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• Risk Management
  • Introduction to Risk Management
  • Mandatory Process
  • Corporate Risk Management
• Risk Management Documents
  • Introduction to Risk Management Documents
  • Risk Management Terminology
  • Risk and Opportunity Management Strategy
  • Risk and Opportunity Management Plan
  • Risk Register
• The Four Stage Project Risk Management Process
  • Introduction to the Project Risk Management Process
  • Identify
    • Identify Stage
    • Categories of Risk
    • Project Areas Affected by Risk
  • Analyse
    • Analyse Stage
    • Qualitative Analysis
    • Quantitative Analysis
  • Plan
  • Manage (Implement)
• Opportunity Management
• Three Point Estimating and Confidence Figures
• Risk Management in Acquisition
  • Business Case Approvals
  • Optimism Bias
  • Contracting for Risk Management
  • Assurance
• Risk Tools
• Competences and Training
• Common Terms
• Contacts

Optimism Bias

What is Optimism Bias ?

Optimism bias is the demonstrated systematic tendency for appraisers to be over-optimistic about key project parameters. It must be accounted for explicitly in all appraisals, and can arise in relation to:

• Capital costs
• Works duration
• Operating costs
• Under delivery of benefits.

To minimise the level of optimism bias in appraisal, best practice suggests that the following actions should be taken:

• Project managers, suitably competent and experienced for the role, should be identified
• Project sponsor roles should be clearly defined
• Recognised project management structures should be in place
• Performance management systems should be set up.

For large or complex projects:

• Simpler alternatives should be developed wherever possible
• Consideration should be given to breaking down large, ambitious projects into smaller ones with more easily defined and achievable goals
• Knowledge transfer processes should be set up, so that changes in individual personnel do not disrupt the smooth implementation of a project.

How is Optimism Bias Carried out ?

The consideration of Optimism Bias in investment decisions is a Treasury requirement. Within the MOD this has been communicated through Finance Instruction 05/03. However, the requirement to address Optimism Bias does not easily sit with the MOD’s approach to Three-Point Estimating, and there is a risk of double counting.

The MOD approach to Optimism Bias is described in detail in JSP507 para 4.2.37. The approach is summarised below:

For all Category A, B and C projects, Optimism Bias should be treated as an independent “top down” assessment of risk, which is then compared with the existing detailed “bottom up” calculation using the recognised Three-Point Estimating approach.

For smaller Category D projects, the Optimism Bias adjustment may be used as a general risk adjustment, as an alternative to undertaking detailed Three-Point risk analysis.

Optimism Bias adjustments are calculated using reference data from JSP507. These are then applied to a Project's calculated single point deterministic estimate (no Risk, no Uncertainty) for both Time and Cost.

The resulting figure is then compared with the Project's calculated percentile Confidence figure estimates. Ideally the Optimism Bias adjusted figures should be "in the region of" the 50 percentile confidence figures for time and cost. A traffic light marking system has been developed to aid the comparison - see image below.

If the result is not "Green" the risk assessment undertaken to arrive at the percentile Confidence Figures and/or the Adjustment figures should be reviewed. Ideally 90% Confidence figures should exceed Optimism Bias adjusted estimates in order for them to be considered a valid 90% Confidence.

This approach should enable the Department to ensure and demonstrate that its use of Three-Point estimation and assessment of risk is robust. The process flow chart at below shows how this approach works in practice.

Commercial Project Enablement Team (CPET) will assist project teams in undertaking Optimism Bias assessments, and to determine the relationship between Optimism Bias adjusted estimates and the percentile Confidence Figures.

Further detailed advice and assistance on Optimism Bias can be obtained from CPET.

Comparison of Optimism Bias Adjusted Figures and Percentile Confidence Figures

Application of Optimism Bias

Notes:

• A Deterministic Estimate excludes any allowance for Uncertainty or Risk.
• The above process applies category A, B and C projects.
• Refer to CPET for detailed guidance.

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