Risk Management in Building
- no longer an oxymoron -
Tony Williams
Building Value Limited
May 2002
Synonyms of risk
attempt
gamble
chance (of) (en)danger/ effect/
/mischance dare
expose
harm
hazard
(im)peril
jeopardy
lay bare
loss
menace
possible/
probable
stake
threat
venture
Synonyms of manage
administer
contrive
conduct/control
cope
deal with
direct
domineer
guide
handle
influence
organise
run
service
succeed/
supervise
wield
Synonyms of building
contract
construct (ion)
co-ordinate
create
edifice
erect (ion)
form (ation)
lay/make
manufacture
produce
put together
structure
subcontractor
top out
work
Alternative synonyms of building
b***tard
combatant
cowboy
cut-throat
high risk
know-it-all
itinerant
late
loss making
robbing
(see top left)
unreliable
ruthless
unkempt
sexist
xenophobic
Definition of risk
 Risk means chance of injury or loss due to
uncertain danger, peril or hazard
 A particular decision or course of action is said
to be subject to risk when there is a range of
possible outcomes….
 ….then, objectively known probabilities can be
attached to these outcomes
Risk vs uncertainty
 Risk is, thus, distinguished from uncertainty,
where there is a plurality of outcomes where
objective probabilities cannot be assigned
 Many situations, which in practice are called
‘risky’ are, on a strict definition, really subject
to uncertainty not risk
 …..and finally,if you are Zurich IC Squared,
“risk is an investment”
Definition of Risk
Management (RM)
 Involves anticipating and/or identifying
potential risks and taking steps to avoid them
or to mitigate the resulting harm
 The aim is to minimise the sum of:
- retained losses
- insurance or other risk transfers
- loss control expenses
A builder’s definition of RM
 Risk is an uncertain event, feature, activity or
situation that can have a positive or negative
effect on an object
 Note, that this encompasses both the upside
and downside of risk
 RM is a formal process that identifies,
assesses, plans and manages the risk
Why builders have RM?
 “A risk aware organisation, capable of
identifying and managing uncertainty in order
to maximise opportunity & deliver max. value”
 “…Its primary aim is to help maximise
business value by doing the right projects,
right the first time.”
 RM quality “and the successful identification,
reduction, communication and control of risk
are key issues and performance drivers….”

Why builders have RM?
 The group “assesses and manages risk to
ensure that:
- the public, our employees and the
environment are safe from the potential
hazards in our operations;
- that new essential assets are created to the
maximum obtainable benefit of their intended
users and the community at large;
- the potential for damage to our clients and
the Group’s corporate reputation and/or
financial loss to our stakeholders is minimised”
Insurance Management
(IM)
 Underwriting focuses on the past e.g. historic
losses, litigation, court decisions
 Insurance coverage is designed empirically
 Insurance industry traditionally adopts a ‘rear
view mirror’ to predict and manage the future
 Risk ‘puzzle’ unidentified/mis-measured
 Insurance buyers need to move from IM to RM
RM vs IM
•
•
•
•
•
•
•
•
Active
Dynamic
Protection orientated
Financial / analytical
Seeks responsibility
Broad based
Creative
Involved in
company’s activity
•
•
•
•
•
•
•
•
Reactive
Passive
Security orientated
Administrative
Seeks safety
Narrow
Responsive
May be involved or
relies on other
RM in Building
 Every activity/project faces full risk spectrum
 Tied to health & safety, environment,
regulations, labour (supply/law), transport etc
 In broad terms, risk can be divided:
•
•
•
•
strategic
operating
financial
information
Strategic risks
•
•
•
•
•
•
Environmental
Natural/man made
disasters
Political
Laws/regulations
Industry
Competition
Financial markets
•
•
•
•
•
Organisational
Corporate objectives
& strategies
Leadership
Management
Investor/credit
relations
Human resources
Other types of risk
•
•
•
•
•
Operating risks
Workforce
Suppliers
Plant & machinery
Protection
Customers
Financial risks
• Capital/funding
• Investing
• Regulatory
environment
Information risks
• Systems
• Strategic
• Operating
RM and risk control
Mgt process
• Identify and analyse
exposure
• Evaluate alterative
• Select most
promising technique
• Implement choice
• Monitor process and
change as necessary
Control
• Avoidance
• Prevention
• Reduction (stop
losses or reduce
damage)
• Segregation of loss
exposures
• Contractual risk
transfer
Building: 4 types of player
Building materials
• Heavy (eg Hanson)
• Light-side (eg Novar)
• Distribution (eg
Wolseley)
Housebuilders
• Speculative
• Public sector
• Property development
Contractors
• Pure (sic)
• Mixed (e.g. PFI)
• Plant hire
Professional Services
• Architects
• Surveyor/engineer
• QS/cost consultant
Building materials
characteristics
Heavy
Light
• Cement, rmc, aggregates
• Largest/Europe
dominates
• International/rationalised
• Resource/extractive base
•
•
•
•
Fragmented
Competitive
Semi-international
Poor performers
Distribution
• Rationalised/rationalising
• Europe cross border push
• 10% margin best in class
Other players
characteristics
Contractors
•
•
•
•
Housebuilders
Low value/valuation
Awful record
International
Creeping rationalisation
•
•
•
•
Rationalisation
International?
Key raw material is land
Undervalued
Professional Services
• Move to one stop shop
• International
• Fee based
Industry EBIT % margins
•
•
•
•
•
•
•
Cement
Aggregates/rmc
Light materials
Distribution
Contracting
Housebuilding
Professional Services
•
•
•
•
•
•
•
20-30
15-20/10-15
10
4-8 (TPK = 10)
1-3 (pretax)
10-20
5-30
Drivers of change
•
•
•
•
•
Today’s focus is on the UK; US, at least on par
Continental Europe is five years behind
LSE & FSA inspired corporate governance
First Cadbury, now Turnbull (Sept. 1999)
Internal Control, Guidance for Directors on the
Combined Code of Corp. Governance
• Widespread endorsement and application
Drivers of change2
• Latham Report 1994
• Agile Report 1998 “variation in control of
project cost and payment leads to an
unpredictable outcome”
• Two thirds of projects over budget and threequarters run late; site deaths at 2-3 per week
• Egan ‘Rethinking Construction’ 1998
• Industry needs total new approach to delivery
of construction product
Drivers of change3
• Aftermath of 11 September
• A major insurance broker is currently
concluding renewals in range from +20-200%
• A small private building material company
(revenue of circa £130m), has been told to
budget for a minimum of +50% in premiums
Heavy Building Materials
A case study
HBM: approach to risk
• Corporate Governance umbrella unfurled by
internal auditors who act as scribes; however,
managers manage the programme
• Regular review of all business units and overall
risk management structure
• Biggest risk, of course, is a commercial one
i.e. product prices fall or demand collapses;
and you cannot insure against it
• Insure for what you cannot control
HBM: risk process
• CFO is custodian of risk and risk management
• Group co-ordinates with single broker
• Insurance carried for liability, property, people
etc with normal array of cover after assessing
how much is claimed; plus uninsured loss
• In addition, there is third party and
contractual risk (fire, flooding etc), but
company carries a threshold of risk
HBM: management
• For managers, “there is no such thing as
insurance”; they should manage all principal
and operational risk
• If the premium is high and you insure to the
“first £1”, this will spoil management
• Eg motor insurance is 3rd party only
• Could pay big premium and avoid bearing risk
internally; but this is costly & removes
responsibility from managers
HBM: Health & Safety
• Health & Safety (H&S) is paramount but
industry record is poor
• Dupont was used as facilitator
• Attitude is critical: hearts and minds; plus
dismissal for H&S contravention
• H&S is first item on monthly board agenda
• Prevention is better than cure eg separating
people from moving vehicles; driving school
• Particular problem is use of external
contractors; governed by company H&S rules
but do not always adhere
HBM: the environment
• Sophisticated environmental management is
vital in an extractive industry
• Each and every site is reviewed; many risks
can be removed eg water leakage etc
• Above all, company needs to guard against
‘loss of right’; restoration, community
relations, being a good citizen are vital
HBM: liability
• Company also has catastrophe insurance
• In US, based on infamous case of ready mix
lorry colliding with school bus & $300m claim
• Sadly, in terms of cost it is better for someone
to be killed than injured
• In other areas such a legal liability,
compensation, sexual abuse etc, company is
self insured with a range of thresholds
• The US is much more expensive, because
there are more cases
HBM: costs 6-9% of EBIT
• In terms of products and materials
performance – there is product liability
• However, the key avoidance method is
continuous testing so as to establish integrity
• All insurance premiums account for 3-5% of
EBIT plus self insured risk/loss is an additional
3-4%; this includes catastrophe insurance
• In past ten years the cost has not grown
commensurately with the business
Contractors
A word of warning
Structural issues remain
• Operating climate improving eg partnering,
PFI etc
• Immense skills exist
• But…..accounting is a ‘black art’
• The risk/reward ratio is lamentable
• There is notorious ease of entry
• Financial record is poor; investors do not (will
not) understand
• Corruption remains rife
Clients are no angels
• Project cost rule of thumb: land (one third);
materials (one third); all fees (one third)
• Everyone’s an expert; love to ‘beat up’
contractors
• Given industry margins of 1-3%, a modest
concession could win immodest co-operation
• UK government is also hard nosed
• Former Railtrack CEO saw no reason why rail
maintenance should attract more than the
normal contractors’ margin i.e.1%
Capital adequacy;
something for another day
• A contractor generally works on negative
capital employed (thus on ROE)
• Like a bank, he makes a large part of his
return in assuming contractual obligations and
holding cash
• The key concept is capital adequacy – the
relationship between shareholders funds and
company’s total commitments
• A new category called “orders in hands” (net
of cash received and work performed) would
be created and added to the asset base
Capital adequacy;
something for another day
• On the other side of the balance sheet are
contract obligations – the contract value of all
work the firm has undertaken to deliver
• These are stated net of invoiced sales but
include a separate line for provisions (i.e. not
netting them off work-in-progress).
• For example, a contractor has shareholders
funds of £100m (including “orders in hand”)
and contract-related assets of £825m
• His capital adequacy ratio would be 12.1x
Contractors
A case study
Risk catalyst
• Every construction company knows about the
principal of risk
• Historically, there was no single or formal
approach to RM
• Initiation can spring from failure/disaster
• In its wake, questions are asked, causes
identified and solutions proffered
• Indeed, a failure can be a powerful catalyst for
a serious change in management
Need for proactive RM
• How to manage risk especially with incoming
acquisitions?
• Began with Health & Safety, spread into
internal audit/finance
• However, ‘Risk Manager’ was purely an
insurance manager
• Part of the solution is insurance, claims etc;
however, proactive RM is vital (not simply a
pass off) & some things cannot be insured
Audit, benchmark &
Turnbull
• An audit of risk assessment
• It was modest, reactive & variable (with
comparison impossible)
• Extra mural, best practice was benchmarked
• Plus external impetus, starting with Cadbury
and, then, Turnbull
• However, company was well on the way, preTurnbull and, three years ago, employed
external consultants
External help
• AEA Technology (Atomic Energy Association)
was used as technical consultant; plus broker
• Leading implementation experts signed up
• Steven Male (value management) and Nigel
Smith (risk management), both professors at
University of Leeds
• Representatives from its main business areas
appointed as ‘champions’; not just ‘top down’
Software
• 18 months into the process, an externally
designed software package was rolled out
• Currently launching second version, on which
company has had more impact
• Mark II is reckoned to be “one of the better
construction based packages” and to afford a
“marketing edge”
One size fits all
• In oil & power industries, RM is first class but
standard
• A large contractor may have 1000 sites (and
10-20,000 employees); its RM, needs to be
flexible
• Application, however, must be homogeneous
i.e.“one size fits all”
• A concise ‘Group framework for RM’ now
exists, including, ‘Uniform Risk Assessment’
Consensus & application
• Training of personnel is essential
• The strength of the process was to win
consensus; “everyone has to be behind risk
review”
• RM also needs to be applied to each stage of a
bid: initial identification; pre-qualification;
design; pricing; on site; and living with it (eg
PFI facilities management for, say, 25 years)
Value management
• Seek to enhance value management over life
(& maintenance) of the project
• Take a concept and ask how it can be value
engineered; what can be done differently
• In accounting terms the costs rise but the
value management increases five fold
• Client involvement facilitates the process
Knowledge is the key
• The key to RM is knowledge and maximisation
of information flow through life of the project
• It is also important to record what courses of
action were rejected
• On site, previously rejected ideas may be
(re)considered; it is thus vital to know why
they were shelved
• In the future, when a new project is planned,
an empirical history of analysis and action
exits; a working register
Risk grading
• RM is now used almost everywhere in the
company; and all major contracts are required
to use it
• This includes generic risk assessment, where
appropriate eg repetitive tasks
• The process can also be quantified with the
Risk Grading Tool via a 10-15 minute
electronic menu
What it looks at
• This encompasses a number of formal stages,
involving the identification, definition and
assessment of:
- business or project objectives
- relevant risks according to nature, causes or
sources and consequences
- the likelihood or risks
Risk categories
Key headings of analysis (comprising some 80
separate risks) are:
- Client
- Contractual
- Resource
- Design
- Regulations
- Financial/commercial
- Scope of work/location/technical difficulty
- Compliance: H&S, legal etc
Colour coded risk
• The output is a matrix on which all principal
risks are plotted
• The Y axis registers consequences, while X
caters for likelihood
• The matrix is colour coded: top right is Red
(‘no’); bottom left is Green (‘yes’); with
Orange and Yellow in between
Quantitative risk
• A total numerical risk score is also calculated,
plus individual category risk scores (1-5)
• Numerically, if a score is less than 25 and
there is no individual risk greater than 5, the
risk is low and the project is a ‘go’
• Conversely, with 25+ and a number of ‘5s’, it
is rejected
Mitigation of risk
• Once this is complete, the identification of
effective controls and action plans is enacted
• Steps are taken to:
- avoid the risk altogether
- reduce the opportunity for risk to occur
- reduce the impact of risk if it occurs
• However, system allows risks to be analysed
and mitigated eg changes to design etc
• Mitigation reduces likelihood and/or severity of
risk
Colour approval
• Activities with residual risks and a Red rating
can only proceed with main board approval
• All Red risks are also sorted and stored in a
critical reference process
• Orange risk can commence with appropriate
authorisation
• Yellow is in the middle, but appropriate
arrangements already exist or will be
developed at the relevant stage
• Green: appropriate normal monitoring and
review procedures are in place
Focus on risk & its cause
• All risk needs to be identified but the company
also needs to win work
• Once a risk has been converted into a value,
“do not lose sight of what is behind it all”
• The focus must be on the risk, and its cause,
not the financial impact
“If you take no risks, you will suffer no
defeats.
But if you take no risks, you will win no
victories”
R M Nixon (1913-94)
Presentation
by
Tony Williams
+44 (0) 1394 410 073