Archived Documents:

Major Scheme Appraisal in Local Transport Plans Part 1:
Detailed Guidance on Public Transport and Highways Schemes

Version 3: 4 April 2003

Annex C: Risk analysis

C1. All investment schemes are exposed to risk. Most risks will be common to conventional public sector procurement and the Private Finance Initiative (PFI). The appraisal must contain an assessment of risk, irrespective of which procurement route may eventually be chosen. The LTP guidance makes clear that "decisions on the acceptability of major schemes are taken prior to any consideration of the possible funding route".^[47] The Department expects to see a full assessment of risk for all major schemes. Where there are major risks, promoters will have to demonstrate that such risks are understood and can be actively managed within the public sector or transferred at an appropriate cost to the private sector.

C2. The full requirements for a risk assessment are detailed in Treasury Taskforce (1999) Technical Note 5 "How to Construct a Public Sector Comparator". Annex 4 of H.M. Treasury (2003) "Green Book" provides further guidance on quantifying and clarifying risk. Part 4 of the Highways Agency's "Value for Money" manual provides guidance on risk analysis for highway schemes.

C3. For smaller schemes, a more simplified set of procedures may be used. The key issues in assessing risk in all cases are:

• the range of possible outcomes;
• the probability of each outcome; and
• the interactions between different elements which affect outcomes.

C4. Although a range of outcomes for any one element of the appraisal may be relatively easy to determine, say through modelled sensitivity or observed outcomes of similar schemes, attaching detailed probabilities to these outcomes is much more problematic. Providing detailed correlation between different elements of the appraisal is also very difficult since there is a wide range of causal and dependent relationships affecting costs, traffic levels / patronage, revenues and benefits of the scheme. For example, there may be linkages between low levels of traffic / patronage and the possibilities of reduced operating or maintenance costs.

C5. Promoters should undertake a three-stage process for all major schemes. The level of detail required will need to be discussed with the Department. As a general rule the amount of time and resources that are devoted to quantifying risks should relate to their likely materiality.

Step 1: Prepare a risk register of the main risks likely to affect the delivery and operation of the scheme. The risk register should start from construction risk, from timescale and cost perspectives, and then move onto operational risks and factors likely to affect traffic / patronage, revenues and delivery of scheme benefits. The Department may be able to offer some further indication of areas to consider, drawing on the outcomes from recent major schemes. The risk register should be included with the appraisal document.

Step 2: Assess a range of possible outcomes that may occur due to combinations or different levels of the risks identified in the risk register. This may be possible through modelled sensitivity analysis or observed outcomes from similar schemes. If using sensitivity analysis, then combinations of sensitivity tests should be used to examine potential interactions between key underlying factors. In this way some of the implicit relationships between individual risk elements are considered.

The range of outcomes should consider both the upper and lower extremes of the possible range, taking into account any reasonable constraints. Constraints may include system capacity on maximum patronage estimates. These constraints would be expected to place an upper bound on patronage and revenue estimates.

Step 3: Assess the likelihood of occurrence for each of the possible outcomes. For smaller schemes it may be acceptable to assess the probability of any one outcome occurring using a simple four-point scale, expanded to more levels if appropriate. This scale would use, at a minimum, very unlikely, moderately unlikely, unlikely or most likely, where the most likely outcome would normally be the central forecast value. For larger major schemes the Department needs to see a full account of risk to be taken with a thorough Quantified Risk Assessment (QRA).^[48] This assessment of risk should be based on numerical probabilities. These probabilities allow expected values and the variation around these values to be developed.^[49] Operating costs, capital costs and benefits should all be based on expected values. The probabilities applied to each outcome will be a matter of some judgement, but will require justification. In general, it is expected that the distribution of cost will be skewed towards increasing costs whilst the patronage and revenue distributions would be skewed downwards.

C6. It is essential that the risk assessment is clear and comprehensive, it helps move the optimism bias adjustment from its upper bound level toward its lower bound. The exact mechanism of how this works is explored in the next section. Also this risk assessment will be reviewed as part of the technical audit of some larger schemes.

C7. It is also important that promoters consider how the individually outlined risks will be managed. Evidence of this consideration and the approach to risk management must be presented within the appraisal submission.

[47] DETR (2001) Guidance on Full Local Transport Plans, Paragraph 71.

[48] Larger schemes will typically be those in excess of £20m. Promoters should consult the Department to determine if a QRA for their scheme will be necessary.

[49] The expected value is defined as the average of all possible outcomes, taking account of the different probabilities of those outcomes occurring. The expected outcome is also known as the "mean" or "unbiased" outcome. It is generally not the same as either the "planned" or "most likely" outcome. The most likely outcome is that which has the highest probability of occurring.

Published: 2 May 2003 | Updated: 12 May 2003