Slide 3_Arpita


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Slide 3_Arpita

  1. 1. Construction Risks and Management By Arpita Ghosh For class Con: 589 Construction Co Financial Control
  2. 2. What is a Risk? <ul><li>Any time there’s anything that might occur on your project and change the outcome of a project activity, is called a risk . </li></ul><ul><li>Not that all risks are negative. A risk which bring a gain is called “Opportunity” </li></ul><ul><li>If your project requires that you stand on the edge of a cliff, then there is a risk that you could fall. </li></ul><ul><li>If it’s very windy out or the ground is slippery and uneven, then falling is more likely. </li></ul>
  3. 3. Project management Objective: <ul><li>To maintain: </li></ul><ul><li>Cost </li></ul><ul><li>Time </li></ul><ul><li>Quality </li></ul><ul><li>Additional objectives </li></ul><ul><li>e.g. Environmental, health and safety, no disruption to existing facilities etc. </li></ul><ul><li>Risk are those which causes deviation </li></ul>
  4. 4. An example of a project disaster: <ul><li>Original </li></ul><ul><li>Estimate: Aus $7m </li></ul><ul><li>Schedule: 4 yrs </li></ul><ul><li>Actual </li></ul><ul><li>Cost: Aus $102m </li></ul><ul><li>Duration: 14 yrs </li></ul>
  5. 5. <ul><li>“ No construction project is risk free. </li></ul><ul><li>Risk can be managed, minimized, shared, transferred, or </li></ul><ul><li>accepted </li></ul><ul><li>It cannot be ignored.“ </li></ul><ul><li>Risk management - The commercial imperative </li></ul><ul><li>… Sir Michael Latham 1994 </li></ul>
  6. 6. If risks are ignored: <ul><li>Increased costs </li></ul><ul><li>Loss or reduction in profit </li></ul><ul><li>Litigation </li></ul><ul><li>Damage to brand / reputation </li></ul><ul><li>At worst disposal of the business or </li></ul><ul><li>insolvency </li></ul>“ Dave determined to go green by using only solar powered tools, will hereafter check weather reports before making bids”
  7. 7. Some typical examples: <ul><li>Client certainty </li></ul><ul><li>(financial, stability, integrity) </li></ul><ul><li>Unforeseen conditions </li></ul><ul><li>(e.g. subsurface conditions) </li></ul><ul><li>Financing </li></ul><ul><li>Performance </li></ul><ul><li>Jobsite injuries </li></ul><ul><li>Defective Construction </li></ul><ul><li>Incomplete/Ambiguous Plans </li></ul><ul><li>Aggressive Schedule </li></ul><ul><li>Liquidated Damages </li></ul><ul><li>Dust Control/Prevention </li></ul><ul><li>Scope of Work Gaps </li></ul><ul><li>Changes in the Work </li></ul><ul><li>Non payment </li></ul>
  8. 8. Classification: <ul><li>Construction risks </li></ul><ul><li>Performance risks: Arises from failure/neglect of professional services (Ex: Bodily injury/damage/error) </li></ul><ul><li>Default risk: Default of general contractor/sub contractor/ supplier </li></ul><ul><ul><ul><ul><ul><li>Delay in approval/permits </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Unforeseen conditions (Ex: environmental issues) </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Legal risks (Ex: contractual issues) </li></ul></ul></ul></ul></ul><ul><li>Combination of both </li></ul>
  9. 9. How to deal with a risk? <ul><li>Avoid: The best thing to do </li></ul><ul><li>Mitigate: Action should be taken that will cause it to do as little damage as possible </li></ul><ul><li>Transfer: Someone else can be paid to accept it. The most common way is to buy insurance. </li></ul><ul><li>Accept: Last resort but stay prepared </li></ul>
  10. 10. Proactive risk management: <ul><li>The only way to avoid risks </li></ul>
  11. 11. Three Golden Rules: <ul><li>The person or party in the best position </li></ul><ul><li>to control a risk should take responsibility </li></ul><ul><li>for the risk. </li></ul><ul><li>Risks that cannot be controlled should be transferred to another person or party whenever possible. </li></ul><ul><li>Risks that cannot be controlled or transferred to another person or party should be insured. </li></ul>
  12. 12. Some facts: <ul><li>Risk has a direct relationship to the </li></ul><ul><li>price a contractor will ultimately charge </li></ul><ul><li>the owner for the construction. </li></ul><ul><li>It depends on how much risk is acquainted for in the budget </li></ul><ul><li>As CDs are not finalized, contractor’s assumptions can lead to the risks </li></ul><ul><li>In any construction project there are reasonable levels of risk that a contractor takes on and others that the owner takes on. </li></ul>
  13. 13. Tools of risk management: X Insurance X X X X X Contingency Funds X X Warranties X Retainage Accounts X Performance Bonds X X X Liquidated Damages Force Majure Hidden Defects Contractor Payment Defaults Start Up and Testing Problems Delay Cost Overruns Instruments
  14. 14. Summary: <ul><li>Proactive risk management: to </li></ul><ul><li>avoid risk </li></ul><ul><li>Contracts: to allocate/transfer </li></ul><ul><li>risks </li></ul><ul><li>Payment performance bonds: to mitigate risks/transfer to 3 rd party </li></ul><ul><li>Private insurance: to mitigate risks </li></ul><ul><li>Contingency fund, sponsor support, Retainage accounts: to stay prepared for accepting risks </li></ul>“ We’ve considered every potential risk except the risks of avoiding all risks”
  15. 15. Damages: <ul><li>Contractual clauses to transfer damages: </li></ul><ul><li>Indemnification: an agreement between two parties to assume risk </li></ul><ul><li>Subrogation: the process used by insurance companies to recover from a responsible third party amounts paid to its insured </li></ul><ul><li>Liquidated damages: A amount is agreed upon by the parties to a contract as adequately compensating for loss in the event of a breach  </li></ul><ul><li>AIA mutual waiver of consequential damage </li></ul>
  16. 16. Tools to mitigate damages: <ul><li>Contingency funds </li></ul><ul><li>Insurance </li></ul><ul><li>Some of the important insurance in construction: </li></ul><ul><li>Commercial General Liability Insurance </li></ul><ul><li>Automobile Liability Insurance: </li></ul><ul><li>Worker’s Compensation and Employer’s Liability Insurance </li></ul><ul><li>Excess/Umbrella Liability Insurance </li></ul><ul><li>Inland Marine Insurances </li></ul><ul><ul><li>Builder’s Risk Insurance </li></ul></ul><ul><ul><li>Equipment Insurance </li></ul></ul><ul><ul><li>Contractor Default Insurance </li></ul></ul>
  17. 17. Non Payment: <ul><li>Contractual clauses to transfer risks: </li></ul><ul><li>the contractor may not be paid for the work performed. </li></ul><ul><li>When the owner fails to pay, it can be felt all the way down the chain. </li></ul><ul><li>“ Pay When Paid” or “Pay if Paid” provisions help transfer the risk </li></ul><ul><li>Sub contractor share the risk </li></ul><ul><li>Tools to mitigate: </li></ul><ul><li>Contingency </li></ul><ul><li>The contract document </li></ul><ul><li>Approved change order </li></ul>
  18. 18. Contractor Default: <ul><ul><li>Tools to mitigate: </li></ul></ul><ul><ul><li>Retainage amount </li></ul></ul><ul><ul><li>Contingency funds </li></ul></ul><ul><ul><li>Surety </li></ul></ul><ul><ul><li>Different types of Bonds: </li></ul></ul><ul><ul><ul><ul><ul><li>Bid bonds: Guarantee the contractor will execute the contract if awarded the work. </li></ul></ul></ul></ul></ul><ul><ul><li>Performance bonds: Guarantee performance of the contract in accordance with the contract terms, conditions, and specifications. </li></ul></ul><ul><ul><li>Payment bonds: Guarantee the contractor will pay all the costs associated with performance of the contract. </li></ul></ul><ul><ul><li>Supply bonds: Guarantee that suppliers providing critical material/equipment in accordance with the purchase order. </li></ul></ul>
  19. 19. Learning points 1: <ul><li>Overly One sided Contractual Requirements not only drive project costs up, but may also engender a more adversarial relationship. </li></ul><ul><li>Indemnity provisions should be also backed up with insurance. Contractual indemnity provisions included in contracts are only as good as the indemnitor’s ability to honor them </li></ul><ul><li>Insurance Requirements should be tailored to the Discipline. </li></ul>“ Your credit rating is a bit low but we can still offer you a loan. Do you have problem with being fitted an electronic ankle bracelet”
  20. 20. Learning points 2: <ul><li>Address Potential Gaps in coverage, scope of work, covered properties. Challenge all assumptions </li></ul><ul><li>Construction contract is the bedrock of risk management: Contracts should be reviewed by knowledgeable attorney. Read the Contract Before Executing It </li></ul><ul><li>Insurance is a critical ingredient, but not the whole of risk management </li></ul>“ There’s really no need for confusion. Part 95 of section 303 ‘ What the contract says goes into the front porch’ quite clearly states…”
  21. 21. Construction Risks and Management In Best Value Concepts
  22. 22. The Theory <ul><li>All the events can happen in only one way </li></ul><ul><li>The outcome of the event depends on initial conditions and laws of nature </li></ul><ul><li>Nobody can control, influence and impact an event </li></ul>Initial conditions Final conditions Time Laws Laws
  23. 23. Sources of risks 1 : <ul><li>The low bid nature of the industry which have no relationship with performance/expertise </li></ul><ul><li>Low bid failing to ensure low cost of the project </li></ul><ul><li>Contracts merely transferring risks than mitigating risk and used as a tool for the client to manage and control. </li></ul><ul><li>Ambiguous nature of contracts leading to no accountability and reactive environment </li></ul>
  24. 24. Sources of risks 2 : <ul><li>Minimum standards forcing high performing contractors to lower their level of quality and giving advantage to the contractor who does minimal work. </li></ul><ul><li>Usage of technical information when making a decision instead of performance information </li></ul><ul><li>Warranties written by the manufacturer’s lawyers safeguarding their clients’ interest. Used as nothing but a marketing tool. </li></ul>
  25. 25. Risk Management 1: <ul><li>Identify the best/expert contractor. </li></ul><ul><li>Expert contractor should not have any risks which is within their control </li></ul><ul><li>An expert should have knowledge of all the risks beyond their control. So should be able to avoid them with proactive planning and actions. </li></ul><ul><li>Contracts should be used as a tool of identifying and managing risks by the contractor </li></ul>
  26. 26. Risk Management 2: <ul><li>An expert should be able to accurately identify what can be offered within the budget. So minimal change orders and surprises </li></ul><ul><li>Once the expert identified owner should let the expert to do their job </li></ul><ul><li>Ensure that the contractor spend more time before the project starts and preplan </li></ul>
  27. 27. Risk Management Tools 1: <ul><li>Before project starts: </li></ul><ul><li>PIPS ( Performance Information procurement system): Ensures identification of best vendors (experts) </li></ul><ul><ul><li>PPI: Evaluates past performance information of the vendor </li></ul></ul><ul><ul><li>RAVA plan: Evaluates all the vendors’ risk assessment and value added plan for non technical risks </li></ul></ul><ul><ul><li>Interviews: Evaluates capability of the contractor to manage risks </li></ul></ul><ul><ul><li>Pre Award meeting: Discussion of technical aspects, technical risk and ensure co-ordination </li></ul></ul><ul><ul><li>RMPs: Ensures risk management planning by the contractor </li></ul></ul>
  28. 28. Risk Management Tools 2: <ul><li>After project start: </li></ul><ul><li>PIRMS ( Performance Information risk management system) </li></ul><ul><ul><li>WRR (weekly risk report): Contractor track, manage and control risk according to the plan </li></ul></ul><ul><ul><li>Director’s Report: Summarized report measures performance of every personnel/organization attached with the projects. Brings transparency </li></ul></ul>
  29. 29. Questions?