Estimating Project Risk Reserves

All projects have risks. To provide resources needed to avert or mitigate these risks, planners must estimate a risk roserve. Setting a "reasonable " reserve is important. A large reserve may cause the project's bid price to be noncompetitive. A small reserve may be inadequate to handle the problems that will inevitably occur. This paper describes a method to estimate an "optimal " reserve for a list o f identified risks. For each risk, the estimator provides the probability and consequences (cost) o f occurrence before mitigation, the cost o f actions that could be performed to mitigate the risk, and the probability and consequences that would remain after performing these actions. The Risk Reduction Leverage, RRL, is the difference in the expected losses before and after mitigation, divided by the cost o f mitigation. (RRL is similar to a Return On Investment except it uses expected costs instead o f total estimated costs.) The method ranks the risks based on their Risk Reduction Leverage, and applies criteria to decide which risks should be mitigated and which should be accepted. The method also gives criteria for deciding which risks should be mitigated immediately ("preventative ") an