TOPIC: Expected monetary value & contingency reserve

I am deep into study for my upcoming exam, and have a question regarding contingency reserves. Any input would be appreciated!

My understanding of contingency reserve analysis is that the amount of contingency reserve that should be applied to an activity is dependent on the expected monetary value (EMV) of the residual risks associated with that activity after risk analysis is complete.

So my question is:

Say a residual risk event has an expected cost of $100,000, and a 5% probability of occurrence. So the EMV of this risk is $5000, which is what should be applied as a contingency reserve for this risk.

Now if the risk event DOES occur, you need $100,000 to deal with it, but you only have $5000 as a reserve to deal with it - so where does the other $95,000 come from???

Thanks,

Clint.

Clint,
The contingency reserves is not static and not just money based.
read reserve analysis on page 171 of 5th ED
You'll see contingency reserve can also mean time as a reserve and as you progress through your project, your risk analysis of known unknowns improves so you can reduce your contingency reserve.
If your contingency reserve is monetary, as it should for overall budget, I can make the same argument.
Now, in your hypothetical example, which seems like a worse case scenario, I hope you periodically re-assessed risk and reduced that reserve as you see progress in your progress. If the worse case scenario happens, though, then it's time to hit ask for some management reserve which is not part of your project budget. Hopefully you have some good management relationships or the project is considered a key to the enterprise, because I'd doubt management would give you the $95,000.
Mike

Thanks for the response Michael,

I re-read the reserve analysis section, and things make a little more sense (in theory). However, in practice, I'm still struggling.

I guess, in my example, EMV into the contingency reserve would not be the best option. Since the $5000 can only be used for this risk event (as per the rules of applying reserves to specifically identified risks), but will not cover the cost of the event, maybe it would be better to try and get the $100,000 put into the management reserve? If there are 5 other identified risk events like this, then maybe the management reserve is agreed to be $200,000 since the probability of each of the 5 risk events is low?

But my problem with this is that contingency reserves are for identified risks and management reserves are for unidentified risks, so that goes against PMBOK.

So, if this risk cannot be eliminated through risk planning, then the only way to be sure that you can deal with it if it does occur (despite its low probability) is to have $100,000 in the contingency reserve, which in itself, is not practical. So then do you accept this identified risk (with no contingency) and apply for a budget change if it occurs?

Thanks again,

Clint.

Dear Klint
I think in your hypothetical example it’s a huge project and if you are not sure about your risk identification and risk assessment proccess you can use more analytical and gives u more analytical results like range estimates and have the lowest- highest - most likely estimates for each task or event and get Pert value and then for the whole project and standard deviation - Variance also for your project assuming that your project apply for normal distribution curve and get the proper contingency reserve with high confidence level 95%
That’s what i would do