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:
These can be introduced internally or externally.
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
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
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
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 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 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 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.
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.
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.
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 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 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 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.
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.
- Designing Buildings Wiki: Residual risk in building development
- Wrike: What Is Residual Risk?
- Designing Buildings Wiki: NRM2
- HasPod: Residual Risk, How You Can Calculate and Control It
- WallStreetMojo: Residual Risk
- Fair Institute: Inherent Risk vs. Residual Risk Explained in 90 Seconds
- ConstructConnect: Construction Risk Management: Identifying and Managing Project Risks
- CBRE: Construction Risk Management
- PlanRadar: 7 major risks in construction projects and how to avoid them
- Construction Executive: The Importance of Risk Transfer Strategies Construction
- StakeHolderMap: Project Management, Project Planning, Templates and Advice: Construction Risks
- Risk MP: Risk Management for Construction
- PlanGrid: 10 Essential Technologies for Construction Risk Management
- PlanGrid: BIM Gets a Mobile Upgrade with PlanGrid