severity of a risk. Further, the understanding that only one party can manage the risk or that one party is best placed to manage the risk does not reflect how risk can be influenced by some or all project participants and stakeholders.

The reality can be that the party who has least bargaining power ends up being the party that bears the risk. In many cases this situation can be attributed to commercial pressures with risk being pushed down to those who will accept it. 

“We believe it is important for a project owner or procuring authority to recognise the concept of risk sharing in successful project delivery and negotiate contract terms that build trust with their contractors”

When faced with a risk that it cannot adequately control, that party will seek to protect itself by either increasing its contract price; or later in the project, by engaging in adversarial behaviour, such as bringing contractual claims or change orders so as to recoup their costs resulting from the consequences of that risk.

Where inflated contingencies are included as a result of inappropriate risk allocation, these costs can be compounded through the contractual chain with a multitude of risk contingencies. An inflated project cost, an owner or government authority may be faced with having to commit greater capital expenditure, or in extreme circumstances, abandoning or down sizing the project. 

All of these outcomes have the potential to call into question the economic viability of a project and subsequently, generate adverse publicity which may create a negative attitude from the end user.

We believe it is important to recognise the concept of risk sharing in successful project delivery. Project owners should negotiate contract terms that build trust with contractors and promote a collaborative means to solve the challenges that will inevitably occur during the course of a project. Contracts must set out and apply clear parameters for risk allocation and sharing in order to avoid situations where each party simply seeks to optimize their own position rather than that of the project as a whole.

We have experienced a number of situations where project owners seek to practice risk shedding rather than risk sharing and it should be remembered that it is almost never possible for one party to totally absolve itself of risk by transferring that risk to another party.

A good example of how the management of risk has evolved is the Code of Practice for Risk Management of Tunnel Works. Since the Code was introduced, the use of a risk register to identify and manage project risk has increasingly become standard practice, and widely viewed as best practice which can be applied to any infrastructure project, with delivery of the same positive benefits.

Insurance premiums can reduce in direct proportion to the understanding and management of risk. The implementation of an effective risk management program will help to drive down the frequency and size of losses. Through proactive risk management and the involvement of a risk advisor at an early stage, associated risks can be understood, facilitating an informed decision of the financial aspects of project risk and insurance.

The desired result is lower insurance premiums, hence a reduced total cost of risk and related cost savings, benefiting the project out turn costs and improving the project programme. Clearly, risks and unforeseen occurrences can and will still occur regardless of risk management. However, mitigating the severity and the frequency are key aspects to achieving the goal of project completion on time and on budget.

Our experience in the infrastructure sector has shown us that this approach will lead to successful and cost effective projects that build the trust of the public and support sustainable infrastructure investment and development.

If you would like to contact Antony Oliver about this, or any other story, please email antony.oliver@infrastructure-intelligence.com.