A Review of Management Reserves in U.S. Government Construction Cost Estimation

While there is some agreement on estimating construction cost contingency for “known unknowns,” there is little consensus on management reserves for “unknown unknowns.” Also, definitions of risk and uncertainty differ between the economics and finance literature and the cost engineering literature. This paper examines how cost engineering guidance on estimating management reserves is interpreted in government-sponsored project cost estimates. This lack of consensus is evident in a specific program: managing, treating, and disposing of 212,000 cubic meters of mixed radioactive and hazardous chemical waste generated by plutonium production at the Hanford Site. Over $30 billion has been invested in treatment facilities, vitrification plants, and laboratories analyzing gases, liquids, sludges, and salt cake from 177 aging storage tanks. The remaining construction and operating costs are highly uncertain, with estimates ranging from $300 billion to $640 billion. Analyses of alternatives for constructing Hanford waste treatment facilities assume 15% contingencies and 40% management reserves. A method is presented to compute the implicit moments of Extreme Value distributions of cost estimates for different options, helping determine whether one alternative’s cost estimate stochastically dominates others. Adopting industry definitions of contingency and management reserves by government agencies could improve construction cost estimation in government-financed programs.