Residual risks in construction are the risks left over after you implement mitigation controls. These are most often assumed by the employer, where other risks are transferred to the contractors. In some cases, you can negotiate residual risk transfers for a cost.Read on to learn more about what residual risks are in construction, how to rank and categorize risk, and what you can do to reduce or eliminate risks as you move your project forward.
What Constitutes Residual Risk?
Residual risk is defined as the risk left over after you control for what you can. For example, one residual risk of prescription medicines is the possibility that children will consume the medications, even after controlling for the risk with child-resistant packaging.In construction, residual risk is assumed by the and not the contractor unless they negotiate a transfer of risk. Transfers of risk usually come with a cost because no party wants to take responsibility for risk unless they are fairly compensated for doing so.
Examples of Residual Risk in ConstructionIn construction, you can break residual risk into four categories:
FinancialResidual financial risks include costs that develop regardless of any mitigation tactics or plans that you make. These can be significant or minor, and you should carefully consider each. Examples of financial risks in construction include:
- Unexpected increases in the cost of supplies
- Poor financial planning leading to an insufficient budget
- Poorly defined scope leading to higher supply costs than expected
- Labor shortages leading to increased costs of labor
- Changes in tax rates
- Changes in exchange rates due to inflation
ContractualResidual contractual risks include all risks associated with unclear or incomplete contracts. This includes all negotiations of schedule, design, and how resources will be used, among other things. Examples of contractual risks in construction include:
- Managing change orders from the client
- Incomplete blueprints and drawings
- Design errors or omissions
- Design process takes extra time
- Poorly defined scope leading to poor time planning
- Poorly written contracts with suppliers and subcontractors
OperationalResidual operational risks include anything that’d come up in the construction operations not accounted for in the plans. Examples of operational risks in construction include:
- Safety hazards leading to worker injuries and accidents
- Labor shortages leading to slowdowns
- Damage to equipment
- Theft of equipment
- Failure to work per contracts
- Public objections
- Changes in local laws and standards
- Inexperienced workers
- Staff turnover
- Delayed deliveries of supplies
- Scheduling errors and delays
- Conflicts within the project team
- Poor choice in plant, crane, or other equipment
- Construction storage areas not large enough
- Not enough time planned for getting permits
- Inadequate planning of road closures
EnvironmentalResidual environmental risks include any risks associated with nature or the environment that were not previously accounted for, including the accessibility of environmental permits and adherence to conservation laws. Examples of environmental risks in construction include:
- Natural disasters
- Unknown or changing site conditions
- Harsh weather leading to delays
- Incomplete environmental analysis
- New environmental impact requirements
- Incorrect or expired permits
- Lead contamination from the use of leaded gasoline
- Need for deep excavations that could lead to collapse, failed materials
- Fire risk from technique, waste, or arson
- Overhead power lines and other obstructions not accounted for
- Destruction of sensitive or protected habitats
- Unexpected buried man-made objects, including hazardous waste or archeological artifacts
- Paleontological artifacts
- Unidentified gas pipelines and other utilities discovered underground
Differences Between Inherent, Secondary, and Residual RisksInherent, secondary, and residual risk are all categories of risk to consider in construction projects.
Inherent RiskInherent risk is a measure of . This figure can be evaluated as very high or very low, depending on which factors you consider. For example, suppose you consider the risk of a construction project without any controls. In that case, you’ll have to assume that your blueprints are all incomplete, natural disasters will happen, and that material costs will unexpectedly increase, among other things. Realistically, you need to consider inherent risk relative to the controls at your disposal. For example, you might consider the inherent risk of flood damage if, for some reason, you aren’t able to implement any drainage controls. This is the inherent risk.
Secondary RiskSecondary risk is the risk that you introduce when you take steps to mitigate an inherent risk. For example, you might choose to switch suppliers based on political uncertainties in the exporting country, only to find that the supplier you switched to offers lower-quality materials. The risk associated with the new supplier would be secondary.
Residual RiskResidual risk is the risk associated with your original choice or action in the presence of controls. For example, the residual risk of a building project could be the risk of flooding even after you’ve implemented a drainage system. This is different from a secondary risk of flooding, which would be the risk that’s the direct result of mitigation tactics for a different problem.
How To Calculate Residual RiskYou can calculate risk by determining the likelihood that some negative outcome will happen and multiplying it by the severity of that outcome. You can calculate residual risk by determining how much risk is addressed by certain controls, subtracting that from the total inherent risk.
How To Manage Risk in ConstructionTo manage risk, you’ll need to compare different risks and rank them in the order that they need to be addressed. Consider the likelihood that a risk will materialize and the severity of the impact that it does, giving each risk a rating that you can use to compare them. Then you can review each one in order and decide how you want to handle them. Your choices are to avoid, reduce, eliminate, transfer, or accept risk.
Avoiding RiskIn some cases, the best thing that you can do is avoid risk by refusing to take on a project. You should carefully weigh the risks involved before deciding to do this, but know that it’s okay to walk away if you can’t find a way to significantly mitigate the risks involved in a project, especially if the rewards aren’t worth it.
Reducing or Eliminating RiskReducing or eliminating risk should be a careful process of breaking down project risks into actionable items that you can address one by one. Sometimes you can reduce risk by hiring more qualified workers or renting better equipment, both of which require some investment upfront in the hopes of a better outcome overall.
Transferring RiskYou may be able to transfer risk to other stakeholders in a project. Stakeholders will sometimes take on or share risk with their employers, often as the result of negotiations in which they are compensated for doing so. You’ll need to know how much risk there is and how severe it is before you can negotiate a transfer of risk. When lawsuits develop, it’s important to know exactly who is responsible: the property owner, the construction project manager, the general contractor, or a subcontractor. The best way to know this is by negotiating the risk ahead of time. The responsible party will then handle the case, including paying all legal fees and handling the lawsuit’s outcome.
Accepting RiskYou may find yourself in the position of needing to accept risk to move a project forward, but you should carefully weigh all of your options before you agree to take on risk. Generally, you should try all of your other options first, but in some cases, it does make sense to accept risk and move forward, like when the risk is low probability and low impact.
What Does a Risk Management Professional Do?Because construction projects are complicated and expensive, many project investors and lenders choose to hire risk management professionals who can detail the financial risks associated with a project.
These professionals are typically very involved in the project from start to finish. They may do any of the following things:
- Review construction drawings, specifications, and documentation
- Analyze budgets, including direct cost and contingency budgets
- Review contracts with subcontractors
- Review agreements with lenders
- Review construction and disbursement schedules
- Prepare a Construction Risk Assessment (CRA)
- Monitor compliance with contracts throughout operations
- Track spending and available funds
- Review testing reports
- Document progress (photographic and other)
- Create Preparation of Project Status Reports (PSRs)
- Review and accept certificates of completion, design compliance, and occupancy (when applicable)