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Managing Risk Properly To Be Profitable
By Michael J. Baker, Esq.


In today's economic environment firms are very busy, as work continues to come through the door at a brisk pace. Even though the work is steady, are you paying attention to the risks you are taking on with each new project? Do you have in place some methodology or basic analysis to alert you to potential problems?

What is risk? Risk is defined as the possibility of suffering harm or loss. The harm or loss is typically measured in financial terms. Risk is manageable, therefore, the professional cannot afford to neglect risk management at either the firm or the project level. To ignore risk or a failure to take steps to proactively manage the risk puts you in a situation where unexpected financial loss hurts the firm and possibly your reputation. One claim, whether it results in payment, can turn a profitable project into a losing one; and, a profitable firm into an unprofitable one.

The engineer needs to recognize that the very nature of the building enterprise is risky, even though the application of sound engineering principles are incorporated into any project design to mitigate such risk. In order to adequately manage risk, you must be able to identify what the risk is and be able to determine who is in the best position to handle issues that may come up when dealing with a particular risk. Risk management typically consists of four components or concepts. They are, evaluation of the exposure, the capability to manage the exposure, the responsibility for and power to deal with the situation or management of the risk.

EXPOSURE / MANAGE / POWER TO DEAL WITH RISK

Risk management or risk exposure deals with the probability, as opposed to the possibility, of any particular loss or injury. The higher the exposure of loss resulting from an activity, the greater the risk management it will require. For example, the use of a previously untried design, specification or construction idea will typically require more attention from the engineer than a routine solution that has been tried and tested successfully over and over. The capability to manage risk refers to the individual or team members that have specialized knowledge to evaluate the risk exposure (probability of loss) and the skill to handle the issue. Responsibility for the risk refers to what the engineer or designer has agreed to be responsible for in the overall process. Engineers are responsible only for what they agree to be responsible for, either by contract or by conduct. Lastly, the concept of power in risk management is the authority to supervise or control the activities, which create the exposure.

There are some basic ways to deal with risk. The following represents the basic principals or concepts which should be considered when determining or managing risk. The basic ways to manage risk are: retain it, abate it, allocate it, transfer it, or avoid it.

RETAINING RISK

When the engineer alone has the capability and power to supervise and control the risk then he/she should determine what risk to retain. As a general principle, when evaluating whether to retain certain risks, an analysis of the capability and power to supervise and control the risk must be undertaken. If you cannot control the risk then it must be mitigated. There are several ways to mitigate the risk exposure. This is done by, allocating, transferring or altogether, avoiding risk.

ABATING RISK

When you lack power and control over a potential activity that can create a loss then you should undertake to abate the risk. Typically, firms may have undertaken projects or tasks that require special skills that they do not have on staff; and, therefore look to outside experts to assign tasks to or move to acquire new or expanding expertise in an area where risk exposure is evident. Having acquired a particular expertise, the risk can be lessened sufficiently to encourage the firm's management of the risk. Your fees can be used to cover the costs of adding such expertise.

ALLOCATING RISK

Another option is to allocate the risk. Typically this is done when the parties sign the contract. Most contract documents apportion risk based upon the participant's role in the design and construction process. Thus, it is important to review your contract to determine whether you intend to agree to the level of risk that has been reduced to writing. Remember, use the contract as a tool to mitigate those risks that you are not willing to fully accommodate.

TRANSFERRING RISK

Similar to allocating risk is the ability to transfer the risk. Again, this is typically done through contract documents such as indemnification agreements. Also, another very common way to transfer risk is to obtain professional liability (errors and omissions) insurance. Simply put, indemnity agreements and insurance pass the risk to an entity more capable of absorbing the costs of the risk transferred.

AVOIDING RISK

Lastly, you can avoid the risk all together. Some situations are so unpredictable or have the potential to be financially costly, that the amount of fee or compensation received to do the work does not make it worthwhile to undertake the work given the risk evaluated.

Risk evaluation should be done at the beginning of project when the timing is appropriate and the negotiations are at the early stages so that each party knows, at the outset of a project, who is responsible for what risk and how that responsibility will be assumed. By focusing on the concepts touched upon here, your risk management strategy will be based upon sound fundamentals. The goal is to keep your project financially sound and profitable.

About the Author

Michael J. Baker is a partner of the construction/infrastructure practice group at the Irvine, California office for the national law firm of Arter & Hadden, LLP. Mr. Baker is a recognized expert, specializing in the representation of local, national and international owners, design professionals and contractors in business and contractual matters, as well as disputes before mediators, arbitration panels and state and federal courts. This representation has included contract negotiations, bid document preparation, contract performance disputes, surety bond claims, and the full range of insurance issues and claims involving major public and private construction projects, engineering systems and specialized facilities. Mr. Baker can be reached at Arter & Hadden, LLP 949.252.3154 or via e-mail: mbaker@arterhadden.com.

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