Defining Risk Management – Part 8: Risk Response Finale

In this Part 8 of a nine-part series on Risk Management, we conclude the discussion of Risk Response. Here we go into detail on where money usually allocated for the different strategies of avoidance, acceptance, transfer, and mitigation. The following information, for the most part, is from an excerpt of the book “The Project Management Question and Answer Book.”

Risk Strategies and Money Allocation

Perhaps it would be a good idea to review how the money is allocated for different risk strategies. Risk avoidance is frequently going to cost some money. The money that we spend to redesign the project so that the risk is eliminated is money that will have to be spent regardless of the probability of the risk. The additional work of doing the redesign and adding more expensive parts will be part of the operating budget. No money needs to be put into the risk reserves if the risk is completely eliminated. If the risk has already been allocated funding in the contingency budget, the increase in the operating budget can be taken from the contingency budget.

Risk acceptance will have money put into the contingency budget if the risk has been identified. If the risk is an unknown risk and has not been identified, the money for it will be roughly estimated and become part of the management reserve. If the risk does happen, the money is taken from the contingency budget or the management reserve and moved into the operating budget when the plan for dealing with the risk is put into place.

Risk mitigation will have money put into the contingency budget to handle the risk if it occurs. There will also have to be money put into the operating budget to take care of the cost of the mitigating activities that are being taken for this risk. The mitigation of the risk will reduce either the probability or the impact of the risk, and the contingency budget should therefore be reduced.

Risk transfer requires money to be put into the operating budget to pay for the additional cost of either subcontracting the risk or buying insurance for it. The money to do the work for the activity affected, not including the risk cost, was put into the operating budget when the task was created. The cost of the transfer, either the additional cost that the supplier will receive or the cost of the insurance premium, must be added to the operating budget. This money can be taken from the contingency budget.

The operating budget of the project, sometimes called the performance budget, is the amount of money needed to do the things that are planned for in the project. This includes all of the work to produce all of the deliverables that were planned for in the project. It is not the total project budget; it includes funding only for the things that are planned for. Subject to limitations in the project policy, this money can be spent freely by the persons responsible for the tasks of the project as long as the expenditures are following the project plan.

The contingency reserve is the money to do the things that may or may not have to be done but that have been identified. This is where the funding for risks that actually take place comes from. When a risk takes place, the project manager authorizes money to be taken from the contingency budget and placed into the operating budget. Generally the project manager must approve money transferred from contingency reserves to operating budgets. In larger projects a subproject manager may approve these funds. The transfer of funds must include any appropriate changes to scope or schedule.

The management reserve is money that is set aside for the risks that have not been identified, the so-called unknown risks. This transfer is made when a risk occurs that has not been identified and money must be spent to solve the effects of the risk. The use of these funds usually has to be approved by a manager one level above the project manager.

In the final excerpt on Defining Risk Management (Part 9), we’ll discuss Risk Control.

Related posts:

1. Defining Risk Management – Part 7: Risk Response Continued
2. Defining Risk Management – Part 9: Risk Control
3. Defining Risk Management – Part 1
4. Defining Risk Management – Part 6: Risk Response
5. Executive Management’s Role in Project Risk Management