Calculating Contingency

The concepts of EMV and Actuarial cost really come into their own when you start to plan for the risks that fall into your Green or acceptable category. You won't have a detailed response plan for each of the individual risks but you will need a contingency sum set aside to deal with those risks that do occur.

Suppose you have 10 green risks identified and each is 50% likely to occur and each will cost £2k if it does occur:

The EMV of each risk = Σ 0.5 x £2,000 = £1k so the total for 10 risks = £10k

The project needs a contingency of £10k to cover these risks.

Of course EMV doesn't equal reality what it is saying is that half of the time you will need £2k per risk and the other half won't occur. Looked at another way the £10k contingency will only be enough to cover costs half of the time. You can be 50% confident that the project can cover its risks.

Contingency for high impact risks

Let's look at another example. Suppose you have a risk that is only 5% likely to occur but if it does it will cost you £250k:

EMV = Σ 0.05 x £250,000 = £12,500

It is pointless having £12.5k in your contingency if this risk actually occurs. A risk with this level of impact would have to be viewed individually and the necessary contingency would need to exist at the institutional, rather than project, level.

At the risk of stating the obvious, averages only work with a range of numbers. EMV is useful for looking at groups of similar risks. EMV doesn't make sense if you are looking at a single risk with high impact or probability.

Contingency for high probability risks

Let's say you have 5 risks each with an 80% probability of occurring and they will each cost you £4k:

EMV = Σ 5 x 0.8 x £4,000 = £16k

Rather than ask for the £16k EMV you should ask for the full £20k that is needed should all of the risks occur. With a probability of 80% you are saying that it is much more likely than not that the risks will occur - so plan for them. What this is really giving you is an opportunity to make savings against a realistic budget. If only 3 of the risks occur you will have saved £8k.

In summary Actuarial cost based on the EMV of groups of similar risks can give you a guide as to how much contingency a project requires. Not all of the risks will occur but the contingency should cover those that do. Special arrangements will need to be made where a single risk could have a very high impact. Unless the probability of such a risk is very low it may undermine the business case for the project.

This technique can also be useful in helping you plan your budget when you are bidding for a research or other contract e.g. for a JISC project. Contingency is not a 'slush fund' or 'padding' to cover for poor project management: it should be justifiable and reviewable. The contingency is there for specific risks and should only be released if a risk occurs. The project Steering Board or its equivalent should authorise the release of contingency funds.