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You are on page 1of 66

Risk Management

Cees van Westen

westen@itc.nl

Risk Evaluation.

Risk evaluation is the stage at which values and

judgment enter the decision process, explicitly or

implicitly, by including consideration of the importance

of the estimated risks and the associated social,

environmental, and economic consequences, in order to

identify a range of alternatives for managing the risks.

We have analyzed the risk either qualitatively or

quantitatively. Now questions arise:

Where is the risk too high?

What is too high?

What do the people think?

Risks can classified into involuntary risk and voluntary risks.

Risks associated with natural hazards are often classified as

involuntary risk.

They often relate to rare events with catastrophic potential

impacts.

Lay perceivers (or non-experts) give more weight to hazards that

take many lives at ones that is to major disasters ( Smith, 2001).

Technical experts assess infrequent hazards that take many lives

at one time equal to regular hazards that take a similar number

of lives just once in a time (over an equivalent period) ( Smith,

2001).

The factual dimension, which indicates the actual measured

level of risk, and which can be expressed in probability of losses

(e.g. number of people, building, monetary values)

The socio-cultural dimension, which includes how a particular

risk is viewed when values and emotions come into play.

Risk perception

Risk perception is the way how

people/communities/authorities judge the

severity of the risk.

Do they know?

Are they worried?

Are they prepared to act?

Who they think should act?

What is it worth to them?

Cultural and religious background.

Social background

Economic level

Acceptable risk: a risk which the society or impacted

Political background

individuals are prepared to accept. Actions to further reduce

such risk are usually not required unless reasonably

Level of awareness

practicable measures are available at low cost in terms of

money, time and effort.

Media exposure

Tolerable risk: a risk within a range that society can live

Other risks

with so as to secure certain net benefits. It is a range of risk

regarded as non-negligible and needing to be kept under

review and reduced further if possible.

Risk reduction situation

ALARP (As Low As Reasonably Practicable) principle:

Principle which states that risks, lower than the limit of

tolerability, are tolerable only if risk reduction is impracticable

or if its cost is grossly in disproportion (depending on the

level of risk) to the improvement gained.

Risk evaluation.

The ALARP principle is that the residual risk shall be as low as

reasonably practicable.

Must be avoided or

reduced;

Risk reduction cost

may be taken into

account. Beyond a

certain point

investment in RR

may be inefficient.

During the life of an average person, the chance of death is never less

than 1:10,000 (1.000E-4): this is due to all causes.

So it would not be realistic to require the risk due to natural disasters to

be lower than this.

These curves differ from country to country. No international standards

Voluntary involuntary risk is also relevant.

F-N curves

dyke rings that protect a

part of the country against

flooding.

The more important the

area, the lower the chance

that the dyke ring breaks and

the area will be flooded.

An important aspect

in risk evaluation is

also:

How much do we

need to spend in

order to reduce the

risk

Benefits

Costs

measures

Cost Benefit Analysis (CBA) is used to compare costs and benefits of a one

specific measures or a set of alternative measures over a period of time for

a. CBA assesses the measure(s) mainly on the basis of the efficiency criterion.

It requires the monetization of all the effects. The effects that cannot be

expressed in monetary terms will be usually described in their original unit of

measurement.

Cost Effectiveness Analysis: (CEA) has most of the features of CBA, but does

not require the monetization of either the benefits or the costs (usually the

benefits). CEA does not show whether the benefits outweigh the costs, but

shows which alternative has the lowest costs (with the same level of

benefits). CEA is often applied when the norm for a certain level of safety

has been set. CEA analyzes which types of solution is the cheapest given a

certain level of safety standard.

Multi Criteria Analysis (MCE) is a tool that allows comparing alternative

measures on multiple criteria. In contrast to CBA, MCE allows the treatment

of more than one criterion and does not require the monetization of all the

impacts. MCE results in a ranking of alternatives.

most

attractive?

If all

alternatives

are all as effective in terms of risk reduction

the cheapest alternative (Cost Effectiveness Analysis, CEA)

If effectiveness in risk reduction differs the cheapest alternative

in terms of risk reduced (Cost Benefit Analysis, CBA)

Levees

Flood proofing

relocation.

reducing measure?

A number (most?) risk reduction measures could be applied

in a variable way

Earthquake resistance of buildings

Legal restrictions land use

..

diminishing returns

Often at higher variable costs

MORE is not necessarily more beneficial

Assessment for whom??

Government and funding

agencies

National and provincial

governments

Governments/general public

Emergency planners

Insurance companies

Private firms/house owners

Accountability - Tax money

Economic loss compensation

Identification of critical

risk areas

Financial loss

Insurance or other

protection measures

whom?

Public: national

ministries, provincial

governments,

emergency planners

values broad economic

perspective

private property

monetary values

owners, insurance

companies

Measures

Costs for (structural) risk reducing measures are

relatively less difficult to estimate

Estimating the benefits is a major challenge !

We need to know:

Avoided damage

Probability of damage

We need to estimate:

how often natural hazard events occur (frequency)

how much damage and losses occur as a result of

the event

- e.g. flooding

Direct damage

buildings

infrastructure

crops and livestock

Machines

human victims

landscape/nature

Indirect damage

income forgone

interruption of economic

and social activities

extra costs of

transportation due to

infrastructure damage

Damage functions

Damage-probability curve

Damage-probability curve

in case of flood protection

against events upto 1:100

years

1.

2.

3.

4.

5.

Identify the type of costs and benefits

Put monetary values on costs and benefits

Compare costs and benefits

Calculate profitability indicators/decision

criteria

6. Sensitivity analysis

7. Make recommendations

scenarios?

1. The costs of both scenarios (investment and

annual)

2. The investment period

3. The benefits (i.e. annual risk reduction) of

both scenarios

4. The life time of the investment

5. Discount rate

Define risk reduction measures

Define cost of risk reduction measures

Define characteristics

Analyze cost benefits

25

within each mapping unit. We do this by

multiplying the building footprint area with

the number of floors.

Then we use unit costs (per square meter)

per urban landuse type for buildings and for

contents of buildings. We multiply these with

the floorspace to get the total costs per

mapping units.

Then we will generate attribute maps that

contain the costs of buildings affected for

each hazard type and hazard class.

We will then use the results from the annual

loss estimation to combine these with the

vulnerability and probability if these are not

yet included.

We will then combine the data and generate

risk curves.

26

Economic risk

27

The municipality of RiskCity has made a

study and the report came up with the

following possibilities for risk reduction. The

following table shows a number of possible

risk reduction measures, including also a

very general indication of the costs that

these measures would take. In the following

section we will evaluate some of these in

more detail.

28

Scenario I (removal)

removal of housing in the 10year Return Period flood zone

10 year RP flood zone is

converted into green areas

buildings are demolished, new

terrain to be bought, and new

buildings have to be constructed

in other hazard free zones

the set-up of a vigilance group

is required

The risk in the area that was

formerly threatened by a 10

year Return Period flood will be

reduced to 0

Scenario II (retention)

construction of an upstream

storage lake

engineering works

flood retention basin and

drainage need maintenance

the retention basin will reduce

the flood losses.

It will retain the discharge for 2

and 5 years RP and reduce the

risk to 0.

For the other return periods the

damage will reduce the losses

and II at different Return Periods

Flooding

Return

Period

Annual

without Scenario Scenario

Probabili mitigation

1

2

ty

2

0.5

0.0

0.0

0

5

0.2

19.3

0.0

0

10

0.1

34.4

19.3

0

25

0.04

100.0

34.4

65.6

50

0.02

199.0

100.0

164.6

100

0.01

510.0

199.0

475.6

200

0.005

1134.0

510.0

1099.6

Costs Scenario I (removal)

Triangles and

rectangles

method

curve is divided into

trangles, which connect

the straight lines

between two points in

the curve and have Xaxis difference as

difference between the

losses of the two

scenarios. Y-axis of the

triangles is the

difference in

probability between

two scenarios. The

remaining part under

the curve is then filled

up with rectangles, as

illustrated in the graph

and table below.

taking the sum of the

triangles 32

and squares in

Simplified

rectangles

method

In this method

we simplify the

graph into a

number of

rectangles, which

have as Y-axis the

difference

between two

successive

scenarios, and as

X-axis the

average losses

between two

successive loss

events. See graph

and Excel table

below

33

Risk reduction

Now that we have calculated the annual loss for the existing

situation, we can also now evaluate the reduction in total

annual losses for the two scenarios.

Calculate in Excel in the same way the average annual risk

for Scenario I and Scenario II ( see earlier table with the

losses for the two scenarios for the various return periods

that you filled in yourself)

Calculate the amount of risk reduction, comparing Scenario

1 and Scenario 2 with the original average annual risk. Fill

in the table below.

34

After calculating

how much the risk

reduction is on an

annual basis for

the two different

scenarios, we can

now evaluate the

benefits. The

benefit is equal to

the amount of risk

reduction.

However, the two

risk reduction

scenarios also

involve certain

costs. The next

table indicates

the investment

costs for

implementing the

two scenarios.

35

Calculate costs

To calculate the A to D component costs from

the table above, you need to know first the

number of buildings in the flood zone of 10

years return period. For the component E

you need to know the area pf the 10 year

flood zone.

36

Costs

After calculating the risk reduction (benefit) and the

investment costs of the two flood scenarios we can

now continue to evaluate the cost/benfits. The

following table indicates the costs of the two

scenarios.

37

Each of the two scenarios will also require long term

investments.

Scenario 1 requires the set-up of a municipal organization that

controls the illegal spread of housing in highly hazardous

areas. It will require staff, office and equipment costs, which

will rise over time depending on the increases of salary and

inflation. The annual costs are estimated to be 250.000. We

consider that these costs will increase with 5 % each year.

Scenario 2 also requires maintenance and operation costs. The

flood retention basin contains a basin in which sediments are

deposited. Annually the sediments from this basin have to be

removed using heavy equipment. Also the drainage works

needs regular repair. The costs for maintenance are considered

to be 500.000 per year. We consider that these costs will

increase with 5 % each year. See table below.

38

Investment period

The investments for both scenarios are not done within one

single year. They are spread out over a larger number of years,

because normally not all activities can be carried out in the

same year.

It is quite difficult to remove existing buildings. The

municipality would like to buy the land of private owners, but

they will resist, and there will be many lawsuits that might

take a lot of time. Therefore we consider that the entire

relocation of all building might take as much as 10 years. The

investment costs are therefore spread out over this period.

The construction of the engineering works for scenario 2 will

take less time. Still it is considered that the costs are spread

over a period of 3 years.

The benefits will start in the year that the investments are

finished. For scenario 1 this is in year 11 and for scenario 2 it

is in year 4.

39

Project lifetime

The lifetime of the scenario 2 is considered to

be 40 year. After that the structure will have

deteriorated and it needs to be rebuilt. For

the relocation scenario it is more difficult to

speak about a life time, but we will also keep

the same period of 40 years.

40

Costs of the Flood Risk Reduction Scenarios

(costs in .10 6)

41

Incremental benefit

called Flood Mitigation

Scenario I ( see figure left).

Column 1: Years ( starting with

1 up to 40 year)

Column 2 Risk Reduction (i.e.

Risk avoided, or Benefit)

Column 3: Invest cost for the

risk reduction scenario.

Column 5: Maintenance

Column 4: Incremental

Benefits

Enter the values and calculate

the incremental benefit over

the 40 years period.

42

We need to take into account that the same amount

of money in the future will be less valuable today.

We will need therefore to calculate the so-called

net present value (NPV)

43

more than money in

the future

Why ?

Inflation

Risk

Consumption

Earning power

(investment

opportunities)

Techniques for comparing values at different

points in time

In CBA mainly concerned with Discounting

for better understanding first: Compounding

Compounding

interest 10%

after 1 year ?

After 2 and 3 years ?

Compounding

start: 100

after 1 year:

after 2 years:

after 3 years:

etc.

100 + 10 = 110

110 + 11 = 121

121 + 12.1 = 133.1

Discounting

the reverse of compounding

it looks from the future back to the present

and asks:

what is the present value of a known future

amount ?

Discounting

at the end of 3 years from now, assuming an

interest rate of 10% ?

Discounting in formula

X0 = Xt / (1 + i)t

X0 = present value

Xt = value in year t

Discounting - example

X3 = 133.1; i = 0.10; t = 3

X0 ?

X0 = Xt / (1 + i)t

X0 = 133.1 / (1 + 0.10)3

X0 = 133.1 / (1.331) = 100

To care of time value of money

We apply discount rates

We discount each future annual amount

year

1

-8.333

-7.576

-8.333

-6.887

-8.333

-6.261

Until

15.690

40

9.742

incremental

benefits

year

NPV_10%

-8.333

-7.576

-8.333

-6.887

-8.333

-6.261

15.690

15.690

Until

year

40

10.716

9.742

NPV decreases if i (interest rate) increases

At one i (interest rate):

=0

IRR

Now we are going to calculate the Internal

rate of return. The Internal Rate of Return is

the discount rate/interest rate at which the

NPV=0

56

Scenario I:

Scenario II:

$ 39.69 * 106

Scenario I:

9.91 %

Scenario II:

42.32%

Criterion

Decision rule

accept

NPV

IRR

reject

Criterion

NPV

IRR

Decision rule

accept

reject

NPV > 0

NPV < 0

Criterion

Decision rule

accept

reject

NPV

NPV > 0

NPV < 0

IRR

IRR >

interest rate

IRR <

interest rate

Flood Risk

Reduction

Scenario

%

% interest % interest

interest

rate

rate

rate

IRR

Scenario I

42.23

-0.38

-14.96 9.91%

203.80

93.69

27.79 42.32%

Scenario II

Result

Question:

Which Mitigation Scenario would you advice

the Municipality?

63

CBA -strengths

Focus on use of scarce resources

Strong methodological basis

Monetary measurement provides comparison

Appeal to policy makers

Natural Hazard and Disaster

Management

Indirect economic damage

Social effects

Irreplaceable items

Stress induced by disaster

Temporary evacuation

Social disruption

Environmental effects

Evaluation of non-structural measures

One approach to assess the efficiency of (structural) risk

reducing measures

Take care of uncertainty of all parameters used

Estimated values of objects at risk

Probabilities of the hazard

Social effects

Irreplaceable items

Stress induced by disaster

Temporary evacuation

Social disruption

Environmental effects

Indirect effects

One single outcome hides assumptions and value judgements

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