2005/06 revenue budget: Supplementary report

Report: 7
Date: 16 December 2004
By: Treasurer and Commissioner

Summary

This supplementary paper reports the outcome of discussions with the Mayor. It also seeks approval to a revised policy in respect of the pensions reserve. The report also updates the medium term financial forecasts and presents the Treasurer’s advice on the robustness of the estimates.

A. Recommendation

Members are recommended:

1. to approve the final budget submission as summarised at paragraph 10;
2. to agree the revised policy in relation to the pensions reserve as set out in Appendix 1.
3. to note that future financial plans will be considered in the context of a review of the service which will be conducted in 2005.

B. Supporting information

Consultation by Mayor

1. The Mayor’s letter consulting on his proposed component budget for statutory consultation was circulated with the main report to the Authority. A meeting was held on 9 December between the Mayor and the Chair of the Authority to discuss the issues raised in the letter.

2. It was agreed that the provision for an Olympics planning team (£0.763 million) would be deleted from the budget on the understanding that this would be funded from the Olympic support budget if the Olympic bid is successful.

3. The Mayor had requested a further reduction of £10 million and it was agreed that this could be achieved by a transfer from the pensions reserve.

Pension reserve

4. The potential for reducing the size of the pension reserve has been reported to members previously and the position was explained fully in the original budget submission considered by the Authority in October. This arises from the planned change in the financing arrangements for police pensions from April 2006.

5. It was not possible to reach final conclusions without an indication of the immediate financial impact of the proposed change. Provisional information is now available and a review of the future reserve requirements has therefore been carried out. The detail of the review is set out in Appendix 1.

6. The key conclusion is that the current purposes for which we hold a pension reserve will no longer apply after April 2006. The Authority will not bear the direct cost of police pension payments on its budget and therefore will not need to provide for liabilities relating to serving officers with full pension entitlement being able to trigger substantial lump sum payments at one month’s notice, nor for liabilities arising from the forecast growth in the number of police pensioners.

7. The available evidence suggests that the transition to the new system should not itself present major financial difficulties. Under the new system there remains the potential for volatility in ill-health retirement costs which the Authority will continue to bear. Some residual reserve should be retained until this risk can be properly assessed. Otherwise the review concludes that the major part of the current reserve will no longer be required under the new financing arrangements.

8. Accordingly a policy is proposed for the gradual run-off of the reserve, other than a residual provision, over the next three years. This would be subject to annual review so that adjustments can be made should future circumstances warrant it.

9. Specifically it is proposed that £10 million be transferred from the reserve to support the budget in 2005/06 and thereby reduce the precept requirement by that amount.

Final budget submission

10. The final budget submission following agreement with the Mayor can therefore be summarised as follows:

[1] In accordance with instructions from ODPM grant under the 2003/04 amending report will reduce the budget requirement.

Medium term financial forecasts

11. The medium term financial forecasts have been amended since the original submission and are summarised below.

12. The forecasts do not include new efficiency savings beyond 2005/06. Under the national police efficiency strategy the Authority will be required to agree a three year rolling efficiency plan commencing with 2005/06. This will be considered by the Finance Committee in February 2005 and it will then be incorporated into the medium term forecasts.

13. The forecasts do not include provision for further implementation of the Step Change programme beyond 2005/06 although there is a clear expectation that policing in London will continue to develop in that direction. The MPS will be subject to review in the new year under the new Commissioner, in conjunction with the MPA, and this will have a major influence on future years’ budgeting. It is unlikely that budgetary growth can be sustained in the future at levels seen over the last four years and therefore the continuing demands and expectations will increasingly have to be met by reprioritisation and redirection of existing resources. The Authority and the MPS will need to approach future financial planning in this context.

Advice on the robustness of the estimates

14. The Treasurer’s advice on the robustness of the estimates is attached at Appendix 2.

C. Race and equality impact

There are no new equality and diversity implications which have not already been addressed through the budget process.

D. Financial implications

The budget will set the financial parameters for 2005/06.

E. Background papers

• MPA/MPS budget files

F. Contact details

Report author: Peter Martin

For more information contact:

MPA general: 020 7202 0202
Media enquiries: 020 7202 0217/18

Appendix 1: Future requirements for police pensions reserves

1. This note considers the requirements for pensions reserves after the police pension financing arrangements change from April 2006 and makes proposals in relation to the existing pensions reserve.

History

2. As at 31 March 2004 the Authority’s police pension reserve stood at £45.5 million. The bulk of the reserve was originally built up as a provision to cover the current liability to meet the commuted lump sum pension costs of serving officers who had reached full pension entitlement and could retire at one month’s notice. The provision was eventually sufficient to meet 75% of the estimated liability, a level which was acceptable to the external auditor. The implementation of FRS17 and the full disclosure of the total accrued liability in respect of police pensions on the face of the balance sheet rendered this provision redundant in accounting terms. The potential commitment to meet the commuted payments remained but the provision had to be reclassified as a reserve.

3. At the same time as the provision was being established the Finance Committee considered a report on future pension costs by actuaries Hymans Robertson. In the light of their projections the Authority agreed to build a reserve to assist in meeting the additional lump sum costs arising from an increase in officers attaining full service for retirement purposes. Sums have been set aside for this purpose in each of the last two years.

New financing arrangements

4. New financing arrangements for police pensions will be introduced from April 2006, subject to final confirmation, and these will have significant implications for the need to hold pensions reserves. Under the new arrangements police authorities will no longer be responsible for meeting pensions costs directly. The charge to police authorities’ budgets will be by way of employers contributions to a separate pensions account whose balance will be met by Home Office grant. Police budgets will not be impacted by the volatility of commuted lump sum payments, nor by growth in the number of pensioners since the employers contributions will be calculated to reflect the accrued liability of current officers.

5. The new arrangements represent a significant long term benefit to police authorities and as such are supported by both the APA and the MPA.

Implications

6. The principal reasons for maintaining pensions reserves will be eliminated by the new arrangements. There are two risks for which reserves may still be required:

• The introduction of the new arrangements involves adjustments to grant distribution as well as changes in the nature of expenditure borne by police authorities’ revenue accounts. There will therefore be a redistributional effect at the point of transition from the old system to the new. If there was to be a net deterioration in the Authority’s financial position it might be appropriate to use reserves to help adjust to the new arrangements.
• The Authority will retain a degree of responsibility for the costs of ill health retirements. If it was considered that the number of ill health retirements might fluctuate in the future it may be desirable to have reserves available to smooth the costs year-on-year.

Assessment

7. The Home Office has commissioned an exemplification of the redistribution arising from the introduction of the new financing arrangements. It is a relatively simplified approach and is still subject to validation. It is based on actual data relating to 2003/04 and shows a net adverse impact on the MPA’s financial position of £5.3 million.

8. The impact of the change when it actually happens will of course be determined by data relating to 2006/07. However there is no reason to believe that the MPA’s figures will alter over that period in a way that would significantly change our position relative to other police authorities.

9. Although the impact is negative its magnitude is not such that would cause significant problems in setting the 2006/07 budget. There is no reason therefore at this stage to hold reserves specifically to ameliorate the implementation of the new police pension financing arrangements.

10. The impact of ill-health retirements under the new system is less easy to assess at this stage. The final requirements are not yet clear. It is likely that capital sums will have to be paid into the pensions account in respect of ill-health retirements. This could exaggerate the effect of volatility in the numbers of such retirements, although there is a suggestion that payments could be spread over more than one financial year.

11. Until there is more information to go on, the possibility remains that a reserve may be desirable to assist in managing the financial impact of ill-health retirements. The eventual judgement will also have to take into account that the objective of authorities retaining direct responsibility for ill-health retirements is to provide an incentive to drive down on such costs. The existence of a reserve might be seen as compromising this objective.

12. At this stage it would be prudent to plan on retaining some balance in the pensions reserve until the remaining risks can be more thoroughly tested. A sum of about £10 million could be earmarked for this purpose, subject to review.

Impact on existing reserve

13. As part of the development of the 2005/06 budget a decision has already been taken to utilise £12 million of the pensions reserve, in line with the purposes of the reserve, to meet the lump sum commutation costs of an increased number of retirees compared with the current year. This reduces the available balance on the fund to £33.5 million. Retention of a balance of £10 million against possible future requirements would therefore free up £23.5 million of the existing reserve.

14. It would be appropriate to return this redundant reserve to the council taxpayers from whom it was ultimately derived. This should be done in a prudent way which minimises adverse financing impacts in future years. It is therefore suggested that the reserve be used to reduce the precept requirement over the next three years on a declining basis as follows: 2005/06: £10m; 2006/07: £7m; 2007/08: £4m. This totals slightly less than the available sum but it can obviously be fine-tuned depending on the circumstances in any particular year. It also means that there will still be £23.5 million in the reserve when the new financing system is introduced which should provide ample fallback if the analysis in this note is proved to have been flawed. The position should be reviewed on an annual basis so that the policy can be adjusted if necessary in the light of changing circumstances.

Peter Martin
Treasurer

Appendix 2: Report on Robustness of the Estimates

Provisional advice on the robustness of the 2005/06 estimates was provided in respect of the budget submission considered by the MPA at its meeting on 28 October 2004.This report now presents revised advice in relation to the final budget submission for 2005/06 to be considered by the Authority on 16 December 2004.

Reliability/accuracy

1. The estimates have been put together by, or with the involvement of, qualified finance staff and reviewed by the Strategic Finance section of the MPS Finance Services Department.

Scrutiny

2. Budget proposals have been through a rigorous scrutiny within the MPS. I have asked a series of questions about the construction of the budget and the nature of individual components and have received responses from the MPS. The Finance Committee has reviewed the original submission in draft as well as subsequent amendments. The budget submission will be approved by the full Authority. In addition there has been a regular dialogue with, and challenge from the Mayor and GLA officers.

Achievability and risks

3. There are a number of areas of risk in the budget as currently proposed. The draft budget requires delivery of savings totalling £65.8 million. This is a higher figure than has actually been achieved in any of the last four budgets. However it includes some measures which require no management action within the service, eg capitalisation of expenditure, and also substantial sums of additional income which are reasonably assured at this stage. Nevertheless there are significant items in the savings list which will require firm management and difficult decisions. Action plans for delivery of these savings will need to be established.

4. Monitoring of the 2004/05 budget shows overall expenditure close to budget. However business group budgets as a whole are predicted to overspend offset by underspendings on police pensions. Significant reductions are already reflected in respect of pensions in the draft budget for 2005/06, whilst some elements of the current overspending, particularly police overtime, have not been carried through into next year’s budget proposals. There is therefore a risk that overspendings will persist in 2005/06. Management action will be required to minimise this risk and to take appropriate corrective action if it does materialise during the year. The position should be reviewed when the MPA approves the final allocation of the budget in March 2005.

5. The Government has made clear that it expects the national average council tax increase in 2005/06 to be less than 5%. It will clearly be prepared to use capping to reinforce this result. In our case capping would actually apply to the overall GLA precept. However since the police component represents approximately 80% of the GLA precept, the increase in the MPA precept will be critical in relation to the criteria for excessiveness applied to the overall precept and a significant impact would inevitably fall on the MPA budget if the GLA precept had to be reduced as a result of capping. The Mayor has had regard to the potential for capping in his decisions about the level of component budgets which should therefore mitigate the risk of actual capping.

6. There are a number of features of the Authority’s financial policies, accounting policies and governance arrangements which mitigate financial risks. These include the following

• An element of the risk of financial loss is transferred externally through insurance arrangements.
• The Authority has appropriate general and earmarked reserves
• The Authority takes a prudent approach to achievability of income and debts due, making appropriate provisions for bad debts.
• The Authority has adopted accruals accounting, in particular making full provision for realistic estimates of future settlements of known liabilities.
• The level of external borrowing is low and therefore the Authority’s exposure to interest rate changes is low.
• The Authority has recognised the risks associated with the major programme of re-tendering outsourced contracts. There are appropriate management arrangements in place and financial provision has been made for associated one-off costs.
• Risk management has been built into the corporate governance arrangements of both the MPA and MPS so that there is proactive assessment of risks and processes to monitor and manage risks.

Future commitments

7. The financial projections for future years included in the budget show a significant level of ongoing commitment. Further work is required on the medium term forecasts to incorporate efficiency savings, to reflect changed arrangements for financing police pensions and to identify how the continuing Step Change developments will be treated beyond 2005/06. This work will need to take place in the context of a review of the service to be carried out in 2005. The medium term position should therefore be reviewed in advance of detailed budget preparation for 2006/07.

8. The Authority’s cash flow requirements are forecast and monitored on a monthly basis to ensure stable and predictable treasury management, avoiding unexpected financing requirements.

Capital

9. The risk inherent in large capital schemes is considered low. The major capital scheme is the C3i project. Risks around the project have been minimised by a rigorous governance arrangement incorporating external validation. The C3i project is substantially supported by government grant thereby minimising risks around available finance.

10. The new Prudential Code has introduced a rigorous system of prudential indicators, which explicitly require regard to affordability, prudence, value for money, stewardship, service objectives and practicality. This is backed up by a specific requirement to monitor performance against forward-looking indicators and report and act on significant deviations.

11. The new capital strategy has drawn together for the first time key processes and arrangements for prioritisation, appraisal, management, monitoring and review of the existing programme and new investment. Although the processes are as yet immature, improvements will be made over the short to medium term which will inform choices on the allocation of additional capital investment and its affordability.

Conclusion

The estimates have been prepared in a properly controlled and professionally supported process. They have been subject to due consideration within the MPS and by the MPA. The risks identified in this report will be subject to careful monitoring.

Peter Martin
MPA Treasurer

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