Monday, January 5, 2009

Four Ways to Transfer Risk

As a project manager, it is important for you to understand that the act of sharing can play a valuable role in your project's risk response planning process. Sometimes, the most efficient and effective way of dealing with project risks is to share the responsibility for their response with others.

Transference is a risk response strategy that does just that. It shifts the responsibility of a risk, or part of a risk, to a third party. Transference does not eliminate a risk or its potential consequences. This risk response strategy simply gives another party responsibility for the management of that risk.

Although a project will encounter many different types of risks, transferring risk liability is usually most effective when dealing with financial risk exposure.

Transference often involves the payment of a risk premium to the party taking on the risk. For example, a company will pay a monthly premium to its insurance provider as payment for the provider taking on one or more of the project's risks.

During your project's risk response planning process, you may decide that transference is the most appropriate strategy to use in order to effectively respond to one of your identified project risks. Once you make this decision, you must choose the transference method that will best address that risk. There are four methods available for you to use when transferring the responsibility for an identified risk.
  1. Insurance
    Insurance is a transference method that shifts the responsibility of specified risks to an insurance company. Typically, insurance companies provide monetary coverage for losses that result from such things as legal liability, fire damage, theft, or vandalism.

    One of the most common methods of transferring risk and its potential consequences is to purchase insurance. As a project manager, you can share the responsibility of some of your project's identified risks by having an insurance company provide financial coverage for potential risk losses. During your project's risk response planning process, you should set aside risks that can be insured and transfer the responsibility for those risks to your company's insurance provider.

    Some of the most common insurable project risks are:
    • Direct Property Damage - to project equipment, project materials or a contractors' property.
    • Indirect Losses - such as equipment replacement and business interruption.
    • Legal Liability - such as public employee bodily injury, design errors, public property damage, and the failure of a product to perform as specified.
    • Personnel Issues - such as employee replacement costs.

    For project managers to transfer a project risk through the method of insurance, two conditions must be met. The first condition is that the potential risk loss must be due to chance. Insurance companies do not want to provide monetary coverage for risks that result from human error or poor project planning.

    The second condition that must be met in order for a risk to be eligible for insurance is that the potential risk loss must be measurable. This means that the risk loss must have an assigned monetary value. A project risk cannot be insured if the potential loss is expected to be personal or emotional.

  2. Performance bonds
    Performance bonds shift the financial responsibility for poor performance back to the contractor. These bonds are usually issued by a financial institution, such as a bank, and force contractors to pay out a specified sum of money if their performance is unacceptable.

    Project managers obtain performance bonds to guarantee the satisfactory completion of contracted work. These bonds provide monetary compensation to a company if its contractor fails to achieve the proposed project work.

  3. Warranties
    Warranties are written guarantees that purchased project equipment will be of good quality. This transference method shifts the cost and responsibility for repair or replacement of defective parts to the manufacturer.

  4. Contracts
    A contract is a binding and legally enforceable agreement between two or more persons or parties. During risk response planning, project managers can use contracts to help eliminate or minimize the impact of identified project risks.

    In most cases, contracts are established between an organization and its contractors at the onset of a project. These contracts contain numerous details and clearly outline the contractor's responsibilities throughout the project. This transference method helps shift the potential cost and consequences of incomplete, tardy, or unsatisfactory work back to the contractor. A contract also protects the contractor, ensuring the company meets its obligations as well. This helps reduce the overall risk impact on the project.

    Another benefit of a contract is that you may not have sufficient expert resources within your company to perform all of the various project activities in an efficient and effective manner. Contracting some of your project work out to someone with superior knowledge and expertise in a particular area can reduce the risk of poor performance or unsatisfactory project design.
It is important to keep the four transference methods in mind when formulating responses to your project's identified risks. If your project requires a contractor, it is good to obtain a performance bond to ensure that expected performance levels are maintained. In addition, if your project materials are purchased from an external source, it is wise to have a warranty in place to protect your company against material defect risks.

If you decide to respond to some of your identified risks by purchasing insurance, you will be able to protect your company from costly, unexpected, and unpredictable risks, such as legal liability and personnel injuries. If you choose to establish a contract at the onset of your project, you will reduce the risk of project plan deviations and miscommunication. You must carefully consider each transference method and determine which one will be most effective in minimizing the impact of an identified project risk.

Insurance, performance bonds, warranties, and contracts are the four primary methods for transference. During the risk response planning process, project managers can use transference to help them reduce the impact of potential risks to project objectives and overall project outcomes.

As a project manager, you should examine all of your project's identified risks and set aside those that will benefit from transference. This will minimize your project's overall risk impact and promote a successful project completion.

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