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Chapter 9
Construction Risk Analysis and Management
9.1 Introduction
Risks associated with construction are numerous, and each of the four main project
objectives of scope, time, cost, and quality remains subject to risk, and their effects
are considered throughout the project. Construction projects can be unpredictable.
Risks start appearing as soon as it is decided to initiate a project and continue to
increase as the project moves further.
Construction projects can be extremely complex with many uncertainties. In any
complex project, there are many things that can go wrong. Risks are therefore inevitable and cannot be eliminated; however, they can be mitigated or distributed with
better preplanning. Construction contracts basically carry risks for both the
Contractor and the Owner. Unfortunately, some project owners try to allocate the
majority of risks to the Contractor satisfying their needs. Whereas contractors consider that they can minimize risk through early completion of the project for less
than the contract price, to maximize profits.
In order to achieve project objectives, managing risks in construction projects has
been recognized as a very important process. Good risk management practices direct
that the distribution of project risks between the various parties shall be made clearly,
sensibly, and equitably. Unfortunately, there is a general failure between the construction industry to handle risk issues properly, which mostly results in excessive
claims and disputes within the parties. It is therefore important to be prepared for risk
occurrences and to handle them timely, through good management and foresight.
9.2 Definition of the Risk
Various definitions have been provided by various professionals. Darnell and
Preston (2010) defines risk as “possibility of loss or injury.” Barber (2005) defines
risk as “a threat to project success, where the final impact upon project success is
© Springer International Publishing AG 2018
A. Surahyo, Understanding Construction Contracts,
DOI 10.1007/978-3-319-66685-3_9
9 Construction Risk Analysis and Management
not certain”. The National Association of Surety Bond Producers [1] defines construction risk as “any exposure to possible loss”.
Risk is basically the product of severity of hazard and the probability of occurrence. Because every construction project is unique, each offers a multitude of different risks. To ensure the success of an undertaking, the Owner initiating a
construction project must be able to recognize, assess, and handle these risks.
9.3 Risk Management
Risk management is concerned with planning, identifying the risks, assessing their
likelihood, and deciding how best to manage the project efficiently in the light of
this information. An effective risk management method can help properly in identifying risks and how to manage these risks in different stages of a project. Effective
risk management increases the likelihood of project success increasing the likelihood of finishing the project on time, within budget and meeting stakeholders’ performance expectations.
For effective management of risks, efforts are required at the early stages of the
project to identify all relevant risks by all team members. A key to the success of any
construction project is having the right Project Manager, with the right project management model, team, and supporting resources. A Project Manager must be able to
recognize and identify the root cause of the risks and mitigate them well. The process of managing contractual risks falls into five main stages.
9.3.1 Risk Management Planning
Risk management planning is the process in which it is decided and worked out how
to approach and conduct the risk management activities for a project. Risk management planning should be carried out during the early stages of the project, i.e., at the
project planning stage. Risk planning will help earlier identification of high risks,
limiting inappropriate changes, rework, cost overruns, time overruns, etc.
To develop a risk management plan, the project team should conduct internal
meetings with all related staff. Mainly the risk management plan should include:
1. Procedures, means, and methods to be used to perform risk management on the
2. Roles and responsibilities (complete with details of who will do what)
3. Budget and time to deal with potential risks
4. A process for identifying risks including risk monitoring procedures
9.3 Risk Management
9.3.2 Identifying the Risk
The second step in dealing with construction risks is to develop a method for the
identification and classification of individual risks related to the particular project.
Every construction project carries various different types of risks; however, some
risks are common to most of the projects. Examples include differing site conditions, inclement weather, contractor reliability, and the risk of maintaining adequate
A common procedure for risk identification and classification is the development
of a risk checklist. For preparing a risk checklist, the past record of risk management for the completed projects is reviewed. This technique allows the user to list
common project risks and then to add those risks which are specific to the project in
hand. Organizing Checklist
There are several approaches for organizing a risk checklist into a suitable format.
One approach proposes that risks should be organized in terms of the nature of the
risk itself, like known risks and unknown risks. A second approach proposes to classify the risks upon their effect on the project, like cost risks, schedule risks, or quality risks.
As such, risk is defined in terms of an event, its probability, and the cost and time
involved; a suitable way of organizing a construction risk checklist is to divide risks
into two broad categories: design and construction risks and financial risks [2].
These risks are most related to the construction projects. Financial risks start affecting the project from the earlier stages of planning and feasibility phases, whereas,
design and construction risks appear throughout the life cycle of a project and especially during the construction period.
Most types of risk that occur on a construction project can be summarized using
the following checklist, Table 9.1, and can be tailored to a specific project in hand.
9.3.3 Analyzing the Risk
The third step in managing risks is analyzing the risks, i.e., assessing the probability
of each risk occurring and severity or impact on main project objectives: cost, time,
and quality. Risk assessment methods are formal processes for employing common
sense and creative lateral thinking to visualize problems and workout ways to reduce
or avoid the likelihood of their occurrence. They depend on good communication,
good documentation of ideas and discussions, and agreement about how the whole
process will be handled. Risk assessment needs to begin at an early stage and be
continuously updated as the project progresses and details are clarified. Risk
9 Construction Risk Analysis and Management
Table 9.1 Risk category checklist
Risk category
1. Funding and payment
2. Planning and designing
3. Construction
Risk factor
Lack of financial resources/funding
Delay in payments
Delay in settling changes & claims
Owner or contractor’s insolvency
Technical feasibility
Economic viability
Inadequate statement of work (scope)
Project complexity
Sole source of material or services providers
Program of works
Design completeness and standards
Inadequate selection of contract types (e.g., lump sum, unit
price, cost plus, etc.)
Inadequate selection of contract delivery methods (e.g.,
traditional, design and build, management, etc.)
Shortage of staff, labor, plant, or materials
Labor productivity
Strikes and unions
Work ethics
Wage scales
Labor disputes
Delay in possession of site
Underground conditions or differing site conditions (soil
conditions, water, utilities, archeological findings)
Inclement weather
Hazardous wastes
Noise, fume, and dust
Defective materials and workmanship
Contractor reliability (e.g., capacity, capability, etc.)
Subcontractors inefficiency
Delayed drawings or instructions
Errors in design and drawings
Incomplete and inefficient supervisory staff
Poor planning and management
Poor communication and coordination
Scope changes and claims
Too much Owner involvement
Acts of God (e.g. storms, earthquake, floods, etc.)
Third-party claims
9.3 Risk Management
Table 9.1 (continued)
Risk category
4. Regulatory conditions
Risk factor
Licenses, permits, and approvals
Environmental regulations and requirements
Taxes and duties
Health and safety regulations
assessment is an important task, which must be carried out successfully by using
reasonable methods of measurement.
Risk assessment should commence in conjunction with the identified risk items
in the checklist described earlier. Using the checklist allows the division of risk
items according to categories which contributes to a better understanding of how
these uncertainties function and affect the project. The risk assessment process
involves itemizing the risks into a ranking that will place them in order of ­importance.
To do this, every item in the checklist should be earmarked as high, moderate, or
low risks (Table 9.3). For example, if an individual project involves major underground construction, then the risks associated with this activity will become very
important and will require extra attention. The checklist can be examined for every
project and filled in so as to reflect specific project characteristics. This method is
called Qualitative risk analysis.
The second risk analysis method is Quantitative analysis which means numerical
analysis of the probability and impact of the project risks. This method is initiated
for the highest risks from qualitative risk analysis and is not recommended for a low
priority risks. Under Quantitative analysis the most common method of assessing
risk is to prepare a fault tree of possible hazards. If the hazards are acceptable, the
risk is calculated by using the concept: risk = impact of hazard x probability of
occurrence [3]. If this calculated risk is accepted, it is then distributed among the
required parties. However, if the hazards are unacceptable, the activity is either
rejected or a method is found to mitigate the hazards and carry on further process.
This method can best be understood by an example. Suppose a sewer treatment
plant plan to install fire fighting system in the plant. They have come up with the
following two options to decide whether to proceed with this item of work or not.
Example 9.1
Scenario 1: Fire fighting system required
Set-up cost = $100,000.00
Issues, problems, maintenance = 20%
probability and $50,000.00 impact
Analysis for this case = 20% × $50,000
+ $100,000.00 = $110,000.00
Scenario 2: Fire fighting system not required
Set-up cost = $0.00
If not installed then risk chances = 60%
probability and $300,000.00 impact
Analysis for this
case = 60% × $300,000.00 = $180,000.00
At initial stage looking at the set-up cost against scenario 1, plant authorities
might think that there is no need to invest $100, 000.00 for this item in comparison
to scenario 2 where the set-up cost is zero, but the analysis proves differently.
9 Construction Risk Analysis and Management
The effectiveness of this technique depends on the ability of those engaged to
identify all possible events. It is worthwhile to mention that risks having very high
probabilities and very low impacts or vice versa are usually not considered important in the construction projects. In fact, it is the combination of probability and
impact that matters. Other Quantitative risk analysis methods include Monte Carlo
simulation, cost-risk analysis, expected monetary value analysis, etc.
9.3.4 Responding and Allocating Risk
The fourth step is to decide which party is best equipped to manage, control, and
assume the risk. Risk response involves procedures to either eliminate a risk before
it occurs by proactive approach or mitigate its probability and impact as much as
possible. Some risks may be insured, as within most of the standard forms of the
contracts, risk is primarily allocated between the parties through indemnity and
insurance requirement provisions.
Since funding is provided by the Owner, it is his privilege to assign responsibilities. He has the opportunity to reduce the total project cost through effective allocation of related construction risks. However, as mentioned earlier, the distribution of
risks between the parties should be carried out sensibly and equitably because misallocation of risks is not cost-effective. Placing an inequitable risk share on the
Contractor should be avoided as it promotes negative working relationships and
increases disputes.
Proper and reasonable risk allocation improves efficiency, reduces costs and disputes, and promotes project goals. In the absence of uncertainties imposed by
unfairly allocated risks, contractors can avoid the addition of cost contingencies in
the pricing of project bids and estimates. By adopting fair risk allocation, the Owner
can expect that their projects will have fewer claims, reduced costs, and timely
completion. The most common options of responding and allocating risks are risk
acceptance, risk sharing, risk avoidance, risk reduction or mitigation, and risk
Riskacceptance The most appropriate method to allocate risk is to have the party
who controls the risk should accept/retain the risk. For example, a Contractor who
is in charge of the construction works, risks arising out of his operations should be
allocated to him. Similarly, as the Designer is in control of the design component,
he should be allocated the risks pertaining to design, e.g., design errors. Similarly,
site selection is the Owner’s responsibility; hence, risks pertaining to site issues
such as access, permits, and acquisition should be allocated to the Owner. In the
same way, if the risk of fire is to be dealt with by an indemnity from an insurer, the
Contractor who is responsible will be tasked with obtaining the insurance coverage
and will be considered as having control over the policy; thus, the risk is allocated
to him.
9.3 Risk Management
Table 9.2 Risk matrix example showing risk and responsibilities of the parties
Possession of site
Financial resources
Errors in design and drawings
Weather (normal)
Inclement weather
Acts of God
Adequate manpower and so on
Under standard forms of contracts, the Owner will also retain risks that are out
of the control of the Contractor, such as acts of God, war, riots, nuclear explosives,
strikes, etc. Risk acceptance may be made with contingency. A typical contingency
sum will be allowed to the project to address these risks. Contingency is a sum of
money or period of time set aside from the general construction funds to pay for
losses that actually occur.
The best way to identify the risk assumed by the various parties is to develop a
risk matrix. Each party should refer to the matrix and evaluate the extent of risk they
are willing to undertake. Parties also should ascertain who is to bear the responsibility for other risks not listed in the matrix. Table 9.2, indicates an example of a risk
matrix showing some of the risks and the responsibilities of the parties involved.
Risk sharing Sometimes it is not possible for one party to control a specific risk.
The suitable procedure is that it may be then shared and managed by dividing it
among two or more parties so as to manage the portion that they are best able to
control individually. An excellent example of risk sharing is the development of a
joint venture by contractors [2]. A joint venture is the result of the unification of two
or more contracting firms to build a single project. Hence all partners share in construction risk in the same way they share in any profit and loss.
Another risk sharing system can be found in the guaranteed maximum price
contract. In this contract type, the Owner and the Contractor agree to a project cost
guaranteed by the Contractor as maximum. With a guaranteed maximum price contract, amounts below the maximum are typically shared between the Owner and the
Contractor, while the Contractor is responsible for costs above the maximum.
Some individual risks are also shared between the Owner and Contractor under
standard forms of contract. For example, the risk resulting from the provision
regarding “adjustment for changes in legislation” is shared between the Owner and
Contractor both under FIDIC Conditions of Contract (Red Book) [4]. FIDIC Sub-­
clause 13.7 refers to increase or decrease in cost due to changes in Legislation.
Accordingly, if a Contractor suffers delay or additional costs, the Owner has to
share the burden. However, if there is decrease in cost, then the Owner can submit a
claim for a credit.
9 Construction Risk Analysis and Management
Table 9.3 Risk response matrix
Risk event
Addition of
internal walls
(scope changes)
Probability of occurrence
Medium Low
Magnitude of impact
High Medium No action
Risk response
Type of action
Risk allocated to
the contractor
Risk allocated to
the contractor
Risk avoidance Avoiding a potential risk will reduce a risk’s probability to zero.
After the risks are identified and analyzed, some risks may be found unacceptable,
e.g., deficiency of funds. Withdrawing a bid by the Contractor or the Owner and not
proceeding with the project are two examples of total avoidance of risks. In such
case the Owner may redefine (i.e., reduce) the scope of work or even abandon the
project for a period of time until the funds are made available to avoid the risk.
Some risks that arise early in the project can be avoided by clarifying requirements,
obtaining proper information, improving communication, or acquiring expertise.
In addition to risks between the Contractor and Owner, consultants are also subject to risks. Consultants can avoid risks by ensuring that the professional responsibilities are clear and unambiguous.
Risk reduction / mitigation Risk mitigation involves reducing the probability or
impact of the risk to an acceptable level. Actions are taken before the risk is triggered to minimize its probability of occurrence and impact. Taking early action to
reduce the probability or impact of a project risk is usually more effective than trying to rectify the damage after the risk has occurred.
The most common risk mitigation efforts include having strong project control,
conducting constructability reviews, expediting variations and claims, avoiding late
issue of drawings, use of standard items or software, using alternative design and
specifications, etc. In short, a well-managed project will have fewer risks.
Risk transfer Risk transference involves shifting the negative impact of a risk
threat, along with ownership of response to a third party. Risk transferring also
eliminates the risk from impacting the project. However, when risks are transferred
to another party, a premium is paid to compensate the third party to take on the risk.
All parties involved in a construction project can protect their interests via insurance but must accept that not all risks are insurable as described earlier. Many of the
standard form contracts insist on certain types of insurance. Insurable risks are generally allocated by contract to the party best able to control, manage, and insure the
risk. Standard insurable risks are for works such as, materials, plants and Contractor’s
equipment, damage to person and property (third-party insurance), etc.
The consultants usually obtain “Professional Indemnity Insurance” so as to cover
themselves and their clients against the risk of failure to perform their duties with
the required level and skills.
9.4 Standard Forms of Contract
The insurance and surety industries provide financial security for parties that
incurred legal obligations. Accordingly, forms of financial security and guarantee
are available to transfer certain types of risk. For example, the risk of nonperformance on a contract can be addressed by a financial guarantee.
Once the risk assessment and risk response actions are finalized, the Risk
Response Matrix can be prepared for proper record and further review during the
risk monitoring and control process. Table 9.3 provides an example of a Risk
Response Matrix with some of the risk examples.
9.3.5 Risk Monitoring and Control
Risk monitoring and control is the process of tracking all the identified risks, analyzing and reviewing these risks, and identifying and planning for newly arising
risks during the life of the project. The progress and performance of risk responses
are evaluated, and risk status is updated periodically.
The main objective of the risk monitoring process is to establish a cost performance and schedule management system. The system should be designed to provide early warning of potential problems to allow management action. As the risk
approaches, the risk strategies are reviewed for appropriate actions, like choosing
alternative strategies, executing a contingency plan, taking corrective action, etc.
As each risk occurs and is dealt with or is avoided, these changes must be documented. Good documentation insures that risks of this type will be handled in a
more effective way than before and that the next project manager will benefit from
“lessons learned.”
9.4 Standard Forms of Contract
In order to achieve fair distribution of risks, standard forms of contract should be
used, which carries appropriate clauses for allocation of risks. For example, clause
17 of FIDIC [4] allocates responsibility between the Contractor and the Employer
for damage, to the works. According to this clause, the Contractor is to bear the cost
of rectification of loss or damage, which arises from any cause, other than those,
which are described as “Employer’s Risk”. Where damage is caused by an
Employer’s Risk, the cost is born by the Employer.
Generally, risks that are severe and outside the control of the Contractor, like
war, earthquake, riots, nuclear explosives, etc., should be retained by the Employer
as is specified by the FIDIC [4] in abovementioned clause.
Construction industry standard forms are produced by construction industry
experts and construction law practitioners over a period of many years after receiving suggestions and feedback from owners, contractors, consultants, sureties, and
9 Construction Risk Analysis and Management
insurers and are also being updated from time to time. Despite all these efforts,
standard forms should not be used without modifications as they are drafted for
broad applicability. Standard form contracts cannot account for all specific legal and
financial terms that the parties need to insert in their agreements. The activity of
allocating risks should be carefully evaluated by an insurance professional, contracts specialist, legal counsel, or knowledgeable design professional to assess specific or unique risks and exposures.
References and Further Reading
1. National Association of Surety Bond Producers – SuretyLearn.Org. Washington, DC, USA.
2. Touran A., Bolster P. J., & Thayer S. W. (1994). Northern University, Boston. Risk assessment in fixed guide way transit system construction. A report prepared for U.S. Department of
Transportation, Washington, DC.
3. Bunni, N. G. (1986). FIDIC’s view of design liability- Construction, Insurance & law. A discussion paper. Published by FIDIC.
4. The FIDIC. (1999). Conditions of contract for construction – (Red book). Author FIDIC.
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