Project risk matrix
September 24, 2014 by DAVID BOWCOTT
Everybody has a risk matrix these days. Often every major stakeholder in a project will develop their own risk matrix in order to identify, quantify and treat risks. This tool is very helpful, as it ensures proper due diligence around project risk is performed and, once mapped to risk treatment solutions, can be used as a checklist to ensure contractual terms, risk controls, best practices and risk finance solutions are put in place.
So what does a risk matrix typically look like? Often it is an Excel spreadsheet that contains the following columns:
- Risk – A brief description of the risk in question.
- Risk Rating – A section whereby each risk is quantified. Often you will see a column for probability rating, severity rating and some form of combined rating (derived from a mathematical formula involving the probability and severity rating). Once the ratings are completed the user can sort the combined rating column from largest to smallest in order to rank the project risks.
- Risk Allocation – Who is currently carrying this risk via current contract forms?
- Risk Treatments – Sometimes only carried out for major risks, but sometimes done for all risks on the matrix. The risk treatments are solutions that are going to be used to manage each risk. Often the risk treatments will be broken into two categories – i) Risk Control Solutions and ii) Risk Finance Solutions. Risk controls are contractual allocations, contractual warranties, best practices, etc., used to manage the risk. Risk Finance represents various forms of security to generate funding (or response) when the risk manifests. Things like insurance, performance security, letters of credit and cash reserves.
- Residual Risk Ranking – It is one thing to quantify risk, but the purpose of the risk matrix is to identify, quantify and treat each risk. Once treated, the risk rating should decrease, and thus it is a good idea to have a residual risk ranking.
There are other categories that can make your risk matrix more robust, but those are the key components.
These risk matrices are effective tools to manage risk, however, they become truly powerful when developed collectively by all major project stakeholders. Having a risk matrix is good, having a risk matrix where all stakeholders agree on major risks, allocations and treatments of those risks, is better! Removing the silos in which each stakeholder identifies, quantifies and treats risk is the most effective way for your project to achieve a successful outcome.
So who are these major stakeholders? The following represent key stakeholders that should participate in the development and execution of a shared risk matrix (bearing in mind this is the construction phase of the asset):
- Lender (depending on the degree of financing)
- Design firm
- General contractor
- Major subcontractors
- Consultants to each major stakeholder, and the insurance/risk advisor
OK, I promise you that I’m not being self-serving by giving the insurance/risk advisor its own chair at the table. Consider that a good insurance and/or risk advisor can bring the following key solutions to the table:
- Data – Some insurance/risk advisors have access to significant claims data that can validate the risk identification and quantification process. They have the ability, if used properly, to provide true quantitative analysis of your risks.
- Risk Controls – In order to place all the covers associated with a construction project, a good insurance/risk advisor needs to be very knowledgeable when it comes to risk controls, or best practices, associated with preventing and mitigating various risks. This library of risk control solutions should be applied to your project.
- Risk Finance – The top insurance/risk advisors do not exclusively trade in insurance solutions. The top players are integrating insurance solutions with solutions from the banking sector and the capital markets to create the deepest toolbox of risk finance solutions. Don’t treat insurance like a checkbox product, as there are several new technologies that are more liquid and integrated in their design, and these solutions can provide your project greater certainty for success.
- Risk Communication – A select few insurance/risk advisors actually help their clients communicate risk management strategies to other key stakeholders of the project. Through this transparent communications process, those key stakeholders can often release their best terms (i.e. project debt terms).
In closing, you should definitely learn more about risk matrices and how to create a unified risk matrix including all key stakeholders. And finally, involve key stakeholders that may provide your project solutions beyond their perceived traditional role.