Risky business part II: sharing risk through procurement

14 May 2018

Since the 2008 Financial Crisis, risk has become a greater consideration in both private and public sectors. Firms such as Deloitte estimate their spend on risk management has increased by 30 per cent since the crash. The UK government has put a ringfence on the amount banks can invest in high-risk areas to limit the economy’s exposure to financial risk.

The austerity programme, in reaction to the 2008 Crisis, attempted to reduce spending by outsourcing more public services to the private sector. Within this, ‘aggressive risk transfer’ has become a priority. Aggressive risk transfer is the attempt to pass on most of the risks associated with delivering public services to a provider. The intention for the public sector is to avoid the financial burden of negative externalities during the delivery of public services, saving money for the public purse. As a result, commissioners attempt to devolve risk in a way that dislocates it as far away from government as possible.

Risk management in government is thus being conflated with risk avoidance. Risk avoidance doesn’t necessarily achieve value for money in outsourcing. Firstly because, as explained in a previous blog, government can never wholly transfer risk. It is always accountable for the public service being delivered.

Aggressive risk transfer is integral to new business models in the private sector. In contrast, companies such as Uber and Amazon’s business model, for example, relies on aggressively transferring risks associated with the provision of labour to employees taking responsibility for risks associated with the provision of their own labour. If an Uber driver is sick or crashes a car or has any unforeseen accidents that prevent them from working the employee bares the financial burden rather than the company. This kind of devolution of risk drives down costs dramatically for the company but makes life for the employee very precarious.

As explained in a previous blog, government can never wholly transfer risk. It is always accountable for the public service being delivered and if an external provider fails, government must spend to provide services. For example, when the East Coast Mainline failed for a second time, it cost the Treasury an additional £2bn—on top of the initial contract—to bring the service back in-house.

With government spend on outsourcing at £242bn, and possibly rising because of Brexit, it is essential that risk management is done right. Government should shift its focus to risk sharing instead of aggressive risk transfer.

A forum for risk management between government and industry could platform better approaches to risk sharing. The forum could agree on frameworks for identifying risks and who is best placed to manage them. Sharing of resources and expertise between government and industry could also lead to more accurate pricing and forecast of risk.

Government can also minimise systemic risk by spreading it more evenly within the private sector. A previous Reform report, on the Work and Health programme, revealed current risk management policies thin public-sector markets. In some cases, procurement policy insists that SMEs who cannot prove they can shoulder financial risks must seek a parent company guarantee – effectively an insurance. This insurance often makes overhead costs too high for them to bid for contracts. As a result, only large companies can operate in this space. This is bad for competition and by proxy makes the entire market more at risk to events like the collapse of Carillion.

A final way to manage risk is to better identify areas of public services that are risk prone. AI technologies lend themselves particularly well to risk management as they can work with large data sets and forecast events with lots of uncertainty. In the long run, this could be adopted in the public sector to drive down costs for government, while also increasing the accuracy of risk forecasting in the delivery of public services.

Government should accept that it’s accountable for delivering public services, with or without outsourcing. If it is going to outsource to the private sector, it must work with, rather than against it. Better risk management can be achieved, therefore, through attempting to share, not transfer risk.

Rose Lasko-Skinner, Research Assistant, Reform

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