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Guidebook for Risk Assessment in Public Private Partnerships

December 2013

 

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2 Framework for Risk Assessment

2.1 Risk assessment is used throughout the project life cycle

Risk assessment is an essential discipline within professional project management. The essence of project management is maximizing achievement of the project's objectives in the most efficient manner possible. The project objectives are typically related to the schedule, quality, and budget. Major risks can and do affect each of these objectives.

There are four major steps in risk assessment, shown graphically in Figure 2-1 below:

  1. Risk identification
  2. Risk management
  3. Risk allocation
  4. Risk valuation

By necessity, identifying risks is the first step. This is followed by allocation conducted in parallel with management, on the basis of which valuation can be determined. Once a project is underway, the management of risks may affect the allocation and valuation. New information may also become available throughout the project life cycle, making regular updates a necessity. 2 After describing the different steps in detail in the chapters that follow, every chapter provides further guidance with respect to process, timing, information, and the experts needed.

Figure 2-1 . Risk Assessment Steps

Figure 2-1 . Risk Assessment Steps

Risk assessment remains a dynamic process throughout the total project cycle. The process illustrated above is repeated at certain intervals or when relevant information becomes available to the practitioner. However, as stated earlier, the risk assessment is not equally detailed throughout all project phases. In the early phases a high level assessment will suffice, whereas in later phases-for example when a P3 transaction is structured or when doing a VfM assessment on the basis of real P3 bids-a much more detailed analysis may be performed.

2.2 Be clear on the goal(s) of the risk assessment

Within the larger purpose of project management, risk assessment seeks to develop:

  • Realistic risk valuation as part of financial feasibility analysis and VfM assessment;
  • Effective risk management measures and strategies; and
  • Efficient and realistic risk allocation to be used in structuring a contract.

The methodologies used in risk assessment differ from project to project. When beginning an assessment, it is important to determine the goal of the analysis in order to fine-tune the methodology. The relative importance of the three goals listed above changes based on the different project phases. Roughly speaking, risk valuation is most relevant during the project assessment and project development stages. Risk allocation is usually most important during the procurement stage, and risk management is most relevant in the project implementation stage.

The three goals do not exist separately, but are instead interrelated. Risk management provides input for risk allocation and helps when answering the question, "Which party is best able to manage a risk?" The ability to manage-and thus accept-the risk influences and determines its valuation. This cycle can also be iterative in nature; constant information updates occur in any given project, therefore risk assessment is a continual process. When new information becomes available, the risk management strategy may change in parallel with risk allocation and valuation.

To conduct a risk assessment as part of the VfM assessment, the following steps are typically followed:

  1. Identification of risks
  2. Initial allocation of risks between the public and private entity for different delivery methods
  3. Initial valuation of risks
  4. Identification of risk management strategies
  5. Optimization of expected value of risks, by choosing the optimal risk management strategy and allocation

Textbox 1: Expected value

Transportation projects typically involve investments that are meant to last for decades. All future cash flows, including risks, are uncertain. Therefore, the valuation of risks results in an expected value. This expected value can be reported in different ways: the most likely or average of possible outcomes, or the full range of possible outcomes, including their probabilities. For risks, the goal of risk management is to minimize their expected value and therefore optimize the expected value of the project.

I-13: The cyclical nature of the risk assessment

Additional research on ground conditions along I-13 was carried out by PDOT, leading to the convincing conclusion that there is little risk related to ground conditions. The risk management strategy will change now that one of the most important measures has been executed. The results of the research also change the value of the risk, because the estimated probability of potential damage due to unknown ground conditions is reduced. Likewise, this may lead to a change in the opinion on the risk allocation, since the private sector may be better able to manage the risk now.

2.3 Project characteristics affect the nature of the risk assessment

To determine the nature and complexity of the risk assessment, it is necessary to examine the project's characteristics. Some of the most relevant risk characteristics are listed in Table 2-1.

I-13: Project characteristics and their impact on the risk analysis

The project is an expansion of an existing highway, therefore the scope is that of a brownfield project. This means that the riskiness is relatively low in comparison with a greenfield project because, for example, the terrain and stakeholders are known. Since the highway will generate toll revenues, revenue risk must be considered. Risk allocation differs depending on the contracting form. This could also influence the valuation of the risk. The types of contracts compared in the VfM assessment are design-bid-build, an availability payment-based P3 contract, and a toll revenue-based P3 contract. The latter assumes that most of the revenue risk (upside and downside) will be transferred to the private party. This risk allocation differs from the traditional approach where most risks remain with the public entity.

Table 2-1 Project Characteristics and Risk Assessment
Project characteristic Example Consequence for risk assessment
Magnitude of Costs
  • Investment costs
  • Life cycle costs
The larger the project, the more detailed the risk assessment required
Scope
  • Greenfield or brownfield
  • Innovative or traditional
  • Multi-functional (combined with, for instance, rail or urban development) or mono-functional (road only)
  • Managed lane or full toll facility
  • Revenue-based or funded by public budget
Greenfield, innovative, revenue-based, and multifunctional projects increase the complexity of the risk assessment
Phase
  • Identification/initiation
  • Scoping
  • Feasibility assessment
  • Procurement
  • Implementation
Typically the risk assessment is generic and basic in the early stages, becoming more specific and detailed closer to project procurement and project implementation
Type of contract
  • Design-Build (DB)
  • Design-Bid-Build (DBB)
  • Build-Operate-Transfer (BOT)
  • DBFOM concession (DBFOM)
    • Availability payment based
    • Toll revenue based
The type of contract affects the risk allocation; risk assessment provides inputs for developing the optimal contract
One or more transportation modes
  • Road
  • Bus Rapid Transit (BRT)
  • Rail
Multiple modes affect complexity of the risk assessment (interface risks) and potentially also the risk allocation

Footnotes

2. This is discussed in detail in the following sections.

 

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