A Guide to Developing Financial Plans and Performance Measures for Transportation Asset Management (2019)

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8 This chapter explores other activities and plans within a TAM program and how they relate to and are supported by the financial plan within an integrated TAMP. Specifically, important concepts and practices in objectives, performance measures, life cycle planning and cost analysis, and risk management are introduced and their respective implications on financial planning are discussed. 2.1 The Financial Context of Asset Management Introduction Faced with limited resources, transportation agencies must adhere to prudent financial manage- ment so that their highways, bridges, equipment, and other facilities can be maintained in the best possible condition, thereby delivering sustained performance and value to taxpayers. As depicted in Figure 2-1, asset management and financial management are linked, as an agency’s strategy for investing in its assets is necessarily related to the level of financial resources expected to be available and to the level of confidence that an agency’s financial projections provide. The converse is also true: Over time, good asset management will avoid costly highway and bridge reconstruction and equipment replacement, thereby maximizing resources available for investing elsewhere to maxi- mize the safe, efficient, and reliable movement of people, goods, and information. Federal requirements for asset management plans are detailed in 23 CFR Part 515. As described in Section 515.15(a) of the final rule on TAM, the federal share for National Highway Perfor- mance Program (NHPP) projects will be reduced to 65% each year that a state does not have an adequate TAMP. Additionally, as described in Section 515.15(b) of the final rule on TAM, FHWA will not approve any further projects using NHPP funds until an adequate TAMP is developed. This chapter is organized into three sections: Performance Measures and Gaps, Life-Cycle Planning and Analysis, and Risk Management. Performance measures help compare actual transportation infrastructure assets against an agency’s goals and objectives. Life-cycle planning and analysis help determine the most cost-effective ways to preserve infrastructure assets over the entire course of its useful life. Risk management involves the identification, assessment, and prioritization of uncertainty, followed by a coordinated and economical application of resources to minimize, monitor, and control their likelihood and impact. These topics are important com- ponents of a satisfactory asset management plan, and each should be developed in concert with an agency’s TAM financial plan. The three sections of this chapter are each organized into three subsections: 1. Key Concepts review important terms and relevant agency best practices in the process of developing a TAMP. C H A P T E R 2 Integrating Financial Plans into TAM

Integrating Financial Plans into TAM 9 2. TAMP Requirements discuss the various federal minimum requirements for what must be included in an agency’s TAMP. 3. Implications to Financial Plan Development highlight how an agency’s financial plans will inform—and be affected by—its asset management plan and program. The TAM professional must draw from bridge and pavement managers and other experts that are responsible for these important TAM elements at a transportation agency to write a comprehensive financial plan. Likewise, the TAM professional helps inform the performance measure development, life-cycle planning, and risk management by incorporating financial planning concepts. Throughout the Key Concepts and TAMP Requirements sections, relevant financial concepts are bolded and noted in the left margin with this dollar sign. Where applicable, graphics tie financial concepts and asset management concepts together. 2.2 Performance Measures and Gaps Key Concepts Objectives According to FHWA’s Transportation Performance Management (TPM) Guidebook, objec- tives are ways to communicate and support the desired outcomes of an agency. An objective is a specific, measurable statement that supports achievement of the goal. As illustrated in Fig- ure 2-2, an objective is “SMART” if it is specific, measurable, agreed-upon, realistic, and time- bound. As this acronym indicates, objectives should add specificity to goals. For example, a goal related to asset condition (e.g., preserve infrastructure assets) might be followed by an objective specific to a particular asset type such as pavement condition on Interstates. Objectives can also incorporate percentage targets, delivery dates, or deadlines. These work to provide further Figure 2-1. Integration of asset management and financial management. Figure 2-2. Elements of S.M.A.R.T. objectives (TPM Stake holder Group 2018).

10 A Guide to Developing Financial Plans and Performance Measures for Transportation Asset Management strategic direction for an agency and more directly lead to performance measure selection (TPM Stakeholder Group 2018). Discussion within the agency and with stakeholders should include consideration of the rela- tive priority of goals and objectives. Priorities may differ among individuals or groups; decision makers within the agency will need to reconcile these differences in order to prioritize spending and other resources. Desired characteristics of goals and objectives are suggested in Table 2-1. Performance Measures Performance measures enable agencies to quantify goals and objectives and communi- cate progress toward achieving those desired outcomes. The Performance-Based Planning and Programming Guidebook lists the following five roles of performance measures. Performance measures are used (Grant et al. 2013): • To clarify the definition of goals; • To monitor and track performance over time; • As a reference for target setting; • As a basis for supporting policy and investment decisions by comparing alternative options; and • To assess the effectiveness of projects and strategies. Performance measures are essential for supporting TPM and financial planning, but it can be a challenge for an agency to determine the exact set of measures to include in its TAMP. Beyond required bridge and pavement measures, an agency may need to include additional measures to characterize performance of other asset types and/or progress toward additional agency goals and objectives. For instance, if “reducing the number of load posted bridges” is an important objective, it may be valuable to include the number of load posted (weight restricted) bridges as a measure in an agency’s plan. The amount of funding necessary to reduce the number of load posted bridges to the targeted level is an important financial gap to communicate to decision makers, as is the expected benefit to commerce (in terms of time, fuel, and other logistics) from upgrading a load posted bridge to eliminate a weight restriction. It should be noted that a compact set of performance measures is preferable to a large list. With each additional measure an agency adds, more data and staff resources to collect and analyze those data may be required. In cases where there are multiple outcome measures for a single asset class, one may find a high degree of correlation between the different measures. Thus, it is important to try to avoid duplicative measures, limiting the set presented in a TAMP to the minimum needed to effectively communicate progress and establish agency targets. Performance measures should be selected with care because they influence what investment strategies are employed. For example, if an agency chooses to measure asset condition based Desired Characteristic Rationale/Purpose Measurable with available tools/data May require no additional cost for data collection Forecastable Enables data-driven target setting based on future conditions Clear to the public and lawmakers Allows performance story-telling to customers and policymakers Agency has influence over result Measures agency activities rather than impact of external factors Table 2-1. Desired characteristics of performance measures (TPM Stakeholder Group 2018).

Integrating Financial Plans into TAM 11 on age, strategies will focus on repairing or replacing the oldest assets rather than those most in need of attention. If age and condition are not strongly correlated, the age-based performance measure will indicate progress toward asset maintenance while the overall asset condition is not actually improving. Because measures are selected to indicate progress toward meeting goals, selecting the wrong measure can push agencies toward simply moving the needle of a measure rather than achieving a goal. To assist with selecting performance measures, some agencies create a logic map, as in Figure 2-3. This can help make the connection between performance measures, objectives, and goals to ensure measures are indeed indicating progress toward desired performance outcomes. Output measures assess the agency level of activity (e.g., miles of pavement resurfaced) and are useful for determining how efficient the agency’s budget has been used. Outcome measures assess effectiveness of an activity. Rather than measure tons of salt applied (an output measure), an agency can measure number of ice-related crashes to understand how salt application may have impacted safety. Targets Targets are established to clearly state what performance the agency hopes to achieve. Using selected performance measures, an agency should determine what level of perfor- mance is desired in quantifiable terms. Targets are “specific numerical figures associated with the performance measure in order to provide direction to performance tracking” and indicate the “[l]evel of performance that is desired to be achieved within a specific time frame.”(Grant et al. 2013). The TPM Guidebook describes the role of targets within a transportation performance man- agement practice: Targets are used to assess progress toward achieving strategic goals, guide planning efforts, inform programmatic decisions and adjustments, and communicate with the public and other stakeholders. Targets make the link between investment decisions and performance expectations transparent for all stakeholders.(TPM Stakeholder Group 2018) NCHRP Report 551: Performance Measures and Targets for Transportation Asset Management provides additional detail on approaches to selecting performance measures and establishing targets specifically related to TAM (Cambridge Systematics Inc. et al. 2013). Looking forward in a 10-year financial plan, agencies must understand how expected funding and staffing may impact performance in various areas. Targets should always be based on data. Baseline data indicates the current level of performance, while historical data indicates performance trends. In addition, agencies should attempt to identify and understand as many influencing factors (e.g., forecasted economic growth, policy change, etc.) as possible. Figure 2-3. Example logic map for development of performance measures.

12 A Guide to Developing Financial Plans and Performance Measures for Transportation Asset Management TAMP Requirements Performance measures and gap analyses are essential components of the asset management plans required for NHS highways under 23 U.S.C. 119 (e). Section 119 requires a performance- driven plan that, at minimum, includes strategies leading to achievement of state targets for asset condition and performance of the NHS as well as supporting the achievement of national goals. These national goals include the following: • Safety. To achieve a significant reduction in traffic fatalities and serious injuries on all public roads. • Infrastructure asset condition. To maintain the highway infrastructure asset system in a state of good repair. • Congestion reduction. To achieve a significant reduction in congestion on the NHS. • System reliability. To improve the efficiency of the surface transportation system. • Freight movement and economic vitality. To improve the National Highway Freight Network, strengthen the ability of rural communities to access national and international trade markets, and support regional economic development. • Environmental sustainability. To enhance the performance of the transportation system while protecting and enhancing the natural environment. • Reduced project delivery delays. To reduce project costs, promote jobs and the economy, and expedite the movement of people and goods by accelerating project completion through elim- inating delays in the project development and delivery process, including reducing regulatory burdens and improving agencies’ work practices. Section 150 requires state DOTs to measure the condition and performance of the Interstate highways and non-Interstate NHS highways. Beyond those required by federal law and regulation, it is suggested that additional state DOT performance targets be incorporated in the plan given: • Performance targeting requirements specify a 2- and 4-year horizon while the asset manage- ment plan has a 10-year horizon; and • 2- and 4-year targets are fiscally constrained. By contrast, in the asset management plan the state DOT needs to determine targets that correspond to the agency’s goals and objectives as well as those that support national performance management measures specified in 23 CFR Part 490 Subparts C & D. These may very well be different from the 2- and 4-year targets. The TAM professional will identify deficiencies hindering progress toward improving or pre- serving the NHS and achieving and sustaining the desired state of good repair. The process should address state DOT performance targets, gaps in performance of the NHS, and alternative strategies to close or address the identified gaps. Note: Federal TAMP requirements do not include explicit financial performance measures. However, the financial plan will help inform decision makers and stakeholders of the funding components of existing performance gaps and fiscally feasible methods to address those gaps. Implications for Financial Plan Development The private sector thrives on financial metrics: operating margins, debt coverage ratios, and many more. Financial metrics are less common in public-sector organizations but may still prove useful, particularly for agencies with tolling authorities or other fee-for-service business units. The following are basic financial measures that help summarize the predicted perfor- mance of a set of assets based on an agency’s TAM financial plan. These include calculating per- formance gaps, calculating the measure termed the “asset sustainability index,” and calculating the measure “asset consumption ratio.”

Integrating Financial Plans into TAM 13 Performance Gap Measurement Once performance measures are established for an agency, it can be a valuable exercise to set target levels of performance and/or measure the gap in predicted and desired performance. A gap assessment is a required component of a TAMP prepared in compliance with 23 CFR Part 515. Specifically, the TAMP should document the gap between current and expected performance and an agency’s “desired state of good repair.” Reporting this performance gap provides a means for relating details on asset conditions to required levels of spending. Figure 2-4 shows the Colorado DOT’s (CDOT’s) graphical representation of a performance gap in its 2016 Transportation Deficit Report (CDOT 2016b). Colorado has adopted a target that no more than 10% of bridge decks on state highways be rated structurally deficient. This target is one that the department expects to achieve given available funding, and that has in fact been achieved. In addition to setting this target, the department has identified additional targets for improvements in other measures related to the following: • Bridges over Interstates, U.S. routes and Colorado state highways with substandard vertical clearance; • Bridges that are load restricted; • Percentage of bridges that are load posted; • Percentage of bridges over waterways that are scour-critical; • Percentage of bridges with leaking expansion joints; and • Percentage of bridges with unsealed or otherwise unprotected deck area. CDOT articulates both fiscally constrained and desired (or “aspirational”) targets for these measures, and quantifies the funds necessary to achieve both. While the department expects to be allocated resources sufficient to achieve improvements over the current condition of each of these measures, the annual gap between the present funding and that which would achieve the DOT’s aspirational vision is significant. Figure 2-4. Colorado Transportation Deficit Report showing performance gap (CDOT 2016b).

14 A Guide to Developing Financial Plans and Performance Measures for Transportation Asset Management Note that this practice example predates current TAMP and performance management require- ments developed by FHWA. As noted above, performance targets developed for federal reporting under 23 CFR Part 490 are always fiscally constrained. Thus, there may be a gap between an agen- cy’s fiscally constrained performance targets and its “desired state of good repair” described in its TAMP depending on the approach used by the agency to define its desired state of good repair. Asset Sustainability Index (ASI) The ASI has been proposed by FHWA as a way to measure needs against available resources (Certified Financial Planner Board of Standards, Inc. 2003). It is defined as the ratio of the amount budgeted for highway infrastructure assets renewal and preservation divided by the amount needed to adequately sustain infrastructure assets at a targeted condition over the long term, as shown in the equation 2-1. If the ASI value is less than one, assets are being underfunded. Amount Budgeted Amount Needed Asset Sustainability Index Equation 2-1 Asset Sustainability Index Formula = This index can be broken down into component parts to isolate pavement, bridge, maintenance, or other sustainability ratios. While the amount budgeted is a straightforward number to deter- mine, identifying the amount needed to sustain infrastructure assets can be a challenge that involves forecasting and estimating. In general, when calculating the sustaining amount needed, agencies should use life-cycle cost based on credible asset inventories, with a direct focus on asset condi- tion. Asset expansion and hard-to-estimate assets should be excluded from this index calculation. FHWA suggests pairing the ASI with estimates of asset valuation to “quickly illustrate whether current investment is adequate to sustain conditions, the magnitude of any shortfall, and the investment level’s effect upon the public’s equity in its highway infrastructure” (Proctor et al. 2012). Asset valuation assigns a monetary value to infrastructure assets and is addressed in further detail in the Asset Valuation chapter of this guide. Asset Consumption Ratio (ACR) As ASI demonstrates, performance measures can be a useful means to report the state of health of an asset to decision makers and support financial decision making for financial plans. As with pavement and structure condition, asset valuation can support a series of performance measures. This can be used to demonstrate the impact on the asset value of investment deci- sions. For example, the ACR is the current or depreciated value of infrastructure assets divided by the gross current replacement cost of infrastructure assets. It may be modified based on historical costs and is expressed as a percentage. In Australia, the ACR has been used for asset valuation to demonstrate the impact of asset depreciation to asset managers and senior decision makers. =Asset Consumption Ratio Current Value of Asset Replacement Cost of Asset Equation 2-2 Asset Consumption Ratio 2.3 Life-Cycle Planning Key Concepts Consideration of asset life-cycle costs—the series of costs incurred to procure or construct an asset, and then maintain the asset over its life cycle—is central to asset management. Addressing the various impacts on those costs and demonstrating that an agency is managing

Integrating Financial Plans into TAM 15 its assets cost-effectively is central to financial planning. The motivation for considering life- cycle costs is simple: transportation assets are long-lived and require significant expenditures of public funds over time. In making decisions about investments in existing assets, it is impor- tant to consider the stream of costs incurred over time as an investment strategy that yields the lowest total cost over time (that is, the lowest practicable life-cycle cost) may be different from the strategy that reduces costs the most in the short term. The underlying concept behind life-cycle planning is the same as that behind changing the oil in a car or replacing a leaking roof on a house. An asset owner needs to make timely invest- ments in an asset to keep it in good repair and reduce the likelihood of having to make more costly repairs later. While foregoing the cost of an oil change today may benefit today’s budget, it represents poor financial planning because of the inevitable and significant cost that decision would yield. Figure 2-5 uses data from the Texas DOT to illustrate this point (Rhode Island DOT 2014). This figure shows costs incurred over time for a 10-mile highway segment using two different investment strategies. In the top panel, repeated repairs are performed over time. The highway is kept in good condition, and the 40-year total cost is $799 million. In the lower panel, work is performed more infrequently. This reduces costs in the short term, but costs more in the long term and results in worse average condition. Customers also have to endure a lower average service and, likely, safety level. In the example reactive maintenance approach, preservation treatments shown in grey are eschewed, and the highway is reconstructed when it reaches an unacceptable condition. This results in a total reconstruction cost of $959 million, an increase of $160 million over a 40-year period. In highway design, best practices are well established for using life-cycle cost analysis (LCCA) to compare different design alternatives for pavement and bridges. The FHWA Life Cycle Cost Analysis Primer summarizes recommended LCCA practices (FHWA 2002). It is important to note that while LCCA approaches are well established, they are typically intended for applica- tion at a project level only once a substantial amount of detail has been established regarding a project. Practicing effective asset management requires considering life-cycle costs pro- grammatically, using life-cycle cost concepts to establish budget levels and predict future per- formance and funding needs before project plans are established. Applying the concepts at a program level typically involves specifying an idealized policy describing what work should be performed on a typical asset over time and/or as a function of condition. Asset management systems then use this information to simulate the conditions that will result from a given set of life-cycle policies and, in some cases, to make initial project recommendations. Those systems often work in concert with budget forecasts to select optimal life-cycle strategies at various funding levels. Understanding life-cycle cost concepts can therefore bolster a discussion of investment strategies. Section 6.2 of the AASHTO Transportation Asset Management Guide, Volume 2 (AECOM et al. 2011) describes how to apply life-cycle cost concepts programmatically as part of an asset management approach. Figure 2-6, reproduced from the AASHTO Transportation Asset Management Guide, depicts a typical asset life cycle consisting of four basic phases: create, maintain, renew, and dispose. Within each of these phases an asset owner may need to evaluate different functions of the asset and determine what actions to perform so that the asset best serves its intended function. Within the planning phase, the asset owner and others better understand the financial needs—constrained or unconstrained—of the program. Of particu- lar importance for asset management is determining how best to preserve an asset during the “maintain” phase. This entails evaluating how the asset deteriorates over time, different potential treatments, and their effects. At a minimum, treatments considered for an asset typically include some form of preventive or routine maintenance, rehabilitation in which comprehensive repairs

16 A Guide to Developing Financial Plans and Performance Measures for Transportation Asset Management Figure 2-5. Example of life cycle cost calculations. are undertaken to restore asset condition, and asset replacement. Figure 2-7, also reproduced from the AASHTO Transportation Asset Management Guide, illustrates the basic process for establishing treatment options. Readers seeking further information on this topic are encouraged to review Volume II of the AASHTO Transportation Asset Management Guide (AECOM et al. 2011). The Guide includes a comprehensive discussion of the full set of tools and techniques involved in asset life-cycle plan- ning, detailing common approaches, including several case studies illustrating the development and application of asset life-cycle strategies.

Integrating Financial Plans into TAM 17 TAMP Requirements FHWA requirements for state DOT TAMP development are detailed in 23 CFR. 515. Sec- tion 515.5 defines life-cycle planning as “. . . a process to estimate the cost of managing an asset class, or asset subgroup over its whole life with consideration for minimizing cost while preserving or improving the condition.” Section 515.7 requires states to use a process for life-cycle planning when developing their TAMPs. The process should include the following: • State DOT targets for asset condition for each asset class or asset subgroup; • Identification of deterioration models for each asset class or asset subgroup (optional for assets other than NHS pavements and bridges); • Potential work types across the whole life of each asset class or asset subgroup with their relative unit cost; and Figure 2-6. Asset life cycle (AECOM et al. 2011). Figure 2-7. Generating asset treatment options (AECOM et al. 2011).

18 A Guide to Developing Financial Plans and Performance Measures for Transportation Asset Management • A strategy for managing each asset class or asset subgroup by minimizing its life-cycle costs, while achieving the state DOT targets for asset condition for NHS pavements and bridges under 23 U.S.C. 150(d). Discussion of life-cycle planning is a required element of a state’s TAMP. To support devel- opment of their TAMPs, states are required to use bridge and pavement management systems. Concerning NHS pavement and bridge assets, 25 CFR 515.13 describes that at a minimum these systems should include documented procedures for the following: • Collecting, processing, storing, and updating inventory and condition data; • Forecasting deterioration; • Determining the benefit–cost over the life cycle of assets to evaluate alternative actions (including no-action decisions) for managing condition; • Identifying short- and long-term budget needs for managing condition; • Determining the strategies for identifying potential projects that maximize overall program benefits within the financial constraints; and • Recommending programs and implementation schedules to manage condition within policy and budget constraints. Implications for Financial Plan Development Developing asset-level life-cycle plans requires specialized knowledge of topics, such as fea- sible asset treatments, treatment costs, and deterioration patterns. In many state DOTs separate staff members develop life-cycle policies for each asset class, and the process of developing asset life-cycle plans is generally distinct from financial planning. At the same time, however, the financial plan developed for a state DOT’s TAMP needs to incorporate the results of this life- cycle planning. Therefore, knowledge of the process and assumptions behind life-cycle planning can be of great assistance in all facets of TAMP development. Staff responsible for developing the TAM financial plan should familiarize themselves with their agency’s life-cycle planning process, especially given the following implications of FHWA requirements for life-cycle planning on financial plan development. Consideration of asset life-cycle plans helps provide a long-term view that greatly assists in formulating FHWA-required 10-year financial plans. TAMPs are required to cover a 10-year period. STIPs cover a period of at least 4 years, and the performance targeting requirements initiated by 23 U.S.C 150 are for periods of 2 and 4 years. However, pavement assets may last 20 years or more before requiring extensive rehabilitation or reconstruction, and structures are typically designed with a life of 75 to 100 years. Given the long asset life cycle, the consequences of a demonstrably suboptimal policy (e.g., deferring needed asset maintenance) may take years or decades to become apparent to the public. The requirement to develop a life-cycle planning process supports decision making considering long-term impacts and guards against the ten- dency to maximize short-term returns while compounding long-term problems. The basic life-cycle strategy defined for a given asset class is an input to financial plan develop- ment, not an outcome. The requirements specify that an asset owner needs to define an effective life-cycle strategy considering costs of the asset over time, as well as an agency’s asset condition targets. This strategy will ideally be determined independently from developing a financial plan, that is, the life-cycle plan should specify how assets should best be managed over time, barring consideration of specific financial constraints. Performance targets help integrate life-cycle and financial planning. While the financial plan should not directly impact asset life-cycle strategies, there is an indirect link. Performance tar- gets are an input to life-cycle planning. These targets need to be set considering a broad range of factors, including agency and national objectives and available funding levels. In other words,

Integrating Financial Plans into TAM 19 overall funding levels established through the financial planning process may impact an agency’s asset condition targets and approach to managing its assets. Documented procedures are required for life-cycle planning, and these should be available for supporting development of the financial plan. The analyses used to develop the life-cycle strategy can and should be used to test different scenarios in developing the financial plan. This includes approaches for predicting future deterioration, projecting conditions, and prioritizing available funds for a given asset class by type of work. For example, Table 2-2 shows a life-cycle cost minimizing policy generated by a bridge management system. The policy illustrates recom- mended treatments for given bridge elements depending on the element’s condition, the treat- ment unit cost, and the savings in life-cycle costs projected after treatment relative to deferring action (assuming the specified treatment is taken). The policy shown in this example illustrates both the determination of the most effective treatment and the use of life-cycle costs. By design, asset-level life-cycle analysis overlooks many factors and constraints that must be incorporated when developing a financial plan. The most fundamental of these is the budget constraint. Despite an asset owner’s best intentions, the funds required to implement the life- cycle plans proposed for each asset may simply not be available. The difference between needed and available funds must be reconciled when developing the financial plan. Another issue is that the optimal strategy recommended for any one element or asset in isolation may turn out to be suboptimal once all assets are considered together, including geographical and logistical constraints. It is thus necessary to impose a “reality check” when developing the financial plan to verify that the plan is reasonable and achievable, taking the full set of factors into consideration. Another difficult but important issue that typically needs to be introduced in the financial plan is project timing. In addition, the gaps between obligating funds, performing work, and observing the effects of work on asset conditions need to be considered. Asset life-cycle planning is an essential ingredient, but not a substitute, for developing an effective financial plan. An asset owner needs to understand how an asset should be maintained over its life cycle. The life-cycle plan quantifies this understanding, but leaves several other Condition State Action Unit Cost ($, m) Recommended Treatment? Unit Benefit ($, m) 1—Good Do Nothing 0.00 Yes 0.00 2—Fair Do Nothing 0.00 No N/A Repair 142.20 Yes 19.64 3—Poor Do Nothing 0.00 No N/A Repair 428.18 Yes 126.11 4—Severe Do Nothing 0.00 No N/A Rehabilitate 1,947.32 Yes 71.43 Replace 4,822.75 No N/A Table 2-2. Bridge element life cycle policy example.

20 A Guide to Developing Financial Plans and Performance Measures for Transportation Asset Management critical issues to be resolved in the development of the financial plan. These critical issues rep- resent potential risks to the agency. The next section discusses how these risks can be managed proactively over the life of the asset to ensure a sustainable infrastructure. 2.4 Risk Management Key Concepts Risk management provides a set of tools agencies can use to better address uncertainty and ultimately develop better and more informed plans. It converts “unknown unknowns” into “known unknowns,” and determines how best to address the effects of the “known unknowns” an organization may encounter. Applied to TAM, 23 C.F.R. 515.5 defines risk as “the positive or negative effects of uncertainty or variability upon agency objectives” and risk management as “the processes and framework for managing potential risks, including identifying, analyzing, evaluating, and addressing the risks to assets and system performance.” Risk management is a key ingredient in asset management planning for two basic reasons: (1) there is great uncertainty about the future and (2) recent history suggests that this uncer- tainty will impact future plans, programs, projects, and budgets. For instance, catastrophic events such as Sandy in 2012 and the 2013 Colorado Front Range Flood had significant negative impacts on the transportation infrastructure assets of the Atlantic Coast and state of Colorado, respectively. Less dramatically, but more frequently, many agencies have undergone periods in which they have had to significantly reshape their plans due to unplanned events such as loss of tax revenue or cost overruns on large projects. Examples of risk categories to include in such plans are shown in Table 2-3. The process of risk management starts with identifying the types of risks an agency faces. Enterprise- or agency-level risks, program risks, and project or activity risks are the common types of risks included in transportation agencies’ risk-management efforts (Proctor and Varma 2012). Figure 2-8, reproduced from this document, discusses these different levels of risk. As transportation infrastructure assets are costly to build, operate, and maintain, and as the economy and citizens’ quality of life are greatly dependent on its reliable performance, prudent asset management is critical to minimizing large and challenging financial risks. It is incumbent on the TAM professional to understand the nature and scope of the types of risks discussed below. Furthermore, TAM professionals should understand their agency’s sensitivity to other types of finance-related risk, such as construction cost inflation that erodes an agency’s purchasing power or other economic factors to which the agency’s revenue and expenditures are exposed. Adapting concepts from International Standards Organization (ISO) Standard 31000 on risk management, Proctor and Varma (2012) describe that risk management in the context of a transportation agency’s functions involves the following basic steps: • Establishing the Context: Review the organization’s mission, operating environment, and tolerance for risk. • Risk Identification: Develop the list of potential risks. • Risk Analysis: Identify root causes of each identified risk, their effects, and their likelihood. • Risk Evaluation: Prioritize risks based on effects and likelihood. • Risk Management: Treat or respond to risks once these have been identified. For an agency’s most significant risks it is often necessary to modify existing processes to specifically acknowledge and manage the risk and/or develop a target program with the goal of addressing a given type of risk. These can be considered “programmatic risks” and an agency’s existing business processes will typically address them.

Category Description Finances Risks to the long-term financial stability of the asset management program, including: Unmet needs in long-term budgets Funding stability Exposure to financial losses Information and Decision Making Risks related to the asset management program include: Lack of critical asset information Quality of data, modeling, or forecasting tools for decision making Security of information systems Business Operations Risks due to internal business functions associated with asset management programs, such as: Employee safety and health Inventory control Purchasing and contracting Asset Performance Risks associated with asset failure (whether acute, complete, or incremental). Areas of failure can include: Structural Capacity or utilization Reliability or performance Obsolescence Maintenance or operation Safety Risks to highway safety related to the asset management program: Highway crash rates, factors, and countermeasures Safety performance of assets, maintenance, and rehabilitation treatment options Safety in project selection, coordination, and delivery External Threats External threats include both human-induced and naturally occurring threats, such as: Change in national-, state-, or agency-level leadership Catastrophic events (e.g., extreme weather, flooding, earthquakes, slope failures and rock falls, lightning strikes) Climate change Terrorism or accidents Table 2-3. Risk categories. Figure 2-8. Levels of risk in an agency (Proctor and Varma 2012).

22 A Guide to Developing Financial Plans and Performance Measures for Transportation Asset Management From a financial perspective, project-level cost and schedule overruns are an impor- tant and common type of risk, and many agencies have well-developed business processes specifically for identifying and mitigating these risks. Many asset-specific risks can be mitigated in part using an agency’s asset management sys- tems. For example, in the case of accelerated pavement deterioration, good risk-management practice would include developing alternative scenarios using varying deterioration assumptions and treatment strategies. Other risks may not be addressed through existing processes; these are the “unknown unknowns” that merit further attention. Various risks of system failure often fall into this category. NCHRP Report 632: An Asset-Management Framework for the Interstate Highway System (Cambridge Systematics Inc. et al. 2009) describes a risk assessment approach specifically tailored to analysis of system failure risks not otherwise addressed programmatically. This approach, though developed for the Interstate Highway System rather than the NHS, is consistent with that required by FHWA for the NHS. A common device for supporting a systematic approach toward financial and other risks is a risk register, which helps identify the risks that require the most immediate attention. The document groups a wide range of identified risks into basic categories and provides summary information on each, such as a qualitative assessment of risk likelihood and consequence across the agency’s programs and projects. Information on available funding sources and uses can serve as an important input to the risk-management process. Figure 2-9 shows a risk register developed by CDOT and is included in that agency’s TAMP. In this example, the first three risks and five of the 11 in total relate to funding risks. The risk-management process results in a set of prioritized risk response strategies that are then incorporated into the agency’s TAMP. Priorities may include specific projects and/or changes Figure 2-9. Colorado DOT risk register (Cambridge Systematics Inc. and Redd 2013).

Integrating Financial Plans into TAM 23 to agency business processes to handle additional types of risks programmatically. Identifying the specific mitigation approaches to implement is a key consideration as these priorities and approaches may drive scenarios in a financial plan. TAMP Requirements 23 C.F.R. 515.7 requires a risk-management discussion be included in a state’s TAMP. This discussion should include: • Identification of risks that can affect condition of NHS pavements and bridges and the perfor- mance of the NHS, including risks associated with current and future environmental condi- tions such as extreme weather events, climate change, and seismic activity; • Evaluation of risks related to recurring damage and costs as identified through the evaluation of facilities repeatedly damaged by emergency events (addressed in 23 C.F.R. 667), and alter- natives to mitigate or resolve their root causes; • An assessment of the identified risks in terms of the likelihood of their occurrence and their impact and consequence if they do occur; • An evaluation and prioritization of the identified risks; • A mitigation plan for addressing the top priority risks; • An approach for monitoring the top priority risks; and • A summary of the evaluations of facilities repeatedly damaged by emergency events that dis- cusses, at a minimum, the evaluations relating to the state’s NHS pavements and bridges. Implications for Financial Plan Development Developing a risk-management plan is a separate activity from developing a financial plan and is likely to involve a broad range of staff from multiple business units. The financial plan developed for a state DOT’s TAMP must incorporate risk-management plan outcomes. Thus, as in the case of life-cycle planning, staff responsible for developing the TAM financial plan should familiarize themselves with their agency’s risk-management planning process. Funding for risk mitigation may overlap with funding for other activities and thus is difficult to itemize in a financial plan. Many risks are mitigated through changes to business processes or through existing programs and their budgets. The funds required for such actions would pre- sumably appear under some other use. Thus, one should not expect all risk mitigation actions to be clearly budgeted in a financial plan. The financial plan should identify any funds specifically set aside for implementing the priori- ties identified in the risk-management plan. Priorities that require funds should be shown as uses of funds in the plan. In these cases funds for addressing the risk may be presented either as a por- tion of an existing program or a separate program. As an example, in its TAMP Caltrans describes seismic risk as a critical concern for California’s bridges. Capital funding for seismic retrofits of existing bridges are budgeted in the state’s Seismic Safety Retrofit Program (Caltrans 2018). Though not specifically required by FHWA for TAMP, one prudent approach to addressing uncertainty in the financial plan is to budget for response to unplanned events. Contingency funding can occur at multiple levels—agency/enterprise (e.g., a separate budget line item or a conservative forecasting of revenues), program level (e.g., programming less work than sup- ported by the budget to allow for overruns), or project level (e.g., 10% project budget set aside for unforeseen contingencies). The TAM professional may wish to be involved in assessment of an agency’s enterprise-wide risks, including its financial risks. In building the risk-based TAMP, these discussions will help

24 A Guide to Developing Financial Plans and Performance Measures for Transportation Asset Management inform scenario planning, assessing the likelihood of budget cuts or revenue increases. Further, those involved with asset management should work together to help quantify the consequences of failure or reduced performance of assets. Referencing the FHWA’s risk “heat” map in Figure 2-10, the author of the financial plan should also understand the relative measurement of consequence. How consequence is defined will help determine the extent to which the financial plan must speak to and plan for uncertainty. For example, that “Severe” may be defined as damage to assets totaling $1 million or as loss of $250 million in revenue annually informs what the financial plan may need to entail. Finally, without careful coordination and consistent application, contingency planning across multiple levels of budgeting and programming can cause agencies to be overly conservative. Just as overly aggressive budgeting can cause problems, overly conservative assumptions about revenues, cost factors, and project set-asides can cause agencies to under-invest in their systems, leaving important needs unmet for longer than actually necessary. When running scenarios as part of developing the financial plan’s investment strategies, the TAM professional should encourage optimistic funding scenarios as strongly as pessimistic scenarios. 2.5 From Asset Management into Financial Planning This chapter discusses key components of TAM related to development of a financial plan. The next four chapters walk the reader through the steps of building a financial plan. While the process of building the plan can stand alone and be completed by a few key individuals in the agency, it is best conducted within the broader context of asset management and with the assis- tance of those who understand performance measurement, life-cycle planning, and risk man- agement, as well as related topics such as asset data collection and analysis. And while the reader may skip to one chapter to help strengthen his or her existing financial plan, those developing their first plan will find each chapter building on the next with increasing degrees of complexity. Figure 2-10. Risk shown as a function of consequence and likelihood (ASAM et al. 2015).