Robustness of the estimates and adequacy of the reserves

Report: 6
Date: 22 November 2007
By: the Treasurer

Summary

The purpose of this report is to provide Members with information on the robustness of the estimates and the adequacy of the reserves, so that Members have authoritative advice available when they make their decisions.

A. Recommendations

That members

Joint Planning, Performance and Review (PPR) & Finance Committee
1. Consider the advice on the robustness of the estimates and adequacy of reserves when referring any comments or recommendations on to the full Authority.

Full Authority
2. Have regard to this report and any comments or recommendations from the Joint PPR & Finance Committee when approving the budget submission (Corporate Business Plan).

B. Supporting information

Introduction

1. Police Authorities decide every year how much their overall budget requirements are. They base these decisions on a budget that sets out estimates of what they plan to spend on their policing services.

2. The decision on the budget is taken before the year begins and it cannot be changed during the year, so allowance for risks and uncertainties that might increase police service expenditure above that planned, must be made by:

a) Making prudent allowance in the estimates for all of the requirements of the MPS, including all its business groups; and in addition,

b) Ensuring that there are adequate reserves to draw on if the estimates turn out to be insufficient.

3. Section 25 of the Local Government Act 2003 requires that an authority’s chief financial officer reports to the authority when it is considering its budget. The report must deal with the robustness of the estimates and the adequacy of the reserves allowed for in the budget proposals, so that Members will have authoritative advice available to them when they make their decisions.

4. Section 25 also requires Members to have regard to the report in making their decisions.

Robustness of the Estimates

Reliability/Accuracy

5. The budget process has involved Members, the Commissioner and his staff and my own staff in a thorough examination of the budget now recommended to the Authority. The estimates have been put together by, or with the involvement of, qualified finance staff and directed and reviewed by the MPS Director of Strategic Finance and her Corporate Finance section.

6. In particular the estimates this year have reflected additional work which has produced more integration between business and budget planning, there is more supporting documentation for the budget submission and there has been a review of our capital needs over a seven year planning period for the first time.

Scrutiny

7. Budget proposals have been through a rigorous scrutiny within the MPS, including the Management Board and Investment Board. 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. A series of informal budget scrutiny meetings have been held by the Chair of the MPA and a small group of MPA members comprising Vice Chairs, and Chairs of Finance and Policy, Performance and Review Committees and members with HR and Specialist Operations interests. Individual MPS business groups and Management Board members were asked to present their detailed revenue growth and savings proposals for scrutiny by the members. The outcome of the review process for the proposed growth and savings items assessed possible impacts of any savings across business groups as well as on strategic priorities. The Finance Committee, and Joint Finance & Planning Performance and Review (PPR) Committee has reviewed update reports on the draft budget submission. The budget submission will be formally considered by a meeting of the full Authority on 22 November after consideration by the Joint Finance and PPR Committee on 19 November. In addition there has been a regular dialogue with, and challenge from GLA officers.

Achievability and Risks

8. There are a number of areas of risk in the budget as currently proposed. In particular the budget is being submitted before the government grant settlement. As the Mayor has set a budget target based on the increase in the Authority’s Budget Requirement rather than including any assumptions about government grant, nevertheless the Mayor will undoubtedly have had to be made estimates of the MPA’s grant entitlement. These current estimates will be replaced by relatively firm grant figures following the provisional settlement (probably the first week in December). At this stage there is a small risk that the grant estimates are overstated and the Authority might well be asked to reflect any reduction in grant expectations with a lower expenditure level. There are also risks around assumptions made for significant increases in expenditure in the policing bids for Counter Terrorism and for the Olympics and Paralympic Games, and there is significant growth assumed in partnership funding. All of these large growth items are assumed to be budget neutral, in effect additional costs such as additional employee expenses are assumed to be offset by income from government or from local partners. Remedial action in the budget would be necessary if income was lower than expected.

9. It is likely that capping criteria will apply again in 2008/09. 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. There is no firm information at the moment as to the criteria that will be applied in 2008/09. In the Mayor’s budget guidance it states that he does not wish to propose a consolidated budget that risks being capped. It is not therefore anticipated that the present budget would be affected by capping unless the criteria were set at much lower levels.

10. The draft budget requires delivery of savings and efficiencies totalling £74 million to balance the budget These have been identified in the draft budget submission and there are significant items that will require firm management. However, the MPS track record in delivery of large savings and efficiency packages has been good.

11. The Authority has regular budget monitoring undertaken by Finance Committee and the informal member led Budget and Overtime Group. Authority agreement is needed for the carry-forward of any year end underspending. The MPS Investment Board, chaired by the Deputy Commissioner is also charged with monitoring the budget. Monitoring of the 2007/08 budget indicates a year end underspending of £14M. There is a risk that this may not be maintained, but the record of management action over the last few years, coping with large unexpected operational expenditure, is good and I consider it would be reasonable to expect that appropriate corrective action will be undertaken if it does materialise during the year or indeed next financial year. If the 2007/08 underspend materialises the sum will be available to transfer to earmarked or unearmarked reserves.

12. 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 though 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 works of the Met Modernisation Programme. 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.
• The budget has recognised that there are financial risks inherent in new funding partnerships, but no commitments will be entered into until satisfactory arrangements are agreed by all parties

Future Commitments

13. The financial projections for future years included in the budget show a significant level of ongoing commitment. However further work is required on the medium term figures in order to judge the implications in the context of the Authority’s overall financial position. These will be reported to Finance Committee who will oversee progress.

14. 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

15. The draft capital programme reflects an ambitious programme across a seven year budget period. Finance Committee has consistently expressed concerned about the continual underspend against agreed capital budgets. The draft programme has introduced an in year downward ‘programme management’ of £60M per annum, to reduce budget totals. The aim of the proposed capital spending plan is to allow officers to start designing/delivering the programme as stated. The proposed capital spending plan, whilst needing efective management, reflects the liklihood that the MPS does not yet have the capacity to spend to the programme requirement. The budget submission reflects the need to review 2009/10 and beyond. This will require substantial work in 2008/09 to be carried out to ensure the best match with strategic objectives is achieved and also to assess the options for increasing capacity from present levels. There will need to be rigorous governance arrangements in place, including oversight by the Authority’s Finance Committee to ensure proper management of these new arrangements. There will also need to be a review of the affordability of the programme against the medium term financial plan, again overseen by the Finance Committee.

16. The 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.

17. The updated capital strategy has drawn together key processes and arrangements for prioritisation, appraisal, management, monitoring and review of the existing programme and new investment. Although the processes are not yet mature, improvements will be made over the short to medium term, which will inform choices on the allocation of additional capital investment and its affordability. This process is supported by the new MPS Capital Programme Review Board (CPRB), which the Treasurer attends.

18. The capital programme is heavily reliant on the generation of new capital receipts from asset disposal. From 2007/08, the MPA Estates Oversight Group monitors monthly capital receipts achieved to date and those forecast against targets for the future programme.

19. In my view the the robustness of the estimates has been ensured by the budget process, which has enabled all practical steps to be taken to identify and make provision for the Authority’s commitments in 2008/09. Estimates have been prepared in a properly controlled and professionally supported process. The estimates have also been subject to due consideration within the MPS and MPA.

Adequacy of Reserves

20. The Authority maintains working balances to manage the effect of uneven cash flows and avoid unnecessary temporary borrowing. These balances are also used to cushion the impact of unexpected events or emergencies. In addition earmarked reserves are used to meet known or predicted future expenditure. Provisions are established when the Authority has a financial obligation as a result of a past event and that liability can be reliably estimated. The CIPFA Local Authority Accounting Panel has issued a guidance note on local Authority Reserves and Balances (LAAP Bulletin 55) to assist Local Authorities in this process.

General Reserve

21. This guidance however, states that no case has yet been made to set a statutory minimum level of reserves, either as an absolute amount or a percentage of budget. Each authority should take advice from its chief financial officer and base its judgement on local circumstances. The Authority has taken a policy decision to increase its level of general reserves (to include the Emergency/Contingency Fund) over the last few years from 1% of net revenue expenditure to a minimum figure of 2% - the figure currently stands at a prudent 2.4% NRE (£62M).

22. In coming to a view on the adequacy of reserves, account needs to be taken of the risks facing the authority. The statement of internal control, within the Authority’s Statement of Accounts, gives assurance in relation to the organisation’s arrangements for the management of risk and ensuring proper arrangements are in place for governing its affairs and looking after the resources at its disposal. In addition a general reserves/balances risk analysis has been undertaken and the factors taken into account in the analysis are as follows:

• The estimates included in the medium term financial plan for inflation and interest rates, and in particular police officer and police staff pay;
• The assumptions used for the level and timing of capital receipts;
• The Authority’s capacity to manage in year budget pressures from demand led services;
• The need for probable but uncosted future demands;
• The need for working capital pending the receipt of grant and other income;
• The need to respond to natural disasters and emergencies whilst at the same time maintaining routine services and provide flexibility during uncertainty and change;
• The need to meet as yet unknown liabilities;
• The financial risk inherent in new funding partnerships, outsourcing arrangements and major projects;
• The adequacy of the Authority’s insurance arrangements;
• Financial control arrangements including internal and external audit arrangements;
• Availability and timeliness of information on changes in the Authority’s financial position
• The size and scope of the capital programme and Prudential Indicators and local determination of borrowing levels;
• The tightening financial position which has already driven out budget efficiencies
• The predicted worsening national financial funding position

23. The setting of the level of reserves is an important decision not only in the budget for 2008/09, but also in the formulation of the medium term financial strategy.

24. Special consideration was given to the Authority’s Medium Term Financial Plan objectives, the Prudential Indicators and the impact of major capital projects. Subject to the maintenance of four key issues: adequate accounting provisions and earmarked reserves, reasonable insurance arrangements, a well funded budget and effective budgetary control, when all these factors are taken into account I am content with the present level where the general reserves (Emergencies Contingency Fund) is an acceptable and adequate 2.4%. of NRE at £62M.

Earmarked Reserves

25. Earmarked reserves have been established to provide resources for specific purposes. These are identified in the main budget submission at £72M. A thorough review of the earmarked reserves and their use was considered and agreed by the Finance Committee at its meeting in October.

Provisions

26. A review of provisions has been undertaken. The remaining provisions are also estimated to be sufficient to meet known liabilities, including in particular the provision for insurance liabilities.

27. Subject to the application of earmarked reserves as a consequence of the budget recommendations and as reported to Finance Committee in October 2007, the level of the General Reserve for the period of the medium term financial strategy is estimated to remain broadly constant.

28. In my view, if the authority were to accept the recommended increase in the 2008/09 Budget Requirement, funding for unavoidable service pressures, proposals for savings and for capital, then the level of risks identified in the budget process, alongside the authority’s financial management arrangements suggest that the level of reserves for 2008/09 are adequate. Members should be aware that there is a need for a strategy to be put in place to address future year savings in order to ensure there is no unnecessary pressure placed upon the need to use existing General Reserves in future years. This has already been highlighted and officers will be addressing this issue as part of the planning for the 2009/10 and future years budget – for which the planning process will again commence early in the New Year.

 C. Race and equality impact

None specific to this report.

D. Financial implications

None other than comments included in the report above.

E. Background papers

Budget Submission 2008/09 and future years
Capital Programme 2008/09 and future years
Capital Strategy 2008/09
Report on Earmarked Reserves – Finance Committee October 2007

F. Contact details

Report author: Ken Hunt, Treasurer

For more information contact:

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

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