What Are Residual Risks in Construction? Full Explanation

When taking on a new construction project, it’s important to understand the risks involved as well as you can so that you don’t end up paying more later. Categorizing and ranking risk can help you do that.

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 employer 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 Construction

In construction, you can break residual risk into four categories:

Financial
Contractual
Operational
Environmental

These can be introduced internally or externally.

Financial

Residual 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

Contractual

Residual 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

Operational

Residual 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

Environmental

Residual 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 Risks

Inherent, secondary, and residual risk are all categories of risk to consider in construction projects.

Inherent Risk

Inherent risk is a measure of risk in the absence of controls. 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 Risk

Secondary 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 Risk

Residual 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 Risk

You 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 Construction

To 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 Risk

In 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 Risk

Reducing 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 Risk

You 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 Risk

You 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)

Construction litigators are also professionals who work closely with property owners and construction project managers to help them understand and manage risk. These attorneys can help stakeholders understand who is currently liable for certain kinds of risk so that they can negotiate a transfer or otherwise prepare for the possibility of a lawsuit.

Risk Management Apps for Construction

There is technology available to make risk management easier. While they cannot predict risks, they can allow you to manage, monitor, and track them throughout the project. Construction teams can use these apps to report back to the project manager, who can then review all necessary information in one place.

PlanRadar

PlanRadar is a risk management app that allows you to identify and monitor risk throughout each construction process. On-site workers can use the app to inspect progress, raise issues, and share information with the project manager, including photos.

PlanRadar also allows you to track changes to risk statements and monitor the progress of remedies. It produces a report of progress at any point in time with a single tap of a button.

When you need to communicate about risk to subcontractors and other responsible parties, PlanRadar allows you to do this easily and quickly. The app centralizes all of this risk information and stores it securely within the app.

Because PlanRadar works so quickly with so many stakeholders having a role, the chances are low that any risk will go unnoticed or unaddressed for long.

Risk MP

Risk MP is risk management software made to guide you through creating, managing, and developing your risk management plan. It is integrated with MS Project and Excel, which means that you can import information into the app to plan and manage risks throughout the whole project.

Risk MP allows you to share your risk management plan with owners, subcontractors, and other stakeholders while tracking progress on-site.

Risk MP also creates a knowledge database for each user so that you can integrate data from previous projects into your understanding of current and future projects. The knowledge database is created after a few projects and serves as a reference for future endeavors.

PlanGrid

PlanGrid offers mobile building information modeling (BIM), enabling BIM use in the field. The app allows you to model data, coordinate work between stakeholders, and improve the time and cost associated with each project.

PlanGrid allows you to import spreadsheets through the Revit plugin, and it integrates the data smoothly into whatever project you’re developing.

PlanGrid also allows you to use BIM-enabled sheets to tap on a blueprint to reveal models and additional information about the project. This functionality even works when you’re offline.

Having this data and modeling available for use in the field makes it easy to monitor progress and assess risk as you go. If you stray from the original plan or design, PlanGrid allows you to quickly catch the miscalculations.

PlanGrid reduces risk by allowing contractors to analyze the site thoroughly before arrival, increasing the odds that they’ll be appropriately prepared.

Final Thoughts

Residual risk in construction is defined as the amount of risk that remains after you take steps to mitigate inherent risk. This is different from secondary risk, which is introduced as a result of the mitigation steps. Residual risk is typically taken on by the employer, although you can negotiate a transfer of risk in some cases.