PMGT5891 Chap.6 Risk Allocation, Transfer and Risk Appetite
Risk Allocation, Transfer and Risk Appetite
This chapter asks who should carry each risk and at what price. It explains the principle of allocating a risk to the party most able to manage and absorb it, the different jobs done by contracts and insurance, and why public-private partnerships transfer less risk than their premiums suggest, using the I-4 Ultimate road dispute.
It then turns to attitude: utility curves for risk-averse, neutral and seeking decision makers, the certainty equivalent, and how organisational risk appetite becomes tolerance thresholds. The Parramatta Light Rail Stage 2 case shows these ideas at government level, and the worked material shows how to decide between a fixed price and a cost-reimbursable contract.
What this chapter covers
- 01
Allocating risk to the party best able to manage it
- 02
Transfer by contract against transfer by insurance
- 03
Public-private partnerships, risk premiums and their limits
- 04
Utility theory and expected utility
- 05
Risk averse, risk neutral and risk seeking attitudes
- 06
Certainty equivalent and the premium an owner will pay
- 07
Risk appetite, tolerance thresholds and policy
- 08
Parramatta Light Rail Stage 2 as an appetite case
Worked example · free
Lump sum or remeasured contract by expected utility
- +1Expected cost of the remeasured contract: 0.6 x 4.8 + 0.4 x 6.2 = 2.88 + 2.48 = $5.36M, which is $0.04M below the lump sum.
- +1Expected utility of the remeasured contract: 0.6 x 100 + 0.4 x 0 = 60.
- +1Expected utility of the lump sum is its certain utility, 62, which is higher than 60.
- +1Choose the lump sum: the authority is risk averse, so removing the 40% chance of a $6.2M bill is worth more to it than the $0.04M saving in expected cost.
Key terms
- Risk appetite
- Risk appetite is how much risk, and of what kinds, an organisation is prepared to seek out or hold while chasing its objectives.
- Certainty equivalent
- A certainty equivalent is the sure amount a decision maker treats as equal in value to an uncertain prospect.
- Risk premium
- A risk premium is the extra price a party charges, or is willing to pay, for taking on or shedding uncertainty.
- Utility function
- A utility function is a curve that converts monetary outcomes into utility values and so shows a decision maker's attitude to risk.
Risk Allocation, Transfer and Risk Appetite FAQ
Why can't a government transfer all project risk through a PPP?
DeGood's analysis of P3 contracts gives two reasons. Contracts are never complete, so a concessionaire can claim that delays are the state's fault, and the I-4 Ultimate agreement listed 24 relief events. Voters also hold elected officials, not contractors, responsible, so the state remains the ultimate guarantor.
His conclusion is that a public sponsor ought to refuse a large premium for transfer, because so little risk actually moves.
Is risk appetite the same as risk tolerance?
Sources differ. Some writers use the terms interchangeably. Others, including Hillson and Murray-Webster, treat tolerance thresholds as the outward expression of appetite, the levels above which action is required. Aven links appetite to pursuing value or reward, whereas tolerance concerns the level of risk alone. In an answer, state which view you are using.
What does a concave utility curve tell you?
A concave curve rises steeply at first and then flattens, so each extra dollar adds less utility than the last. That shape belongs to a risk-averse decision maker, who will accept a sure amount below the expected value of a gamble. Baccarini notes that studies find most corporate decision makers are risk averse.
When is insurance a sensible way to transfer a risk?
Insurance suits risks with a low probability and a large potential consequence, because a modest premium replaces a loss the organisation could not easily absorb. It moves only the financial effect, so the organisation still manages the hazard itself. Some cover, such as public liability, is required by law.
Exam move
Treat this topic as two linked skills: judging who should carry a risk, and pricing what moving it is worth. For the first, practise a three-question routine on any case risk: who controls the cause, who can absorb the loss, and who deals with the third party involved. For the second, drill short calculations of expected cost, certainty equivalent and the premium a party will pay, then state the attitude each implies.
Sketch the three utility curve shapes from memory until you can label them in under a minute. When you read the I-4 Ultimate or Parramatta material, write one sentence on whose appetite drove the decision and one on what risk stayed with the state. Those two sentences turn a description of a case into the analysis the group report and the written exam ask for.
Working through Risk Allocation, Transfer and Risk Appetite in PMGT5891? Sia is AskSia’s AI Project Management tutor — ask any PMGT5891 Risk Allocation, Transfer and Risk Appetite question and get a clear, step-by-step explanation grounded in how PMGT5891 is taught and assessed. Read this chapter free, then take your hardest questions to Sia.
