7.2 Calculate Transferred Risk

Once all the Transferred Risks have been identified, the size and timing of the expected cash flows associated with each risk needs to be aggregated to determine the NPC of the Transferred Risk component of the PSC. Each of the risks should be included as a separate cash flow item and then added to form the Transferred Risk component to allow for a detailed analysis of the key risks and their sensitivity to the overall PSC.

Risk Allocation and Standard Commercial Principles provides further detail on the risk allocation framework.

Example 2 Valuing Transferred Risk

Consider a project for the provision of a new educational facility and related ancillary services. The material and quantifiable risks associated with the project, which have been summarised and simplified in this example, are then allocated as shown in Table 7-1.

Table 7-1 Simplified risk allocation
Risk	Transferred Risk	Retained Risk
Design and construction risk	x
Change in law risk		x
Operating risk	x
Demand risk
• base level demand		x
• additional usage*	x
Maintenance risk	x
Security risk (e.g. vandalism)
• during school hours		x
• after school hours	x
Technology risk (e.g. computers)	x

	* Includes any potential third-party revenue risk.
The costs and revenues associated with each of the Transferred Risks are then specified in the PSC model as a periodic cash flow based on the expected timing of their financial impact through the process outlined in Example 2. Table 7-2 is an example of the Transferred Risk section of the PSC model for the first five years of a project.

Table 7-2 Transferred Risk cash flow valuation - real flows
Cost	Year 0 ($m)	Year 1 ($m)	Year 2 ($m)	Year 3 ($m)	Year 4 ($m)	Year 5 ($m)
Design and construction risk	10.0	20.0	2.5
Operating risk		5.0	5.0	5.0	5.0	5.0
Demand risk additional usage		0.5	0.5	0.5	0.5	0.5
Maintenance risk		2.0	2.0	2.0	2.0	2.0
Security risk (e.g. vandalism) after school hours			1.0	1.0	1.0	1.0
Technology risk (e.g. computers)		1.0	2.0	3.5	4.5	2.0

Note that there is a small design and construction risk cost remaining in Year 2, due to the low probability of a delay greater than one year. Technology risk is assumed to increase prior to replacement, due to the increased risk of technological obsolescence over time.

The effects of expected inflation (or appropriate cost index) are now included to give the appropriate periodic cash flows, and are then discounted to give the present value of Retained Risk for the project. In this example, all costs are assumed to increase by inflation at 2.5 per cent per year.

Table 7-3 Transferred Risk cash flow valuation - nominal flows
Cost	Year 0 ($m)	Year 1 ($m)	Year 2 ($m)	Year 3 ($m)	Year 4 ($m)	Year 5 ($m)
Design and construction risk	10.0	20.5	2.6
Operating risk		5.1	5.3	5.4	5.5	5.7
Demand risk
• additional usage		0.5	0.5	0.5	0.6	0.6
Maintenance risk		2.1	2.1	2.2	2.2	2.3
Security risk (e.g. vandalism)
• after school hours			1.1	1.1	1.1	1.1
Technology risk (e.g. computers)		1.0	2.1	3.8	5.0	2.3
Total Transferred Risk	10.0	29.2	13.7	12.9	14.3	11.9
Discount factor (assume discount rate @ 8.65% p.a.)	1.00	1.09	1.18	1.28	1.39	1.51
Discounted cash flows	10.0	26.9	11.6	10.1	10.3	7.8
Present value	76.7

In this hypothetical example, the present value of Transferred Risk for the project is $76.7 million. This demonstrates the importance of accurately assessing the expected timing as well as the size of the costs of risk.