A Guide to Construction Risk Management: How to Mitigate Different Types of Risks

Each construction project is full of numerous different moving pieces and each activity comes with its own set of risks. In the absence of proper risk management, these unidentified hazards can jeopardize project success and the bottom line, emphasizing the role of construction risk management at every stage. 

The Hub International 2024 Outlook Survey reveals that risk management will be vital for construction companies to be successful in 2024. 

For these reasons, we have created an extensive guide for commercial contractors and owners on construction risk management, helping them address and prevent different risks flawlessly to ensure a smooth project completion. 

Let’s get going! 

What is Construction Risk Management? 

Construction risk management is the process of identifying, assessing, and mitigating potential risks in construction projects. 

Construction risks are any event or factor that negatively affects the successful completion of a building project such as financial losses, delays, legal disputes, quality issues, and safety hazards. The goal of this strategic process is to minimize the impact of construction risks throughout the project lifecycle within the allocated budget and timeline. 

Here are the most hazardous risk factors construction companies and owners face during a project:

• Delays
• Interrupted cash flow 
• Poorly written and organized documentation 
• Incorrectly defined scope of work
• Design errors or construction defects 
• Failed coordination due to miscommunication 
• Non-compliance to regulatory and legal requirements 
• Health and safety hazards
• Lack of skilled labor and resources 
• Extreme weather conditions 

A “risk management plan” in construction projects helps stakeholders proactively address risks, ensure smooth operations, and make increased profits. Ideally, it should encompass preventive measures, remedial solutions for addressing hazards, and contingencies to fund unexpected expenses.

Construction companies implement various risk management strategies right from the planning stage until project delivery. Medium and large-sized businesses hire a construction risk manager while smaller companies designate a project manager or supervisor to handle construction risks. 

As Brent Miller, director of Risk Management at Dome Construction tells Risk and Insurance, “COVID-19 demonstrated how risks can profoundly affect industries and society. To thrive, companies must innovate, leveraging risks for rewards. Those unwilling to adapt will be surpassed by those who can.” 

Types of Risks in Construction Projects (and How to Mitigate Them) 

Most construction projects are highly complex where general contractors tackle different types of risks. To formulate a solid construction risk management plan for your projects, it’s necessary to first understand the common types of risks and their specific examples. 

Construction projects can involve mainly two areas of risk, namely, internal risks and external risks. 

Internal Risk: Derives from parties involved in the project, their qualifications, management skills, and the activities they undertake. For example, a general contractor’s poor cost estimation results in budget overruns. 

External Risk: Arises from outside the project and is not in control of the construction team. An external risk of natural phenomena such as earthquakes may impact the building site and delay the project work. 

Further, discover the prominent types of construction risks you may encounter and how to mitigate them: 

Safety Risk

Safety risks are on-site hazards that lead to accidents, injuries, and long-term health issues, or even death. Typically, construction workers are vulnerable to safety risks including falls, electrocutions, equipment malfunctions, high noise levels, and airborne pollution. 

How to Mitigate: 

• Train workers in safety programs focusing on harnessing techniques, using personal protective equipment (PPE), tool handling, basic rigging, and how to communicate hazards. 
• Every construction company must implement rigorous safety protocols. Keep an emergency response plan ready to minimize losses. 
• Followed by a thorough risk assessment, contractors must detect potential hazards and on-site violations, only to create preventive strategies for worker safety. 
• Risk managers in construction projects should enforce strict safety guidelines as prescribed by OSHA (Occupational Health and Safety Administration). 

Financial Risk

Reasons that destabilize a construction project’s finances like inadequate cash flow, hiked material prices, cost overruns, supply chain disruptions, and economic downturns are known as financial risks. For instance, when contractors don’t mention clauses to adjust market-driven fluctuations of material prices in their bid contracts, they can face significant cost burdens, affecting profitability. 

In its 2023 General Contractors Risk Report, inflation, labor, and subcontractor risks were identified as 3 key economic risks for general contractors. 

How to Mitigate: 

• Unexpected expenses can be avoided by accurately estimating project costs and regularly tracking your budget. 
• Construction inventory software helps contractors monitor labor and supply costs. 
• Establishing project parameters, allocating liabilities, and defining payment terms in your contractual agreement helps maintain cash flow. 
• Explore alternative construction financing options such as private equity, mortgages, and government grants beyond traditional bank loans. 
• Plan a contingency fund to mitigate financial risks, at least 10% of the total project costs. 

Legal Risk

The construction industry is highly regulated and prone to legal disputes. Legal risks fundamentally arise from contractual disagreements between the owner and the general contractor. Additionally, non-compliance with building permits and contractor licensing requirements can result in hefty fines or even legal troubles. 

While the owner may file expensive lawsuits for workmanship defects, construction companies may take legal action if the owner delays payment or breaches agreement terms. Construction business owners are legally liable for issues related to employment contracts, worker’s compensation insurance, and labor laws. 

Construction legal risks may lead to monetary loss and damage to a business’s reputation. 

How to Mitigate: 

• Ensure the contracts have clearly defined obligations for both the owner and contractor. Subcontractor contracts must establish metrics for measuring performance regarding workmanship and schedule adherence. 
• Include risk-shifting provisions such as indemnification and insurance clauses in the project contract. 
• Communicating with governmental organizations, inspection officers, and legal professionals to stay updated with the latest regulatory standards and building codes. 
• You can shift the risk by opting for a “design-build” delivery system which reduces finger-pointing among designers and construction workers anytime delays or defects happen. 
• Hire professionals who have commercial general liability, workers’ compensation, and professional liability insurance. 

Project Risk

In construction projects, hazards of poor management can throw off a project. These management hazards are called project risks. Project risks entail improper resource allocation, miscalculation of schedules and project deliverables, and last-minute scope changes. 

Alongside, inadequate pre-construction site analysis, design errors, and incorrect structural calculations by the engineer can also cause expensive project risks at later stages. 

Let’s say, there’s a delay in scheduling steel beam delivery due to a miscalculation of the delivery timeline between suppliers and contractors. This postpones structural work by 2 weeks, causing a domino effect on subsequent tasks and delaying the project timeline. 

If projects are not delivered as per the client’s expectations, building contractors may face the risk of litigation. 

How to Mitigate: 

• Perform a resource management analysis of materials, equipment, and laborers. 
• Allocate responsibilities and designate a specific timeline for each task. Establish effective Request for Information (RFI) procedures. 
• As the construction work progresses, risk managers should ensure adherence to safety guidelines on-site and quality standards.
• Investing in cloud-based project management software will enable stakeholders to receive updates in real-time, avoiding the risk of delays or cost overruns. 
• Building Information Modeling (BIM) models allow for 3D visualization, helping stakeholders anticipate and mitigate risks related to building system clashes, design inconsistencies, and safety. 
• Contract documents must be clear, mentioning understandable design specifications and change order provisions to avoid misinterpretation. 

Environmental Risk

 

Natural phenomena that make the construction site inaccessible and destroy the building work fall under “Acts of God” or environmental risks. Delays or damages because of extreme weather conditions like floods, earthquakes, hurricanes, snow, and heavy rainfall can result in reworks or repairs, affecting the project’s success. 

Failure to comply with regulations like the Clean Air Act and Clean Water Act is another significant environmental risk for which you have to pay hefty fines. For example, The U.S. Environmental Protection Agency (EPA) is vigorously enforcing regulations on lead dust and debris and is finalizing requirements for renovation of commercial buildings where lead-based paint is used. 

Moreover, unsuitable soil conditions may negatively impact your building’s foundation, drainage, and stability. 

How to Mitigate: 

• Risk managers should conduct thorough environmental impact assessments (EIAs) before any construction project and develop targeted risk mitigation strategies.
• Educate construction workers on on-site environmental procedures including waste management and proper handling and disposal of hazardous materials.  
• Test soil conditions with the help of engineers. It’s also necessary to implement soil erosion practices (installing silt fences, sediment basins, or revegetation) to stabilize the soil. 
• Adopting other risk management strategies such as using noise barriers, low-emissive construction materials, and dust control measures. 
• Project managers must stay up-to-date with the latest environmental standards and technologies. 

Cyber Risk 

In a keynote presentation at the International Risk Management Institute’s Construction Risk Conference, Travelers Institute President Joan K. Woodward highlighted research indicating that “cyber security is the biggest risk” for business professionals. 

Rapid digitalization has led to the construction industry becoming susceptible to cybersecurity risks like ransomware attacks, data thefts, phishing attacks, and breaches in control systems. 

Often, contractors or subcontractors have access to sensitive cyber data which can get hacked or deliberately leaked, this is known as third-party vendor risk. 

For example, a renowned Texas-based construction company was targeted in a phishing attack by a fake email claiming to be their business partner, prompting them to send payment to a fake address in Washington. 

How to Mitigate: 

• Regularly assessing cybersecurity risks considering your unique operational environment or activities.
• Training construction employees against opening phishing emails and protecting sensitive networks with passwords or encryption.
• As a construction company, seek cyber insurance coverage that covers the costs of forensic investigation and breach notification linked with a cyber incident. 
• Reviewing cybersecurity practices of business partners, general contractors and clients. 

Construction Risk Management Plan: 7 Key Steps 

Once you have understood the potential construction risks, devise a risk management plan to mitigate their negative impacts on your project. From identifying, assessing, and managing risks, here’s a step-by-step guide to building an effective construction risk management strategy. 

Step 1 – Identify the Construction Risk

The first step towards mitigating risks is identifying the factors that can jeopardize your project. Start by reviewing project plans, specifications, site conditions, and other documents. Research historical data from previous construction projects similar to yours. 

Hold brainstorming sessions with project stakeholders and your team to identify all risky scenarios before submitting bids. Ask for their valuable insights and recommendations on potential risks. Whether there are safety, financial, legal, or environmental hazards, you will know what type of risks you will be managing for the project. 

Step 2 – Assessing and Prioritizing Risks 

The U.S. government defines risk assessment as: “A risk assessment is a process to identify potential hazards and analyze what could happen if a hazard occurs.” 

Risk analysis in the pre-construction stage can be done using downloadable construction risk assessment templates that will help you address risks at every stage of the project. Alternatively, you can use workflows or techniques, including cause and effect diagrams, probability and impact matrix, or fault-free analysis. 

Using qualitative and quantitative methods, you have to prioritize risks in order of importance. Construction risks should be evaluated based on a two-factor risk analysis, like this: 

• Potential impact of the underlying risk on the business (in dollars) 
• Probability that the risk is most likely to occur (in percentage points)

Manage high-impact, high-probability risks first and low-impact, low-probability risks last. For example, 

• Inflated prices of building materials can be ranked as medium priority. 
• For a subcontractor facing labor shortages or strikes, delaying the project timeline is a high-priority risk. 
• Neighbors’ noise complaints due to construction activities can be rated as low priority. 

You can arrive at the mentioned conclusions by developing a 3×3 priority grid, and a risk assessment matrix. Simply draw a visual grid with low-medium-high probability up the left-hand side and low-medium-high impact from left to right along the bottom of the grid. Then write each risk in the corresponding square. The ones in the bottom right corner (high probability, high impact) are the highest priorities while the ones in the bottom left corner are the lowest priorities. 

In this way, evaluating the severity and probability of a risk can help you further plan a construction risk management strategy. 

Step 3 – Create Your Risk Response Strategy 

Having a risk response plan is essential so that your construction company can promptly deploy a well-structured reaction if any identified risks materialize. Although these risks are diverse, there are 4 construction risk management techniques: 

1. Avoidance – If your construction business is unprepared to handle the risk, either adjust the scope of work or decline the project altogether. For example, suggesting project completion in manageable phases or referring the client to other builders, thereby avoiding the risk. 
2. Transfer – If you aren’t the right contractor to manage a specific issue, discuss with other stakeholders to whom you can transfer the risk via contractual clauses. You can pay the risk premium to the risk-taking party, for example, insurance, performance bonds, warranties, and guarantees. 
3. Mitigation – To reduce the probability of a risk or minimize its impact on the project, you can implement risk management techniques. For example, by streamlining processes using technology, examining job sites before construction, or hiring more talented workers. 
4. Acceptance – Unfortunately, sometimes a building contractor needs to accept particular risks and repair the damage with the help of a contingency plan. Natural disasters, for example, are impossible to manage or avoid. 

Whichever risk response strategy you finalize, ensure it’s based on your company’s ability to withstand the risks or potential rewards linked to the project. For instance, construction risk management can improve client satisfaction and position you as a trustworthy contractor, driving repeat business and positive referrals. 

Step 4 – Develop a Contingency Plan

A good construction risk manager understands that some issues will erupt no matter how many preparations you make. Hence, it’s wiser to develop a contingency plan that offers a buffer to your organization during unexpected events. 

A contingency plan reduces the negative impact of construction risks by allocating extra resources, time, and budget to a project. Every project stakeholder should be aware of this contingency plan and their role in its implementation. 

Suppose, your contracting company undertakes a project to restore a historical building into a commercial office space, accepting the legal risks involved. In this case, your contingency plan should include: 

• Appointing a historic preservation officer or consultant 
• Obtaining approvals from local review boards 
• Researching the building’s history and renovations over the years 
• Structural integrity assessment and accessibility upgrades 
• Applying for zoning variances or special permits 

Best practices of construction risk management say at least 10% of the total project budget should be allocated for contingency funds. 

Step 5 – Execute the Risk Management Plan

The most important step of construction risk management is executing planned mitigation strategies. Construction companies rely on different resources to optimize their selected risk response strategy in building projects. For example, 

• Software – A cloud-based construction management software helps streamline and manage tasks like building design, costing, safety compliance, and project management. 
• Financing – Obtaining construction business credit lines empowers you to handle client’s late payments or payment disputes. 
• Professional Advice – Legal firms specializing in construction contracts and litigation, bankers and accountancy firms, as well as consultants are great options for seeking risk-related professional advice. 
• Insurance – Your insurance company can advise you on different requirements, pros and cons for construction insurance; for example, contractor-controlled insurance programs (CCIP) and subcontractor default insurance (SDI). Remember some construction risks will always be uninsurable. 
• New Technology and Methods – BIM, drones, and other construction technology simplify various complex processes. Prefabrication, modular construction, and 3D printing largely reduce project timelines and risks linked to worker safety and weather. 
• Employee Training – On-the-job training of construction workers in handling specialized materials, equipment and maintaining work safety is an excellent preventive measure for construction risk management. 

Don’t forget to communicate your construction risk management plan to all team members and project stakeholders including site managers, engineers, and regulatory agencies so that they understand their participation. 

Step 6 – Recover from the Losses 

If your company has experienced losses, it’s necessary to recover damages by implementing already formulated contingency plans, lessening its impact on the project. Every contracting company’s risk management plan must have a standard procedure and policy for recovering losses. 

You can recover from significant losses in the following ways: 

• Filing an insurance claim
• Filing a mechanics lien or payment bond claim
• Sending accounts to collections
• Filing a lawsuit
• Declaring bankruptcy 

Step 7 – Review and Monitor 

Finally, an independent team should review whether the construction manager was successful in managing the risks or not. The goal of this audit is to review how effectively the risks have been managed, including the assessment of root causes and mitigation techniques used. All the review results will be added to your risk register. 

Eliminating the risks associated with a specific aspect is not enough, you need to monitor hazards throughout the project’s lifecycle. As requirements and stakeholders change, the nature of risks and their probabilities change too. Hence, the contractor’s team should perform risk monitoring as a regular exercise.

Using your performance data, you can better forecast potential risks that can materialize and incorporate learned lessons in future projects. 

Importance of Risk Assessment and Mitigation in Construction 

Identifying and managing construction risks productively offers several advantages to your contracting business. From elevating profitability, avoiding lawsuits, and improving quality, safety, and client relationships, construction risk management helps your business successfully finish projects. 

We have explained the biggest reasons why construction risk management is an integral part of any building project. 

Improves Operational Efficiency 

Documentation about the identified risks, the risk analysis, and the implemented risk response plans are useful for making informed decisions in future construction projects. Since your team has garnered essential knowledge and tools from previous experience, it improves operational efficiency. 

Creates Safer Construction Sites

Having a construction risk management plan in place means your team follows all safety standards and is well-equipped to avoid possible on-site accidents or safety hazards. As a result, construction workers, visitors, and other employees feel safe on job sites, which avoids the threat of litigation. 

Saves Time and Money 

Addressing risks early in the project lifecycle saves money and time associated with accidents, delays, and rework. Careful scheduling of tasks with the help of technology means the team follows the timelines, without delaying the work. Construction risk management also reduces cost overruns and the need for emergency measures. 

Boosts Profitability 

When all the jeopardizing construction risks are managed well by the contractor, it executes the project with streamlined operations, lower costs, and shorter timelines, which ultimately increases both client’s and builder’s profits. 

Greater Client Satisfaction 

Analyzing construction risks together during team meetings fosters better communication and collaboration between stakeholders. When your construction company focuses on safety, quality, and diligent project management, it builds the client’s trust in the project. Overall, construction risk management leaves clients satisfied with your performance. 

Prevents Litigation 

A single lawsuit has the potential to break your company. By practising effective risk management strategies, you nurture good client relationships and satisfaction. This saves you from damaging legal issues. 

How a Commercial General Contractor Helps 

A talented commercial contractor plays a pivotal role in overseeing all aspects of the construction project and executing a risk management plan. 

After performing a thorough assessment of potential risks, the general contractor will develop an effective risk management strategy outlining quality control measures, safety protocols, and contingency plans to avoid losses. 

Since contractors are responsible for selecting and hiring subcontractors for your project, it is ensured that every subcontractor has the necessary qualifications, experience, and insurance coverage to work legally and safely. They monitor the workmanship quality of subcontractors and whether they are adhering to safety requirements.  

It’s the general contractor’s duty to hold regular meetings, give updates, and report potential risks to stakeholders, which avoids miscommunication and delays in risk mitigation. Leveraging their established relationships with local regulatory bodies and officials, they make your building code-compliant and free of legal troubles. 

A reliable commercial general contractor will always be vigilant for emerging threats, scope changes, or external factors so that they adapt risk management strategies as needed. 

Overall, it is important for project owners to hire a reputable commercial general contractor skilled in identifying, addressing, and monitoring risks to deliver a successful construction project on time and within their budget.

Case Study: Luxury Auto Center

Project Brief – A local contractor specializing in commercial projects undertook the construction of an ultra-modern Mercedes-Benz flagship store. The auto center required world-class standards of workmanship reflective of the luxury automotive brand. 

Solutions – As soon as the contractor was awarded the building contract, they identified and measured the possible impact of this risk on the project. Specialized tasks such as installing custom automotive equipment and integrating electronic systems needed the services of accomplished subcontractors, who were difficult to secure. 

By leveraging its industry network, the construction company secured skilled subcontractors early in the planning stage after an extensive pre-qualification assessment. To attract and retain top talent, the hired contractor offered competitive compensation packages.

Results – Using appropriate risk management solutions, the commercial contractor was able to procure the highest standards of subcontracting services within tight deadlines.

This case study essentially demonstrates how early identification and assessment of potential risks, as well as proactive mitigation by a commercial general contractor, can help manage risks in a construction project. 

Final Thoughts

Construction risk management is an indispensable part of construction projects that should take place before breaking the ground. Every construction company must keep a mitigation plan ready for overcoming various risks related to safety, finances, litigation, environment, and other project aspects. 

This prepared approach minimizes the resultant damage or losses as well as prevents future hazards. Over time, update this strategy with every lesson learned, the latest technology, and evolving market conditions. 

Work with Us

Constructive Solutions, Inc. has delivered excellence in multiple projects across San Francisco, San Jose, and San Mateo with its exceptional commercial construction and project management services. From planning to completion, we ensure the finest standards of quality, safety, and efficiency. 

Contact our team today to let us bring your vision to life. 

FAQs

What are the biggest challenges in construction risk management? 

Some of the major challenges that construction teams encounter while managing risks are a lack of risk mitigation strategies, changing project scope, resistance to change, communication failure, or external factors like natural disasters. 

What are the 4 types of construction risk?

Construction risks can be safety-related, financial, legal, or environmental, typically caused by internal and external factors.

What are the 5 principles of construction risk management?

Identifying risks, assessing their probability and impact, mitigating them, recovering from losses, and preventing future risks are the 5 principles of the construction risk management process. 

Relevant Resources:

• 12 Biggest Challenges in Commercial Construction, and How a General Contractor Can Help
• How to Create an Achievable Construction Schedule – In Easy 8 Steps