2.12 Uncertainty and risk
- 2.1 Overview
- 2.2 Social cost benefit analysis and financial analysis
- 2.3 Benefits
- 2.4 External impacts
- 2.5 Costs
- 2.6 Present value and discounting
- 2.7 Time frame
- 2.8 Do minimum and benefit and cost differentials
- 2.9 Benefit cost ratios
- 2.10 Incremental cost benefit analysis
- 2.11 First-year rate of return
- 2.12 Uncertainty and risk
- 2.13 Alternatives and options
- 2.14 Packages
- 2.15 Transport models
- 2.16 Other inputs to funding allocation process
- 2.17 References
2.12 Uncertainty and risk
Introduction
The forecasting of future costs and benefits always involves some degree of uncertainty, and in some situations the resulting measures of economic efficiency (the BCR and FYRR) may be particularly sensitive to assumptions or predictions inherent in the analysis.
Two types of uncertainty may occur in a transport project. Uncertainty about the:
- Size or extent of inputs to an analysis, such as the variation in construction, maintenance or operating costs; future traffic volumes, particularly due to model results, growth rates, and the assessment of diverted and induced traffic; travel speeds; road roughness; or accident reductions
- Timing and scale of unpredictable events, either from natural causes (such as earthquakes, flooding and landslips) or from human-made causes (such as accidental damage and injury from vehicle collisions
Assessing the sensitivity of evaluations to critical assumptions or estimates shall be undertaken using either a sensitivity analysis or risk analysis, or both, as appropriate.
The uncertainty described here is not directly comparable to assessing the uncertainty as part of Land Transport NZ's funding allocation process, which focuses on the confidence in the proposed project (or package) delivering the desired outcomes.
Sensitivity analysis
Sensitivity analysis involves defining a range of values for an uncertain variable in evaluating and assessing the effects on the economic evaluation of the assumptions or estimates within the defined range. This will highlight those variables for which a change in the input value has a significant effect on the economic evaluation, particularly the BCR and FYRR.
Risk analysis
Risk analysis is a more detailed type of sensitivity analysis involving describing the probability distributions of the input variables and those of the resulting estimates of benefits and costs. For a risk analysis to be possible, both the costs arising from each of the possible outcomes and their probability of occurrence have to be estimated.
The purpose of a risk analysis is to develop ways of minimising, mitigating and managing uncertainties.
Choosing the appropriate analysis
Sensitivity analysis - for most projects the completion of a sensitivity analysis will be considered an adequate assessment of uncertainty.
Risk assessment must be undertaken for all projects with any of the following characteristics:
- the principal objective of the project is reduction or elimination of an unpredictable event (eg, a landslip or accident)
- there is a significant element of uncertainty
- the project capital value exceeds $4 million.
Land Transport NZ's Programme and funding manual provides addition guidance on risk analysis.
Methods for sensitivity and risk analysis
Guidance on completing a sensitivity analysis for road projects is given in section 3.8 of this volume. Sensitivity analysis for other types of project is described in volume 2.
Appendix A13 outlines the methodology for a risk assessment of road projects. Chapter 12 of volume 2 describes how these risk assessment procedures can be applied to other types of project.
The general procedure for evaluating risk by an analysis of probabilities and expected values comprises the following steps:
- Identify the uncertain elements in the project and the chain of consequences for any unpredictable events.
- Determine the benefits or disbenefits to transport users and the costs to the project for each possible outcome
- Identify an annual probability of occurrence and the period of years over which this probability applies for each uncertain element.
- Compute the expected values of benefits and costs for the uncertain elements in each year as the product of the costs and the annual probability of occurrence. Include these in the project benefit and cost streams when discounting the cash flows.
A numerical-simulation approach may be required in cases where the number and interaction of uncertain variables makes an analytical approach impractical.
