Revenue Reserves

Report: 6
Date: 7 June 2007
By: Treasurer and the Acting Director of Resources on behalf of the Commissioner

Summary

This report sets out a review of the likely reserves prior to closing the 2006/07 accounts. The report reviews and confirms the policy that the general reserve should lie within the range of a minimum of 1.5% to 2% of net revenue expenditure when conditions permit, identifies an opportunity to increase the General Reserve by £5M and proposes a new Budget Resilience Reserve of £5.1M.

A. Recommendations

That members

1. Confirm the policy of increasing the general reserve within a range of a minimum of 1.5% to 2% of net revenue expenditure as and when conditions permit;
2. Approve the proposed use of the 2006/07 underspend and other reserve adjustments as the basis for closing the 2006-07 accounts (paragraphs 10 –11 and 17); and
3. Agree that a report be presented to the Finance Committee in October reviewing the use of reserves for budget purposes.

B. Supporting information

Introduction

1. When preparing its 2006/07 accounts closure the Authority should consider the establishment and maintenance of reserves. Revenue reserves are cash backed balances, held on the balance sheet until they are spent or released for other purposes. As such, they can only be spent once, and are not part of the ongoing base budget.

2. It is necessary to present this report to CoP because the final accounts statutory closure date has been progressively brought forward over the last few years and decisions on the use of reserves need to be taken for inclusion in the draft final accounts which are to be considered by Corporate Governance Committee on 15 June.

3. The Authority’s balance sheet reserves are held for three main purposes:

• A contingency to cushion the impact of unexpected events or emergencies – this forms part of general reserves;
• A working balance to help cushion the impact of uneven cash flows and avoid unnecessary temporary borrowing – this too forms part of general reserves; and
• A means of building up funds to meet known or predicted liabilities or to smooth significant expenditure requirements – known as earmarked reserves.

4. There is no statutory guidance on reserves, and there has never been an accepted case for introducing a statutory minimum level of reserves, even in exceptional circumstances. CIPFA guidance issued in June 2003 confirms that authorities on the advice of their treasurers should make their own judgements on such matters, taking into account all the relevant local circumstances.

5. The Authority’s external auditor has responsibility to review the arrangements in place to ensure that financial standing is soundly based. This includes reviewing and reporting on the level of reserves taking into account their local knowledge of the authority’s financial performance over a period of time. It is not their responsibility to prescribe the optimum or minimum level of reserves for an individual authority.

6. The Authority must retain adequate reserves so that unexpected demand led pressures on its budgets can be met without adverse impact on the achievement of the authority’s key priorities. The authority’s policy for reserves and balances should be based on a thorough understanding of its needs and risks. Part of this process is to give clearer explanation of the existing and proposed reserves and this is addressed in the paragraphs below.

General reserve

7. Present policy is that the general reserve should be a minimum of 1.5% of net revenue expenditure and the opportunity should be taken to increase it to 2% as and when conditions allow. This does depend however that there are appropriate ear-marked reserves, reasonable insurance arrangements, a well funded budget and effective budgetary control. A realistic level of general reserves could help address any extraordinary, unexpected and unbudgeted costs or provide breathing space to manage the implications of any adverse movements in funding of the service. However, it has to be recognised that reserves can only be used once and additional funds have to be raised through the precept or grant or by reduced expenditure to replenish them. Presently, the General Reserve and the Emergencies/Contingency Reserve (which can be counted for this purpose) total 1.7% of net revenue expenditure (NRE).

8. In deciding what level of General Reserve would now continue to be appropriate for the Authority, a number of matters need to be addressed.

• What are the potential calls on the reserve? One scenario, which may have seemed more remote five years ago, would be a sustained increase in unavoidable operational policing activity generating substantial unbudgeted costs. The events of the last two financial years has proved that unprecedented costs such as the July 2005 bombings/attempted bombings, the SE Asia tsunami and Operation Overt in 2006, need to be factored into assessments of the quantum of the General Reserve.
• How flexible is the Authority’s budgetary position? Whilst the MPS’s budget is large and has been historically able to cope with unforeseen demands, a tightened financial position has driven out budget inefficiencies therefore reducing future budget flexibility. The sheer scale of the savings necessary in this (2007/08) financial year (c. £90M) has added to the potential risks.
• What are the longer-term prospects? The latest indications are that increases in government funding over the medium term will be below the likely rate of increase in expenditure. This in turn will lead to greater pressure over the medium term for successively progressive budget reduction to achieve a balanced budget.
• Is the financial risk being covered in other ways? Certainly the existence of earmarked reserves would provide for specific risks but risks of the more general nature would fall on the General Reserve.

9. A review has been undertaken of the adequacy of this approach to ensure that the General Reserve is appropriate and reasonable, and the factors that have influenced the Treasurer’s judgement are attached at Appendix 1. This will ensure that the General Reserve is neither too low leaving the Authority exposed, nor too high drawing away resources unnecessarily from other policing activities. I have taken into account CIPFA guidance and current practice in other police authorities.

10. At present having regard to the risks contained in Appendix 1 it is appropriate to confirm the present policy on the General Reserve (which in itself represented a substantial increase on the previous minimum of 1% NRE). Any progress towards the 2% upper limit would represent real achievement. As can be seen from paragraph 14 below there is capacity to increase the General Reserve by £5M to £33.84M following a review of the utilisation of current reserves.

11. There is also an opportunity to transfer £5.1M of the expected 2006/07 revenue account underspendings to an uncommitted reserve, the Budget Resilience Reserve within the direct control of the Authority. Members identified at the last Finance Committee that they considered it essential that any opportunity to add to reserves should focus on the need to provide transitional protection over the medium term for successively progressive budget reductions to achieve a balanced budget (which would address the second and third bullet points in paragraph 8 above).

12. Taking these together would provide uncommitted cover of £59.104M (1.9% of NRE), comprising the General Reserve (£33.84M), Emergencies Contingencies Fund (£20.134M) and the Budget Resilience Reserve (£5.130M). The precise final figures will be subject to completion of the accounts closure process, but is unlikely to be markedly different.

Earmarked reserves

13. CIPFA define revenue reserves as “resulting from events that have allowed monies to be set aside, surpluses or decisions causing anticipated expenditure to have been postponed or cancelled.” Revenue reserves can be either classified as earmarked reserves or unallocated reserves, often termed balances.

14. A review of the usage of the present earmarked reserves has been undertaken and it is proposed to transfer £5M from the Pensions Reserve to the General Reserve. The Pensions Reserve was maintained at £5M to cover off the possibility of financing unbudgeted discretionary police officer pension payments costs in the first year of the new financial arrangements for police officer pensions. Revenue budget provision has proved sound and it is now unnecessary to maintain a separate earmarked reserve. An increase in the General Reserve itself will obviously also provide flexibility and security.

15. Some other earmarked reserves usage has remained reasonably static over the last few years and there may be opportunities as part of the 2008/09 budget process to rationalise these. A review has been carried out and it is accepted that budget plans for this year already allow for their full use. However, it is appropriate that a further review be brought to the Finance Committee in October.

Latest outlook for revenue underspendings 2006-07

16. The provisional outturn position for the revenue account in 2006/07 is an underspend of approximately £5.1m. This is however after MPS Management Board has agreed to the creation of a number of earmarked reserves during 2006/07.

Proposed use of reserves directly from the underspend

17. The following table outlines the MPS Investment Board’s approvals to requests for appropriation to reserves, subject to this committee’s approval.

A fuller description of the proposed reserves is attached at Appendix 2.

Summary of reserve movements

18. A simplified summary of the reserves proposals after the various adjustments and transfers are shown below, highlighting movement in balances at 31 March 2006 and 2007.

Abbreviations

ACPO

Association of Chief Police Officers

BIU

Borough Intelligence Unit

BOCUs

Borough Operational Command Units

CDRP

Crime and Disorder Disruption Partnerships

GLA

Greater London Authority

GGWRB

Guns, Gangs and Weapons Reduction Board

IAG

Independent Advisory Group

MAPPA

Multi Agency Public Protection Arrangement

MATS

Mediation and Transformation Service

NIM

National Intelligence Model

NOMS

National Offenders Management Service

PPO

Prolific and other Priority Offenders

TTCG

Tactical Tasking and Coordination Group

UCLAN

University of Central Lancashire

VCD

Violent Crime Directorate

YJB

Youth Justice Board

YOTS

Youth Offending Teams

C. Race and equality impact

19. There are no specific implications arising from information set out in this report.

D. Financial implications

20. Financial implications are set out throughout this report.

E. Background papers

• Final Accounts papers 2005/06 and 2006/07

F. Contact details

Report author: Ken Hunt, MPA.

For more information contact:

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

Appendix 1

General and Earmarked Reserves Policy

1. The Authority maintains working balances (the General Reserve) to manage uneven cash flows, avoid unnecessary temporary borrowing, help address any extraordinary and unbudgeted costs, or provide breathing space to manage the transitional implications of any adverse movements in funding of the service. 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 or liability as a result of a past event and that liability can be reliably estimated.

2. An essential element of medium term financial planning is an assessment of the adequacy of reserves and provisions.

General Reserve

3. The MPA/MPS has in place a risk management strategy and a system of internal control. Of particular importance in this context is the MPA/MPS budget monitoring policy. It ensures that regular budget monitoring is carried out and requires approval for carry-forward of any underspending and that any net overspending by MPS Business Groups is made good, unless other exceptional arrangements are approved by the Authority. The MPS has a good record in identifying budget pressures and taking appropriate remedial action. These existing systems, controls and procedures provide a firm foundation from which the need for reserves and balances can be calculated with a reasonable level of confidence.

Risk Analysis

4. 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;
• 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

5. 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 it is felt that the appropriate level for the General Reserve (including all uncommitted reserves) is in the range of a minimum 1.5% to 2% of net revenue expenditure, to be attained as and when conditions permit. The proposal at the present time, including the General Reserve, the Emergencies Contingency Fund and the Budget Resilience Reserve are within this range.

Earmarked Reserves

6. The Authority has a number of earmarked funds and reserves. These are identified in the table below. Individual descriptions of the funds are also provided.

Provisions

7. A review of provisions has been undertaken. The remaining provisions are also estimated to be sufficient to meet known liabilities.

Conclusion

8. The Reserves are based on a detailed estimate of known liabilities and expenditure plans and a risk analysis of future expenditure arising from unforeseen events. The level of reserves is judged prudent in the context of the Authority’s Medium Term Financial Plan.

Analysis of proposed Revenue Reserves 2006-2007

Revenue Reserves

Explanation of Existing Reserves at March 2007

• Airwave - Connection fee for the provision of Airwave at Heathrow Terminal 5. Under the delegated control of the Commissioner, to be reviewed October 2007.
• Budget Pressures - This reserve was to meet specific unbudgeted demand led pressures in 2005/06 and should normally be expected to be fully utilised by year-end. Carried over to 2007/08 where the reserve should be fully utilised. Under the delegated control of the Commissioner, to be reviewed October 2007
• Budget Resilience Reserve – To allow for transitional costs in implementing budget reductions which should be managed over a period of years. Under the control of the Authority. To be reviewed in October 2007
• Budget Smoothing Reserve – this reserve was created to provide the initial £24 million required to balance the budget in 2006/07. Now deleted.
• Communications project – monies set aside for the development of an integrated communications system for the MPS. The expectation is that this will now be fully used in 2007/08. Under the delegated control of the Commissioner, to be reviewed October 2007
• Emergencies Contingencies Fund – An uncommitted reserve under the direct control of the Authority for emergencies. Considered to be effectively part of the General Reserve. Under the control of the Authority. To be reviewed in May 2008
• General Reserve - For unexpected day to day pressures as indicated in paragraph 1 above. Under the control of the Authority. To be reviewed in October 2007.
• Kickz - Crime reduction project engaging young people in constructive activities in partnership with the football world. To enable the scheme to be rolled out over all London boroughs and to obtain matched funding from the Football Association. Under the delegated control of the Commissioner, to be reviewed October 2007
• Laming Inquiry – This reserve contributes to the continuing costs of implementing the recommendations to come out of the Laming Enquiry (the Ministerial enquiry chaired by Lord Laming following the death of Victoria Climbiè). Under the delegated control of the Commissioner, to be reviewed October 2007
• Legal costs - This reserve is to provide for the cost of potential lawsuits. Under the control of the Authority. To be reviewed in October 2007
• MPA - The reserve supported accommodation costs of office moves, and Independent Custody Visitors – organisational scheme management. Under the control of the Authority. To be reviewed in October 2007
• Operational costs - The reserve provides for a number of operational activities planned and also includes the Mettime Reserve (£3.6M), Metafor Project Reserve (£0.63M), purchase of vehicles for the emerging threats team (£0.175M) and the projects reserve (£0.295M). The expectation is that the majority of the reserve will be used in 2007/08, with the balance being required in the medium term. Under the delegated control of the Commissioner, to be reviewed October 2007
• Pandemic response – The reserve is to be used for the cost of anti-viral drugs in order to maintain essential services. Now closed as bills paid
• PFI Contracts – The reserve has been established to part meet the costs of a PFI development. A proportion of it would normally have been required in 2006/07, with the remainder required in the medium term. Under the delegated control of the Commissioner, to be reviewed October 2007
• Police Pensions – Reserve closed
• POCA – Proceeds of Crime Act – This reserve is maintained to hold the anticipated POCA balances still awaiting distribution at the end of the financial year. Under the delegated control of the Commissioner, to be reviewed October 2007
• Property related costs – This reserve has been established to meet the cost of various building related projects. A proportion of this was required in the 2006/07 with the balance required in the medium term. Includes the IT related costs for safer neighbourhoods (£2.5M). Under the delegated control of the Commissioner, to be reviewed October 2007
• Protective Clothing – This reserve provides for the cost of protective clothing for officers including research and development and costs. The expectation would normally have been that the reserve will be fully utilised in 2006/07, but it is now expected to be spent in 2007/08. Under the delegated control of the Commissioner, to be reviewed October 2007
• Rent Smoothing – This reserve has been set up to fund future years increases on rent payable on a newly occupied building. The reserve will be required in the medium to long term. Under the delegated control of the Commissioner, to be reviewed October 2007
• Systems – The reserve contributes to the cost of developing financial systems. Under the delegated control of the Commissioner, to be reviewed October 2007
• Vehicle recovery services – This reserve was established to contribute towards the expansion costs of the vehicle recovery service. It was anticipated it will be fully utilised in 2006/07, but the reserve has been carried forward. Under the delegated control of the Commissioner, to be reviewed October 2007

Appendix 2

Description of proposed transfer to reserves 2006/07

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