Contingency Fund Management for Major Projects

Engineers can estimate project costs using different methods. Estimates can be developed based on project parameters and major cost elements. It may include analysis of historical bid data, actual cost or a combination of methods. Special care must be taken to make a complete capital cost estimate. A common error in the economic analysis and budgeting is the underestimation of project construction and related costs. Contingency funding is a fiscal planning tool for managing the risk of cost escalations and covering potential cost estimate shortfalls. Inclusion of a contingency amount in the cost estimate will minimize the impact of cost increases inherent in an overly optimistic estimate and provide for an earlier discussion of how potential circumstances can be addressed.

Risk Assessment and Contingency Funding Levels

An Office of Inspector General (OIG) audit recommended that risks be defined with specific costs allocated to them, as opposed to just "Bumping up" the total cost to compensate for poor early planning. A risk allocated cost contingency should be included in the total project cost estimate for the mitigation of all significant risks. Risk management and contingency funding can be utilized to mitigate those risks that cause cost escalations throughout the project continuum.

During the preparation of the initial estimate, a risk assessment should be performed on the entire project in order to define and quantify the potential risk areas and types. Risk assessments should also be performed periodically throughout the project continuum to update contingency amounts. Some examples of risk assessment areas may include the analysis of differing site conditions, utility impacts, hazardous materials, environmental considerations, third-party concerns, etc.

When preparing the project cost estimate, a risk assessment can include allocating risk contingencies for major cost elements. This will assist in the mitigation of uncertainties and help create a conservative cost expectation. Probability of occurrence, severity and expected dollar value are variables that may be utilized when quantifying risk as a contingency amount. After all known risk mitigation, the cost estimate's contingency-funding levels should reflect the amount of remaining risk associated with the project's major cost elements. Additionally, a overall management contingency can be included to cover unknown, unanticipated risks.

The following are major cost elements for contingencies that should be considered for Major Projects: 1) a Construction contingency to cover cost growth during construction; 2) a Design contingency (based on different levels of design completion); 3) an overall Management contingency for third-party and other unanticipated changes; and 4) other contingencies for areas that may show a high potential for risk and change, i.e., environmental mitigation, right-of-way, utilities, highly specialized designs, etc. Other areas of interest for contingency cost estimating may include contractor availability and historical contingency levels for similar projects.

Contingency Administration and Management

Currently for Major Projects, contingency funding management is handled in similar ways throughout the country. Construction contingencies are typically established and adjusted on a sliding scale or based on the assessed risk in exposure to construction cost escalations. Project funding can be reviewed at periodic intervals and unused contingency funds can be released to be made available for other contracts.

Design contingency amounts are based on the amount of design completed. When the final design is complete, the design contingency amount in the cost estimate should equal zero. Projects under design are not over estimated, however the contingency is based on the uncertainty inherent in the remaining design to be completed.

A portion of Project Oversight Management will include managing cost and schedule deviations from the approved budget and schedule, impacts resulting from the deviations, and initiatives being analyzed or implemented in order to recover any cost overruns or schedule delays. While individual construction contracts are analyzed for exposure to changes, comprehensive risk and contingency management tools and processes are not always in place. Major projects contingency funding management procedures can include continual comprehensive risk analysis to quantify and refine contract contingencies, individual contract contingency tracking, and a contingency drawdown plan that includes contingency forecasting.

A overall management contingency is highly reccommended for large projects. This contingency is usually a "stand alone" piece of the cost estimate that is managed by an executive and used for a broad spectrum of uncertainties. For example, the State of Massachusetts Legislature approved and the Governor signed a $2.476 billion bailout plan for the Central Artery, of which $1.846 billion was reserved for an overrun, with a contingency reserve of $130 million for a broad spectrum of uncertainties. Chief Executive Officer/Executive Director of the Massachusetts Turnpike Authority (MTA), Rick Capka, managed the $130 million dollar management contingency. On other Major Projects, phase or contract under runs are retained within the project and serve as a project-wide contingency.

Management of the transfer of costs to and from contingency line items needs to be administered and tracked carefully for decision makers. Cost transfers should be correlated to the major element type of cost escalation. For example, if work outside of a clearly defined scope is found to be essential and justifiable in the future, then a management decision can be made to pay for the added work from the management contingency or another appropriate contingency. On the other hand, if you have a specific utility issue that has a utility contingency, careful tracking of this particular contingency can help management better analyze cost overruns.

Reasons supporting contingency transfers should be noted and included in all pertinent reporting. This is so a comparison analysis to the available contingency amounts can be periodically analyzed for contingency usage rates. This analysis will show project managers that a reasonable and sufficient amount of contingency remains to keep the project within the latest approved budget.

Reporting Contingencies in Financial Plans

Financial plans provide current information about project cost, financing, schedule, and technical issues to enable the Department of Transportation, States, Congress, Project Managers, and the public to evaluate the fiscal health of a project.

TEA-21 added the requirement for a financial plan on major projects under 23 U.S.C section 106:

(h) FINANCIAL PLAN. -A recipient of Federal financial assistance for a project under this title with an estimated total cost of $1,000,000,000 or more shall submit to the Secretary an annual financial plan for the project. The plan shall be based on detailed annual estimates of the cost to complete the remaining elements of the project and on reasonable assumptions, as determined by the Secretary, of future increases in the cost to complete the project.

Construction cost estimates should not be shown as a lump sum total, but should be presented as the sum of costs for each major element of the project. The contingency amounts can be clearly identified as separate line items associated with each major element. Contingencies may include design contingencies (to reflect the percentage of design completed to date), construction contingencies, management contingencies and other contingencies based on an assessment of risks. In this way, the reviewers of future updates will be able to track where and how project costs are changing. This may provide information on reoccurring patterns and reasons behind cost escalation. Contingencies can be disclosed as a dollar value or a percent of the major element cost element.

Laws and Barriers

Design, Construction and Management Contingency funding has been accounted for in federal law. Section 181 of Title 23 states:

(1) ELIGIBLE PROJECT COSTS. -The term "eligible project Costs" means amounts substantially all of which are paid by, Or for the account of, an obligor in connection with a project, Including the cost of-

• Development phase activities, including planning, Feasibility analysis, revenue forecasting, environmental review, Permitting, preliminary engineering and design Work, and other preconstruction activities;
• Construction, reconstruction, rehabilitation, Replacement, and acquisition of real property (including Land related to the project and improvements to land), Environmental mitigation, construction contingencies, and Acquisition of equipment; and
• Capitalized interest necessary to meet market Requirements, reasonably required reserve funds, capital issuance expenses, and other carrying costs during construction.

*Highlights added

If a Major Projects contract escalates in cost, then utilizing an overall management contingency established in the cost estimate will help mitigate public and media scrutiny. In highly publicized Major Projects, project management contingencies are highly recommended to broadly mitigate all risk.

Some STA's may have political or planning barriers in utilizing a "stand alone" fund for a project management contingency. The STA may rather defer the project management contingency monies to smaller projects. An appropriate cost/benefit analysis of the large project during the initial planning phases of the project should include the effect on the entire statewide program. For example, a Major Project should never use 100% of a states available funding. The Public and Media expectation of how the large project and the statewide program are managed, in parallel, is a key performance measurement and can be attributable to the level of perceived success of a transportation program. Careful preparation of the contingencies included in the project cost estimation is a crucial element in meeting the key performance measurement of user satisfaction.

References:

• Lessons learned: http://www.fhwa.dot.gov/programadmin/mega/lessons.cfm
• Project Management Planning: http://www.fhwa.dot.gov/programadmin/mega/megaiii.cfm
• Financial Planning: http://www.fhwa.dot.gov/programadmin/mega/fplans.cfm
• The Central Artery: http://www.masspike.com/bigdig/
• Title 23: http://www.fhwa.dot.gov/legsregs/title23.pdf

Appendix A - Example of Contingency Analysis

Goose Island Bridge Project
Needsmore STA Contingency Analysis

The following summarizes the separate contingencies included in NSHA's current cost estimate:

Construction Design Contingency

The purpose of design contingencies is to account for items not included in the current estimate. At the early stages of design, many details are incomplete hence the design contingencies are large. NSHA typically utilizes a sliding scale for design contingencies, beginning with a 30% to 40% factor for PI plans (30% complete) and reducing to 0% for PS&E documents (advertised set). For example, four Needsmore contracts included in the current estimate now carry 0% design contingencies (the completed BR-1 Contract; the awarded BR-2 Contract; the bid-opened contract MA-1A, and the PS&E submittal for contract MA-1).

In addition to design contingencies, for categories with incomplete design information, adjustment factors are included. These factors vary by estimate category and the level of completeness of plans. These factors are reduced as the plans are completed. NSHA standard estimating procedure allows flexibility in calculating individual category adjustments. This flexibility encourages designers to make allowances and adjustments based on specific site and contract conditions. Maintenance of traffic, complexity of the construction and site conditions can warrant category adjustments.

In addition to this attachment, the letter to the Secretary of Transportation dated July 26, 2002 addressed in detail all of the FHWA comments regarding the estimate. This letter reviewed each design contingency and each of the category adjustment factors. NSHA believes that this letter and detailed back-up addresses all of the FHWA comments. NSHA and the GEC believe that the contingencies and adjustments utilized by the designers are appropriate and will not materially affect the overall cost estimate. The amounts included in the current estimate as a Construction design contingency are as follows:

Change Order/Claim Contingency

A separate 10% Change Order/Claims Construction contingency is included in the current estimate. This cost is intended to cover unforeseen field conditions, contractor claims and changes, owner requested changes and any other additions to the original contract amount. Amounts included in the current estimate are as follows:

Current NSHA experience is that construction change orders are below the 10% level used for this project.

Escalation

For the four Needsmore contracts that are at or beyond the PS&E stage (i.e., the completed BR-1 Contract; the awarded BR-2 Contract; the bid-opened contract CA-1A, and the PS&E submittal for contract CA-1), no additional escalation has been used for the current estimate. Generally, the current Construction Cost Estimate is based upon Year 2003 estimates. In many cases, these dollars will not actual be spent until several years in the future. In order to adjust these Year 2003 dollars into Year of Expenditure dollars, the current schedule (31-May-04) was used to cost load the various activities. To accomplish this, a 3% per year escalation factor was used. This factor was based upon the following information:

• Metropolitan Needsmore Council of Government's Region Inflation Rate has hovered around 3% over the past two years. The March 2003 Needsmore Regional Inflation Rate was 2.4% year over year.
• The recently proposed "Budget of the United States Government for Fiscal Year 2003" adopts an annual inflation rate of 2.5% for the next 10 fiscal years.
• The ENR Construction Cost Index annual inflation rate was 0.9% in May 2003. The ENR Common Labor annual inflation rate was approximately 2.9% for the same month.
• The FHWA Three-Quarter Moving Index increased 3.3% from fourth quarter 2000 to fourth quarter 2003.
• A long-term national inflation forecast from 1999-2025 is 3.1% annually. (Source: Predictions of the Past and Forecasts of the Future: 1976-2025", Roger G. Ibbotson, Chairman, Ibbotson Associates, Professor in the Practice of Finance, Yale School of Management, April 1999)
• 3% is the rate used by Needsmore for purposes of the six-year Consolidated Transportation Plan. For the right-of-way, a different set of escalation assumptions were used to maintain consistency with Wantsmore (see Attachment R). The escalation used is 10% for 2003 through 2004 and 6% for 2008 through the completion of the project.

Amounts included for escalation from 2003 are as follows:

Total Contingency/Escalation Allowances for Needsmore

* or 16.0% of the total current

Needsmore cost of $1.366 Billion