Infrastructure investment and cost overruns

24 November 2015

As the south of England’s infrastructure continues to attract investment and the range and complexity of projects grow, effective risk management must be at the heart of project planning.

Infrastructure is a particular focus for investment in the south of England.

Tunnelling work across London for the £14.8 billion Crossrail scheme (Europe's largest construction project) was completed in June. And High Speed 2 – the planned high-speed railway directly linking London, Birmingham, Leeds and Manchester – is expected to cost more than £42 billion.

Meanwhile, in July the independent Airports Commission recommended the development of a new northwest runway at Heathrow Airport, at an estimated cost of £17.6 billion, including a £2.6 billion risk allowance.

Further afield, a £25 billion nuclear power station is proposed at Hinkley Point in Somerset, while Berkshire is undergoing an unprecedented series of major infrastructure investments in its national road and rail network costing approximately £5 billion.

Alongside motorway projects for the M4 and road improvements in Slough, Newbury and Bracknell, a new rail station at Green Park Reading on the Reading-to-Basingstoke line will improve public transport accessibility and reduce local road congestion. 

Meanwhile, housing developments are planned in Wokingham and Bracknell, creating thousands of new homes, schools and other community resources.

Despite the optimism surrounding these projects, their scale brings risks of attracting negative media attention, disrupting local businesses and communities and running over budget.

Adequate protection

If the benefits of such infrastructural investment are to be fully realised, effective risk management and mitigation and transfer are vital, says Andrew Birt, Partner in the Construction team at JLT Specialty.

With large-scale projects the optimum insurance solution is not always achieved, however, because procurement teams are sometimes overly focussed on price, which can result in insurance products being purchased¬ that are not necessarily fit for purpose. 

“We have seen deals where, from an insurance perspective, there is disproportionate loading on up-front cost, with less emphasis on overall value for money,” says Birt.

Moreover, project teams often express the desire to work with small, local suppliers but this has to be balanced with the need to engage companies with healthy balance sheets and robust risk management processes, Birt notes.

Major projects typically have an insurance policy that would apply to all the parties involved and cover accidental damage to third parties, explains Birt. 

“But with major projects, the number of potential third-party liabilities is much greater and compulsory purchase is also an issue,” Birt says.

The consideration for mid-market companies is the level of protection provided by a project policy and how much risk they have to retain, Birt adds.

“With some policies, the insurance might be provided only with high deductibles or restricted cover, in which case the mid-market contractors would have to buy additional cover to ensure that their exposure remained manageable.”

Risk profiles

Companies need to understand whether there is a risk register that is regularly reviewed and updated and to which all parties subscribe, says Birt. 

“It should consider its risk management strategy, the efficacy of its mitigation processes and whether they have been fully tested, and the extent to which residual risks been allocated to the party best able to bear that risk.”

Engagement with senior management is consistently referred to as a key element of effective project risk management. In an interview earlier this year, Crossrail Head of Risk Management Rob Halstead said his team had provided a process and a set of tools that senior managers could understand and relate to in order to help them manage risk.

In addition, there has to be an appreciation that not all risk is insurable: there is no specific insurance product, for example, that economically covers cost over-runs from involvement in a major infrastructure project.

This has been an issue on major rail projects in the past – London Underground's Jubilee Line extension took almost two years longer than expected to complete and cost almost twice as much as originally forecast.

Cost overruns

There is currently no great demand for insurers to provide for cost overrun cover. But the situation might change for major civil works, Birt advises, on account of the difficulty of meaningfully pricing the risk of cost over-runs on projects like nuclear power stations, where the sums involved can run into billions of pounds.

“Having an external party willing to pay part of any cost over-run would make it easier for government and private sector developers to budget for major projects,” Birt concludes. 

“This is particularly relevant to the nuclear industry, where there are many examples of plants running significantly over budget.”

Check-list

Organisations involved in major infrastructure projects should:

  • Avoid over-reliance on a small number of clients or contracts
  • Ensure that they cannot be held liable for factors beyond their control, such as project delays or cost over-runs
  • Maintain operational standards even during their busiest periods
  • Review existing standard covers before and during each project.

Download whiteboard article

For more information please contact Peter Cant, Head of Reading Risk Practice on +44 (0)118 945 0107