Risk Assessment and Allocation for Highway Construction Management

1. Introduction

1.1. Project Management Approach

Successfuly delivery of national and State highway facilities requires the application of a broad set of program and project management tools. Scope, design, cost, and schedule management are all regarded as essential for every major project. Highway agencies and their partners in the contracting community are well versed in cost estimating and scheduling techniques for these facilities and often apply them numerous times on each project. The treatment of risk is much less uniform and understood across the transportation community. Risk management processes, tools, documentation, and communication are less standardized than any other dimension of transportation project management. The goal of this document is to provide a concise guide to the risk assessment and allocation process in highway construction, as well as to draw on other infrastructure and major project areas for examples of risk management practice.

The international community has an awareness of risk assessment and allocation techniques that is just now evolving in U.S. highway agencies. The Highways Agency in England has developed Highways Agency Risk Management (HARM) to model the uncertainties of estimates for cost and time to ensure robust and realistic budgets for publicly financed projects. ⁽¹⁾ The Ministry of Transport, Public Works, and Water Management in the Netherlands has developed the Public Sector Comparator and the Public-Private Comparator (PSC/PPC) to assist with these same analyses. ⁽²⁾ Both agencies have dedicated staff that support project teams in identifying and quantifying project risk using probabilistic techniques, and then choosing delivery and contracting strategies that can best control and mitigate these risks.

Risk management and risk planning are used interchangeably to describe a sequence of analysis and management activities focused on creating a project-specific response to the inherent risks of developing a new capital facility. Various organizations and mission agencies such as the Project Management Institute and the U.S. Department of Energy use similar steps, but slightly different terms, to describe their risk management approach. ⁽³⁾⁽⁴⁾ The most common set of processes would include risk identification, assessment, analysis, mitigation, allocation, and monitoring and updating. This document will use these processes or steps as the primary structure for an FHWA standard for project risk management. This document focuses on risk assessment and allocation techniques that will ultimately lead to alignment of the entire project team with customer-oriented performance goals.

While few State highway agencies use formalized risk assessment and management programs like HARM and PSC/PPC, awareness is developing in the U.S. highway community. In particular, the Washington State Department of Transportation (WSDOT) has developed the Cost Estimate Validation Process (CEVP) and Cost Risk Assessment (CRA), and the California Department of Transportation (Caltrans) is employing a risk management program ⁽⁵⁾⁽⁶⁾. There are also a number of excellent examples in the United States of project-based risk management plans, many based on published standards from industry associations such as the Project Management Institute (PMI) and the Association for the Advancement of Cost Engineering International (AACEI) ⁽³⁾, ⁽⁷⁾. This document relies heavily on these examples as well as examples from other infrastructure and major project areas to form the best risk management practices described.

1.2. Business Case for Project Risk Management

Perhaps the most compelling argument for pursuing risk assessment and allocation as a standard practice for highway programs is that the best agencies and organizations worldwide are doing it, and with great success. Several reports from recent FHWA International Technology Scanning Program studies (e.g., Contract Administration: Technology and Practice in Europe, Construction Management Practices in Canada and Europe, and Asphalt Pavement Warranties: Technology and Practice in Europe) identified risk assessment and allocation as key components of professional practice ^(8)(9)(10). These scanning reports recommended that the highway community:(1) better align team goals to customer goals, (2) develop risk assessment and allocation techniques, and (3) strategically apply alternate project delivery methods.

The U.K. Highways Agency in its January 2001 report on a framework for business risk management makes an eloquent argument for the necessity of formal risk management. ⁽¹⁾ Its business case is based on maximizing value for money (VFM).

If Agency colleagues take decisions in ignorance of the associated risks, regardless of their possible impact on business, they are likely to reduce VFM rather than enhance it. This is exacerbated if the Agency is actively encouraging a more well thought approach towards risk taking, without defining the framework or criteria within which colleagues are expected to do so.

This report conveys a firm belief that active, thoughtful risk taking is just as important as risk mitigation. In the report, the agency poses three questions for itself:

1. Does the agency have adequate and dynamic processes in place to identify existing and new risks faced?
2. Does the agency have the right balance of arrangements in place to deal with these risks?
3. Does the agency have an adequate framework for risk analysis and evaluation to support decisionmaking processes?

It is the taking of opportunities that will yield the greater gain, and to do so requires a rigorous analysis capability, as well as an understanding of the implications of associated management actions. The proposed framework is built on a foundation of organizational changes, modified behaviors, analytical tools, and an overall commitment to "living risk management" within the agency.

One can also look more locally for compelling arguments. The WSDOT CEVP and CRA processes, the Caltrans risk management handbook, the FHWA guidance on cost estimating, the Federal Transit Administration's (FTA) report on risk assessment methodologies, and the U.S. Department of Energy's (DOE) risk management practices all provide procedural outlines for the broad range of risk issues confronting major transportation projects ^{(5)(6)(9)(11)(4)}. Table 1 covers the time range from beginning alternatives analysis and conceptual design through construction completion and enumerates the many risk issues, objectives, and expected outcomes impacted by the project's risks.

Figure 1: FHWA International Technology Scanning Program scans citing risk assessment and allocation

It is the pervasiveness of these risks and their potential for changing the bottom-line value of the project that, in the end, demand attention.

The DOE's 2003 report on risk management practices further amplifies these considerations: ⁽⁴⁾

Risk management is a team function. This stems from the pervasive nature of risk and the impact that risk-handling plans may have on other project plans and actions. In the aggregate, risk planning, assessment, handling, and monitoring affect all project activities and organizations.

The DOE study emphasizes that risk management must be a formal, structured process if it is to have its full value.

The need for a formal risk management process arises from the nature of risk and the complexity of acquisition projects. . . . A formal approach is the only effective method to sort through numerous risk events, to identify the risks and their interrelationships, to pinpoint the truly critical ones, and to identify cost-effective ways to reduce those risks, consistent with overall project objectives.

In addition, the DOE report emphasizes that risk management by its very nature must be forward looking. It must "identify potential problems...long before they occur and develop strategies that increase the probability/likelihood of a favorable outcome." ⁽⁴⁾

The business case for including risk assessment and allocation as a standard project management component of major capital projects is unambiguous: The ability to better understand potential risks and how to manage them yields benefits far in excess of the costs of adopting risk management practices. A 1979 study by the Massachusetts Institute of Technology, A Quantitative Method for Analyzing the Allocation of Risk in Transportation Construction, found a high benefit-to-cost ratio in dealing with contractual risk through improving both contract clarity and contract management practices. ⁽¹²⁾ The Construction Industry Institute states that there is a realistic prospect of a 5 percent cost savings through better contracting practice, of which risk identification and allocation are major components. ⁽¹³⁾

The importance to highway project development is especially high, from initial feasibility and conceptual planning through user availability. The long durations, environmental and community interactions, public contracting requirements, and physical dimensions all contribute to this importance and value. Guidance from the best practices globally and across other project domains implies that risk planning and management should start at the project's beginning and be applied continuously throughout the entire implementation period. It should be built into the organizational structure and become one of the critical project management practices applied to every major highway project and program.

1.3. Definition of Key Terms

A glossary in this document contains the most commonly used risk terms. The Project Management Institute's A Guide to Project Management Body of Knowledge is the primary reference for these definitions. ⁽³⁾ Some of the more critical concepts are worth explaining here. Among those are the two basic types of risk defined by Pennock and Haimes: "technical risk denotes the risk that a project will fail to meet its performance criteria" and "programmatic risk has the two major subcomponents of cost overrun and schedule delay." ⁽¹⁴⁾ By extension, other project execution metrics such as labor productivity would be classified as programmatic, while other outcome performance measures such as reliability would be technical. These distinctions are important because too often the focus of risk identification is on project features integral only to technical performance and misses features critical to overruns or delays such as external markets.

Another term often used to characterize risk is contingency. However, this term is often misunderstood and misused. For the purposes of this document, contingency is formally defined as "an amount of money or time needed above the estimate to reduce the risk of overruns of project objectives to a level acceptable to the organization." Contingency is typically greatest in the beginning of a project and is gradually reduced as the project is designed, risks are resolved, or the contingency is spent. Figure 2 graphically depicts how a project range cost and its associated contingency is reduced as the project moves through the development process.

Figure 2: Conceptual refinement of a cost estimate

1.4. Risk Management Process

The six primary steps in project risk management are the following:

• Identification
• Assessment
• Analysis
• Mitigation
• Allocation
• Tracking and updating

Each step will be described in this document. The focus here is on the linking of these steps and the repeated application of the processes. A good example of how these steps are related is captured in the overall process flowchart in figure 4 from the Caltrans Project Risk Management Handbook, which was derived from the Project Management Institute Body of Knowledge. ^(6,3) The flowchart shows the division of analysis into qualitative and quantitative analyses; these require considerably different tools and levels of effort, as explained in Chapters 3 and 4.

Figure 3: Caltrans Project Risk Management Handbook

Figure 4: Caltrans risk management process

An important underlying concept of this approach is that the overall process is repetitive and cyclical (see figure 5 ). As the project evolves, some risks will be resolved or diminished, while others may surface and thus be added. These steps are continually applied throughout the project implementation period.

Figure 5: Cyclical nature of the risk management process

A study performed for WSDOT provides an interesting graphical summary, shown in figure 6 of how the application of this process and its steps varies throughout the project development period. In particular, it demonstrates how the relative importance of the risk management activity corresponds to project cost verification and validation activities.

Figure 6: Risk management and cost validation in the WSDOT CEVP process

The type of expertise necessary to support risk management, especially for identification and assessment, varies over time. The earliest stages of project development may depend heavily on expertise in environmental planning, funding, and operations. As engineering evolves and design nears completion, there will be more reliance on specialists in such areas as scheduling, cost estimating, and budgeting/controls. Table 2 (see page 7) from the 2004 FTA report Risk Assessment Methodologies and Procedures provides an excellent summary of key expertise needed for risk identification and risk assessments by project phase. This amplifies the value of considering risk management as a core project management process with broad-based team support. The Caltrans Project Risk Management Handbook offers an additional framework for considering the proper role of expertise over the project lifetime. ⁽⁶⁾ It presents a matrix of key responsibilities by process step and key stakeholder, shown in table 3. It distinguishes roles by the categories of "responsible," "support," and "approve." These responsibility assignments could be a valuable mechanism for insuring broad team participation.

1.5. Outputs from Risk Assessment and Allocation Process

Depending on the nature of the project, several outputs from the process are possible. Among the most common are the following:

• Expected value analyses of cost and duration with probability values for other potential outcomes.
• Value of information and control.
• Contingency assessments for cost and duration.
• Sensitivity analysis for individual risks.
• Risk management mitigation plans and strategies.
• Risk-based analyses of preferred project contracting/procurement approach.
• Risk allocation decisions that align team members with customer-oriented performance measures.

These outputs will be explained later in this document, including examples of best practices from throughout the transportation community and elsewhere. There are indeed some excellent examples from WSDOT, Caltrans, FTA, and DOE. Effectiveness of the process as a management decision aid is most often linked to the clarity of its communication. The simplest representations often work best. While the analysis may be supported by a complex, rigorous, and probabilistically sophisticated model, it is of little value if its outputs are obscured in jargon or overly complicated in their representation. Similarly, simple qualitative analyses that are easily understood by the decisionmakers can have a powerful influence on the risk measures taken. Communication is very much a key in using these outputs to their full potential.

1.6. Successful Use of Project Risk Management

A May 2001 survey conducted by DOE identified several characteristics of successful risk management programs: ⁽¹⁵⁾

• Feasible, stable, and well-understood user requirements.
• A close relationship with user, industry, and other appropriate participants.
• A planned and structured risk management process integral to the acquisition process.
• An acquisition strategy consistent with risk level and risk-handling strategies.
• Continual reassessment of project and associated risks.
• A defined set of success criteria for all cost, schedule, and performance elements (e.g., performance baseline thresholds).
• Metrics to monitor effectiveness of risk-handling strategies.
• Effective test and evaluation program.
• Formal documentation.

These findings are directly transferable to the planning, design, and construction of highway facilities, and thus serve as an excellent starting point for launching a standardized process for highway project risk management.

1.7. Conclusions

The rigorous process of risk identification, assessment, analysis, mitigation, allocation, and monitoring and updating described in this document allows for a more transparent and informed allocation of project risk. When risks are understood and their consequences are measured, decisions can be made to allocate risks in a manner that minimizes costs, promotes project goals, and ultimately aligns the construction team (agency, contractor, and consultants) with the needs and objectives of the traveling public.

1.8. Illustration: Strategic Approach

At the end of each chapter, this document provides an illustration that applies the concepts covered in the chapter. A fictitious State highway agency, QDOT, and project example, US 555-SH 111 interchange, have been created for the illustrations. The objective is to simulate an agency developing a risk assessment and allocation program and applying it to a project. Where possible, the illustrations draw from actual experiences of public sector agencies in the highway, infrastructure, and building industries.

Overview of QDOT'S Issues and Opportunities

QDOT has been facing growing capital project needs as well as a backlog of maintenance. The agency is operating an aging infrastructure under tight funding constraints and increasing environmental challenges, all with leaner staffing resources. The agency and its industry partners have become more aware of customers' needs because of some high-profile issues that have played out recently in the public forum. Among the most pressing issues are the following:

• Severe cost escalation from planning through final design and construction.
• Legal actions from stakeholders adversely affected by new projects.
• Construction management problems, including environmental violations.
• Project management mistakes because of the large number of complex projects.

QDOT also has a number of opportunities that offer hope for addressing the significant challenges it faces. Among the most significant opportunities are the following:

• Legislation at the State and Federal levels that allows for innovative project delivery and procurement options.
• Private sector partners who are making unsolicited proposals to help finance and operate QDOT's facilities.
• Recent successes in partnering that have helped make QDOT an owner of choice for small- to medium-sized contractors.

QDOT's New Strategic Approach to Risk Management The QDOT executive management has decided to create an agencywide risk management program to address the challenges and capitalize on the opportunities the agency faces. It believes that a better awareness of risk analysis and allocation techniques can assist it in improved planning, engineering, and construction management. The executive management has decided to dedicate resources for the following critical tasks:

• Creation of a strategic risk management oversight committee with representatives from planning, engineering, environmental, construction, and all other major groups.
• Investment in full-time staff and a commitment to on-call consultant agreements for facilitating risk identification workshops, performing risk assessments, and monitoring and updating project risk management plans.
• Development of a training program to create an awareness of risk identification, allocation, and management for planners, designers, estimators, and others.
• Development of a risk-based estimating approach for creating range estimates and supporting the risk assessment and allocation processes.
• Pilot (or test) of the risk management process on the US 555-SH 111 project.
• Monitoring and continuous improvement of the risk management process at periodic intervals.