Cost Benefit Analysis

Alex Apostolou

We have learned that risk reduction measures (safeguards/controls) are in many forms, either hardware based, administrative controls based, or a combination of both. The general philosophy of risk management is that if a risk reduction, however small, can be achieved by administrative control (SMS procedures) using existing resources, then it should be implemented, and a cost-benefit analysis (CBA) may not be required.

When a hardware solution is identified, a CBA is generally conducted. It takes the following steps:

  • Calculate the monetary loss resulting from the accident event.
  • Multiply the frequency of the accident event by the loss estimate to obtain a probable loss per annum ($ pa).
  • Calculate the revised monetary loss as a result of the risk reduction measure.
  • Calculate the revised frequency of the accident, assuming the new control measure in place.
  • Calculate the revised probable loss (new frequency times new loss value in $).
  • The difference in the two probable loss values gives an indication of the reduction in loss by the implementation of the control measure. This can be treated as a de facto return on investment.
  • Evaluate the life cycle cost of the control measure. This includes capital cost, design and installation cost, and on-going maintenance costs for the expected life of the component.

These methodologies mentioned above can be applied through RiskView which contains the ability to conduct Cost-Benefit Analysis for both Qualitative (Automatically Calculated) or Semi-Quantitative Analysed risk. RiskView can define:

  • The financial impact of certain consequences (health & safety and business).
  • The financial impact of the Risk (current and proposed).
  • The financial cost of preventative and mitigative controls (current, proposed and net present value).
  • The disproportion factor and acceptable disproportion factor.

cost benefit analysis

Controls or Base Controls?

RiskView supports two ways of performing the Cost Benefit Analysis: on the risk control or on the Base Control. To use the latter the setting Perform Cost Benefit Analysis On Base Control in Configuration has to be checked and the Base Controls fully set up:

  1. Fully set the Base Control: ensure that Assessment Type is set to Quantitative on Base Control, meaning the rick control inherits the assessment characteristics of the base control. Then define from the same screen the hierarchy, the criticality, the effectiveness and the status.
    NB: as we are here in a Cost Benefit Analysis, the base control is set to a Proposed Status.
  2. Then edit the Costing Details of the Base control
  3. Set the fully set up base control against a control by clicking on the lens to select from the dropdown list.  All the values set above will be common among the controls having the same base control, but the field applicability factor allow some flexibility. It impacts the quantitative values, PFD and CBA.

Estimating Cost

In regards to the implementation of risk controls, identified controls should be considered reasonably practicable unless the cost of the implementation is grossly disproportionate to the benefits returned. This is expressed mathematically using the following expression where costs are grossly disproportionate when:

Cost/Benefit > 1 x DF

Where:

Cost = the cost of implementing the risk control.

Benefit = the benefit, in terms of risk reduction, if the control is implemented.

DF = Disproportion Factor based on the existing safety and health risk.

Both the cost and the benefit may be expressed as Present Values (PV’s) based on the life of the plant or the control (which ever comes first). The PV’s should be calculated using the current company discount rate.

The cost of implementing a risk control needs to be estimated ensuring that all contributing components are considered without the cost becoming extraneous or excessive.

The following gives guidance on the components to be included and excluded in the estimate:

  • Installation, operation, training, additional maintenance and business losses from plant downtime for control implementation are all costs that need to be included.
  • Any ongoing production losses that are a direct result of the risk control implementation should be included.
  • Only those costs incurred by the duty holder should be claimed. Costs incurred by other parties e.g. members of the public, contractors where the costs are not passed on to the duty holder, should be excluded.
  • Where lost production costs strongly influence a decision to reject implementation, further analysis should be completed to determine if implementation during scheduled or opportunity down time changes the balance.
  • Only costs associated directly with the implementation of the control should be considered e.g. If down time is incurred for implementation, but other work is conducted during the outage, not all the lost production should be attributed to the control implementation cost.
  • Only non re-coverable costs should be claimed e.g. if it is feasible to make up lost production incurred through implementation, then the production loss should not be considered.
  • The costs considered should only be those necessary and sufficient for the purpose of implementing the risk control (no gold plating or deluxe measures).
  • Any savings as a result of the measure (e.g. reduced operating costs, reduced maintenance costs, avoidance of damage) should be offset against the implementation cost. These are not considered to be safety benefits but are counted as ‘cost savings’.

Estimating Benefits

The benefits of implementing the risk control need to be estimated ensuring that all contributing components are considered and that the value of the components is not underestimated in any way.

The following gives details on how to meet these requirements:

  • The reduction in risk to workers and the wider community need to be included. Risk reduction benefits should be broken down into prevented fatalities, injuries (minor to Serious), illness, business losses and environmental damage.
  • Benefits should include the avoidance of costs associated with emergency response, evacuation, post accident clean up etc.
  • The values to be used for estimating the benefits of preventing health and safety are as follows:’
    • Single Fatality = $5,000,000
    • Single Permanently Incapacitating Injury/illness = $1,000,000
    • Single Serious Injury/illness = $100,000
    • Single Minor Injury/illness = $5000
  • All benefits of a risk control measure should be included. If a control is identified for a specific event but reduces the risk of other events as well, those benefits should be counted.

Note: These values can be configured to suit your company’s policies.

Calculating Acceptable Disproportion Factor (DF)

Using rules of thumb provided by HSE, the algorithm used to determine an acceptable disproportion factor are as follows:

  • Risks to workers: DF ~ 3 (costs three times larger than benefits acceptable)
  • Low risks to members of the public: DF ~ 2
  • High risks to members of the public: DF ~ 10

A more consistent approach to DF estimation is described below and it is recommended that this approach be followed when conducting a cost benefit analysis.

The values in the table below are a simple mapping of the HSE rules of Thumb to the Risk Matrix:

Likelihood (Events/Year) Consequence ($) Risk ($/Year) Acceptable Disproportion Factor
1.E-06 $30,000 $0.03 2
1.E+00 $100,000,000 $100,000,000 10

The plot of the Acceptable Disproportion Factor against Risk which is done to determine the best fit relationship between the two.

Based on the line of best fit shown in in the plot, the relationship between Acceptable Disproportion Factor and Risk is expressed mathematically as:

DF = 0.3648 x ln(R) + 3.2793

Where:

DF = Disproportion Factor (Present Value of Cost/Benefit)

R = Initial Risk Cost ($/Year)

This approach to the selection of a disproportion factor does not necessarily add any accuracy above that of the HSE rules of thumb, but it will enable a higher resolution comparison to be made between identified risks when it comes to selecting and prioritising risk reduction measures to implement.

Good Practice

From a risk point of view, good practice can be defined as a relevant practice accepted as reducing risk to ALARP. As discussed, a cost benefit analysis should not be used on its own to reject a risk control that is considered to be relevant good practice (an exception to this may be if the cost outweighs the benefit far in excess of the selected disproportion factor).

If the control is not to be adopted, it needs to be demonstrated that the alternative(s) are at least as effective as the good practice if not more so, or the risk associated with implementation exceeds the benefit returned.

The benefit of adopting a good practice for control of a certain risk is that the evidence required to make an ALARP justification for that risk is provided by the fact that a practice is ‘good’ because it reduces the risk to ALARP.

It is important to understand that commonly accepted or recognised engineering practice in industry may not necessarily be good practice. It should not be assumed that it is. Good practice also needs to be kept under review as the passage of time may make it irrelevant; new legislation may void its acceptance or new technology may make a higher standard ‘reasonably practicable’.

Calculating Cost

Calculating Cost of Consequence

RisskView analyse the financial consequences by estimating the severity and impact on the business and the health and safety aspect. RiskView will calculate the probable loss based on the data within corresponding fields.

To display the following form, you would need to navigate to a Consequence node and click on “Costing Details”.

The following table describes the labels in this screen.

Label Description
Fatalities The number of a fatality.
Permanent Injuries The number of a permanent injury.
Serious Injuries The number of a serious injury.
Minor Injuries The number of a minor injury.
Damage The financial impact of damages to properties, quantified in term of $,000.
Loss of Income The financial loss of income, quantified in term of $,000.
Restoration The financial cost of restoration to its previous state, quantified in term of $,000.
Total Total financial cost of each sections (Health & Safety, Business and Overall).

Calculating Control Cost

RiskView, we can also further analyse the cost benefits of the controls used in the study. By defining the cost details in RiskView, it will generate a summary on how cost efficient that particular control is and operators/users can then decide whether to further utilise that control in other scenario or to seek for alternate cost benefit solutions.

The following table describes the labels in this screen.

Label Description
Implementation Cost The cost of implementing the control, quantified in term of $,000.
Operation & Maintenance Cost The operational and maintenance cost of the control, quantified in term of $,000 per annum.
Expected time in Operation The expected life of the control.
Present Value The present value of the control.

Calculating Benefits

Once each section is completed the results summary of the benefits are shown on the Top Event node.


The following table describes the labels in this screen.

Label Description
Total Health and Safety Consequence Cost Total financial impact on health and safety.
Total Business Consequence Cost Total financial impact on the business.
Total Consequence Cost Total financial cost of all consequence.
Inherent Risk Cost Initial financial impact of the Risk, ignoring the effect of all control.
Current Risk Cost Financial impact of the Risk, taking into account the effect of control which are in service.
Proposed Risk Cost Financial impact of the Risk, taking into account the effect of control which are proposed and in service.
Risk Cost Benefit Financial benefit of implementing a proposed control.
Current Control Cost Total cost of control which are in service.
Proposed Control Cost Total cost of control which are proposed and in service.
Present Value Control Cost Total present value of controls.
Disproportion Factor Displays the disproportion factor for the current risk.
Acceptable Disproportion Factor

Displays the acceptable disproportion factor for the current risk.

(If Acceptable Disproportion Factor > Disproportion Factor then the installation of controls will be justified)

Costing Assumptions Assumptions made when conducting a cost benefit analysis.

Example

A risk is assessed as having a likelihood of occurring 1 time in every 10,000 years (0.0001 times per year) and a consequence of 1 fatality, 5 serious injuries, 1 month of production loss at $600,000 per day and $2 million worth of property damage. It is proposed to install a SIL 2 rated safety instrumented function which will reduce the likelihood of the risk from 1 in 10,000 years to 1 in 1,000,000 years (0.000001 per year). The cost of implementing the safety instrumented function is estimated to be $200,000 up front capital with $2,000 per annum of ongoing maintenance for the life of the plant which is estimated to be 20 years. The discount rate for the organisation is 8%.

Consequence of Fatalities = 1 x $5,000,000 = $5,000,000

Consequence of Injuries = 5 x $100,000 = $500,000

Consequence of Property Damage = $2,000,000

Consequence of Lost Production = 30 x $600,000 = 18,000,000

Total Consequence Cost = $2,000,000 + $18,000,000 + $5,000,000 + $500,000 = $25,500,000.

Inherent Risk Cost = Initial Likelihood x Total Consequence Cost = 0.0001 x $25,500,000 = $2,550/year.

Reduced Risk = Reduced Likelihood x Total Consequence Cost = 0.000001 x $25,500,000 = $25.50/year.

Benefit = (Initial Risk Cost – Reduced Risk Cost) x Plant Life = ($2,550 – $25.50) x 20 = $50,490

Present Value of Cost = $219,636

Disproportion Factor = Present Value of Cost ÷ Benefit = $219,636 ÷ $50,490 = 4.4

Acceptable Disproportion Factor = 0.3648 x LN(R) + 3.2793 = 0.3648 x LN($2,550) + 3.2793 = 6.1

If Acceptable Disproportion Factor > Disproportion Factor then the installation of the safety instrumented function will be justified. As 6.1 > 4.4, the installation of the measure is justified.

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