Estimating Contingencies: Variations in Applying, Setting and Managing

Ramani Sundaram
The basis, means and methods of applying, setting and managing contingencies vary depending on the stakeholder, the type of contract and who is managing the funds.

The definition of contingency according to the Association for Advancement of Cost Engineering International (AACEI) is "an amount added to an estimate to allow for items, conditions, or events for which the state, occurrence, or effect is uncertain and that experience shows will likely result, in aggregate, in additional costs". The purpose of contingency is to account for uncertainty and cover perceived risks. Although the purpose is same, the basis, means and methods of applying, setting and managing contingencies may vary depending on the stakeholder, the type of contract and who is managing the funds.

Differs between Stakeholders

Items perceived as risks by one stakeholder may vary from the other. A contractor may consider it risky and add contingency if it is a new type of construction work never done before, whereas, for an owner, the same project may just be a repetition of similar projects done before and so may not pose any risk. Similarly, if the owner is familiar with only conventional construction procurement methods and is trying new types like construction management (CM) or design-build (DB), the owner may consider it risky but a contractor won't, if already familiar with that type.

Contingencies may also vary from one contractor to another or one owner to the other based on their risk tolerances.

The owner will add contingencies for change orders or other risks for which the reasons may differ from a contractor. For example, if the contract allows compensation for extra work, the contractor need not worry about adding a contingency but the owner will be adding a change order contingency to the budget estimate. This is because the owner has to allow for funds in the budget, outside of the estimated payment to the contractors for the base scope.

Risk levels differ among stakeholders depending on the type of construction procurement methods like lump sum (LS), guaranteed maximum price (GMP), DB, etc., and so the contingency applied will be different. Contingencies may also vary from one contractor to another or one owner to the other based on their risk tolerances.

Differences among Types of Contracts

Methods of setting contingencies differ depending on the types of contracts. In a LS contract, a contractor's contingency may be buried in the LS price and may not be visible, whereas, in a GMP or DB contract, risk or construction contingency can be kept transparent and the savings are shared between the owner and the contractor, if contractually agreed.

As the design will be 100 percent complete, no design contingency will be included in a LS contract. This is different if it is a GMP contract. With a 75 or 90 percent design, the construction manager would add design contingency and may also foresee risk of a subcontractor's pricing due to design incompleteness and add contingencies accordingly. Also, depending on the ratio of self-performed versus subcontracted work, these contingencies will vary. In a DB contract, an approach similar to the GMP contract, may be followed for setting design and construction contingencies with some differences. Methods to incorporate contingencies in a DB contract is indicated in the sample form of agreement in on the Design Build Institute of America (DBIA).

Difference among Levels of management

Owners set two levels of contingency – one at the project manager's level to cover project risks and another at the program or upper management level to cover company risks, which is also known as management reserve. Project contingency funds are meant to be used for the project by the project manager. Management reserve is meant for unidentified risks and is set and handled by the upper management.

Policies and guidelines should make it clear how the funds will be managed at the project level and at the senior level.

In an owner's organization, often there may be issues regarding the ownership of authority over the contingency funds. Policies and guidelines should make it clear how the funds will be managed at the project level and at the senior level. At the project level, contingency is owned by the project for the risk items and so effective management of contingency is in the hands of the project manager. The project manager should be free to handle the project level funds without much interference or micro management from the upper management.

The purpose of contingency and how the details may vary are to be understood by all stakeholders involved in a project. The basis and methodology of applying, setting and managing contingency may differ but with good understanding and focused efforts, contingency funds can be used efficiently for the intended purpose.

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Ramani Sundaram Lead Estimator Contact me View my profile >