The continuous strengthening of risk management is a key element of Skanska's business plan for profitable growth. The aim is to identify, prevent and manage risks – not to avoid all risks.
Skanska operates in a changing world, as its operations develop and grow. Consequently, the work with risk management must be developed on a continuous basis. In 2012, a specialized unit, Skanska Risk Team, was reinforced and now comprises ten employees with a combined total of 160 years of experience in Skanska's operations. Risk management has been intensified and expanded in local units, partly through continuous support from the Skanska Risk Team and partly through the highlighting of risk-management responsibilities in local units. These measures generally mean that the analysis of risks and opportunities prior to and during each project are an integrated component in the processes of all units. Systematic risk management was introduced in 1999 and the operating margin in construction has since improved.
The risk profile of the construction and project development business differs from other industries. There is less tied up capital, order backlogs are longer, fixed costs are lower, operating margins are lower and the risks primarily exist in the thousands of projects that are executed every year. All projects can be described as unique in some regard, such as in their formulation, function or location. Risks originate in the low degree of automation in construction activities and depend heavily on the skills and engagement of employees. However, the trend is towards more standardization and industrialization that enable greater volume purchasing, which requires that Skanska focus on the monitoring and technical analysis of materials purchased in order to prevent errors recurring. Even changed market conditions where, for example, customers strive to minimize their risks by transferring them to contractors results in adaptation of the risk management work.
The percentage-of-completion method means that earnings are recognized as costs are accrued. A loss-making project that previously reported a profit must expense all previously recognized profit together with the entire estimated loss. If no further changes occur, the project will then recognize zero gross income during the remainder of the construction period.
In a number of the markets where Skanska operates, seasonal variations due to weather constitute a risk that must be managed with regard to the allocation of revenue and earnings in relation to expenses that are relatively constant over the year. This is especially true during cold winters, when civil construction work cannot be performed. These projects generally have a somewhat higher operating margin.
Risk management focuses on identifying, preventing, managing and minimizing the risks of individual projects. Approximately 30,000 potential projects are analyzed each year, and a correct assessment lays the foundation for winning bids and positive end results. The Senior Executive Team (SET) handles strategic, financial and legal risks with the support of Group functions. However, risk analyses are mostly performed by the respective business units. The analysis work utilizes a number of variables or matrices that are refined and systematized over time in order to achieve Group-wide uniformity and reliability in risk management. To proceed to the tender phase, a project must be checked in relation to the Skanska Heat Map – an identification of core competence in the various units. This analysis determines whether the unit has the correct workforce and knowledge of the local market and whether the contract form and customer profile provide the prerequisites for a positive end result. The Skanska Heat Map is revised annually. Risk management is currently being further developed in two areas: the application of processes throughout a project's life cycle and their local application in the business units' regional operations. The life-cycle perspective means that projects are followed-up on and repeatedly supported throughout the duration of the project, from tender to commencement of construction, execution and final delivery. This ensures the continuous sharing of best practices and risk-analysis training.
Risk management in Construction
The Skanska Tender Approval Procedure (STAP) and Skanska SET Tender Board (STB) process approximately 500 tender proposals per year based on their size. Supplementary information is provided for some projects before they proceed to the tender phase. In 2012, 4 percent of the proposals did not proceed to the tender phase. Risk management procedures were expanded in 2012, concerning threshold values and the number of checkpoints for residential projects, renovation projects, long-term service contracts, energy-guarantee actions and issues concerning responsibilities following project completion. The review of conceivable tenders also highlights the new or extended opportunities of a potential tender – whether Skanska can strengthen its competitiveness or profitability by offering extended and/or improved services.
Risk management in project development operations
There are additional dimensions to the analysis of risks in project development operations, since Skanska's role is also that of a property developer in these situations. Project planning includes analyzing macroeconomic factors and risks in connection with investment, leasing and divestment. Four new checkpoints were introduced in Residential Development operations for the approval of land purchases, concepts, pre-sales and construction starts. In Residential and Commercial Property Development, capital exposure is limited to a maximum amount. Reaching maximum capital exposure will mean that Skanska may not start up any new projects until room for this has been created by selling homes that are under construction or finished or by leasing or selling commercial space in projects under construction or finished. Capital exposure equals the estimated cost of completion for all unsold homes or unleased commercial space, in previously completed and ongoing projects. Investments in new projects are adapted to any sharp economic fluctuations or a major downturn in demand that may occur. In Infrastructure Development, Skanska conducts an annual appraisal of the project portfolio. Estimated future cash flows are discounted at an interest rate equivalent to a required return on equity. This return is based on country risk, risk model and project phase for the various projects. The appraisal is not performed primarily to determine the specific value of investments in the project portfolio. The appraisal is intended to provide, through the use of consistent methodology, an indication of changes in underlying values arising from active management or factors beyond the Group's control, while clarifying the impact of transactions carried out during the period.
The Skanska Financial Services support unit evaluates financial risks, such as credit risks, payment flows, customers, subcontractors and joint venture partners. Skanska regularly follows up its risk assessment for all major projects implemented over an extended period. The SET and Board of Directors also perform quarterly reviews of major projects, altogether equivalent to about one-third of the total contract value of ongoing projects. Foreign-exchange risks Project revenue and costs are normally denominated in the same currency, thus limiting the transaction risks in exchanges between different currencies. Known and budgeted financial flows with currency exposure are hedged. The foreign-exchange risk that arises because portions of the Group's equity are invested long-term in foreign subsidiaries is partly hedged.
Interest-rate risk is the impact on earnings arising from a change in interest rates. Interest-bearing liabilities currently exceed interest-bearing assets, which means that net financial items are adversely impacted by an interest-rate hike. At year-end 2012, the average fixed interest period for interest-bearing assets totaling SEK 13.2 billion was 0.2 (0.3) years and for interest bearing liabilities, excluding pension liabilities, totaling SEK 11.0 billion, the period was 1.3 (0.6) years, taking derivatives into account.
Refinancing risk and cash flow
Refinancing risk refers to the risk arising from lack of liquidity or from difficulties in obtaining or rolling over external loans. At year-end 2012, the Group's unutilized credit facilities totaled SEK 5.7 (7.1) billion. The average maturity of the borrowing portfolio, including the maturity of unutilized credits, was 3.3 (2.4) years.
Management of pension obligations
Skanska has net pension obligations totaling SEK 3.6 billion. These obligations mainly comprise defined-benefit pension plans in Sweden, Norway and the United Kingdom. Provisions totaling SEK 12.0 billion have been made to pension funds in order to guarantee this obligation. Changes in the size of the pension obligation or the pension fund assets under management have a net effect on pension liability. This net effect increases or decreases the equity of the Group.