Reserves policy

Report: 07
Date: 21 February 2002
By: Treasurer

Summary

The report addresses policy issues in relation to the Authority's reserves and proposes ways forward.

A. Recommendations

The Committee is recommended:

1. To confirm its policy for the minimum level of the Authority's general reserve (para 2)
2. To note that the conditions supporting the minimum level will be addressed as part of the financial management strategy (para 4)
3. To note the need to develop the provision for accrued third party liabilities commencing with the 2001/02 accounts (para 6)
4. To note the need for both an adequate provision for the current potential pensions liability in respect of officers who have completed thirty years service and a reserve for future increased pension liabilities (paras 7-8)
5. To support the use of actuaries to provide information to underpin the pensions reserve policy (para 11)
6. To support the proposals for adding to reserves set out in paras 15-16.

B. Supporting information

Introduction

1. An urgent priority as part of the financial management strategy is to agree and implement the Authority's policy on reserves. This will:

• Ensure future financial resilience.
• Address the concerns in the external auditor's annual letter.
• Develop confidence in the Authority's ability to manage its financial affairs.
• Ease pressure on operational expenditure when in-year budget variations occur.

General reserve

2. The Authority has already agreed, on my advice, that the minimum acceptable level for a general reserve, to meet unforeseen and unfunded emergency expenditure or financial demands, is 1% of total net expenditure, provided that there are appropriate accounting provisions and earmarked reserves, reasonable insurance arrangements, a well funded budget and effective budgetary control.

3. As at 1 April 2001 the general reserve stands at £13.5 million which is just 0.7% of net expenditure. Furthermore none of my conditions has been satisfactorily met as yet.

• The auditor's qualification of the 2000/01 accounts highlights the inadequacy of the accounting provisions and earmarked reserves
• The liabilities insurance arrangements require £40 million self-funding with significant limitations on the scope of the cover.
• A budget which for next year relies on achieving £60 million savings could probably not be described as 'well funded'.
• The experience of actual and forecast overspendings underlines the weakness of budgetary control.

4. Implementation of the agreed general reserve policy therefore requires action on two fronts, to raise the actual level of the reserve to at least 1% (£21 million based on the 2002/03 budget) and to secure an acceptable position on the four conditions. So long as the conditions remain unsatisfied it would be appropriate for the general reserve to be held above 1%. The conditions will be addressed as part of the financial management strategy.

Accounts qualification

5. The external auditor qualified the Authority's accounts for 2000/01 because of reservations about the adequacy of the provisions set aside to meet third party and police pension liabilities. These issues need to be addressed as a matter of urgency in order to secure unqualified accounts as soon as possible.

Provision for third party liabilities

6. The problem with establishing a properly based accruals provision for third party, or insurable, liabilities has been the inadequacy of the available information arising from the absence of insurance arrangements in the past. Such information is now being identified and will form the basis for building such a provision over the next few years. This process will start in the current year's accounts where performance against the compensation budget is already reflecting time lags before the settlement of identified liabilities.

Pensions reserve/provision

7. The pensions liability takes two forms. Firstly there is the current liability represented by officers who have completed thirty year's service and who could therefore retire on full pension at one month's notice in which case the Authority would have to meet the immediate cost of the lump sum commutation. The total potential liability beyond the normal budget provision has been assessed at £44 million against which we have an earmarked reserve of £8 million. It is this position that the external auditor has described as inadequate in the context of the 2000/01 accounts. He has not indicated what he would regard as adequate but it is probably less than 100% of the potential liability.

8. Secondly our forward projections indicate a significant increase over the next ten years in the volume of officers reaching retirement age. This will produce a bulge in commutation costs in the years when the number of retirements peaks. To provide for this future increased liability, the Committee has previously agreed that we should seek to build up a pensions reserve utilising any underspendings on the pensions budget. The outturn forecasts for the budget as a whole have so far suggested that the predicted pensions underspending of around £10 million would not be available for this purpose because it would be needed to offset overspendings elsewhere. This position would change if the overall budget underspends.

9. I am in contact with officers of the London Fire and Emergency Planning Authority (LFEPA) who also have an unfunded pension scheme to deal with. LFEPA have used consulting actuaries to produce information to support the level of their pensions reserve. It would be appropriate for the MPA also to secure an actuarial assessment of future pension liabilities to inform our pension reserve strategy.

10. There is a further issue in relation to pensions that will require actuarial input, which is that, under revised accounting requirements, the Authority will have to show in its balance sheet the full accrued pension liability in respect of current officers. This will be an amount running into several billions of pounds and will be offset by a matching reserve thus ensuring that there is no actual impact on the Authority's finances. However the calculation of this liability is an actuarial exercise.

11. I intend to speak initially to Hymans Robertson about both the new accounting requirements and the scope for securing an independent actuarial assessment of the future liabilities to enable us to quantify the pensions reserve policy. Hymans Robertson were selected on a competitive basis to advise the Authority on the civil staff pensions options and they are also the actuaries to the London Pension Fund Authority which also falls within the ambit of the GLA.

12. The issue of pension reserves and provisions will have to be kept under review in the context of any changes which the Government may eventually agree as to the future funding of the police pension scheme.

Other reserves

13. The Authority retains capital reserves which comprise resources which can only be applied for capital purposes, i.e. to finance capital expenditure or to repay debt. These are primarily unapplied capital receipts which are planned to be largely consumed over the period of the five year capital programme. In seeking to optimize the use of its estate the Authority should be identifying opportunities to generate further capital receipts which would be added to the capital reserves and increase the Authority's capacity for capital investment.

14. Other purposes for holding reserves may be identified from time to time. These will have to be assessed as they arise in the light of the Authority's financial position and availability of resources.

Options for adding to reserves

15. Sources have been identified which could add to reserves in the short term:

• The Committee has already agreed that the balance of the MPA contingency in the current year should be put into the general reserve. This would amount to £4 million if not required to offset an overspending.
• The balance of the budget saving on civil staff pensions in 2002/03, as reported to the last meeting of the Committee, amounts to £3.6 million and would be available for the reserves if not required to support next year's budget.
• There is an increasing probability of an underspending in the current year which could also be added, in whole or in part, to reserves. The Authority should first review with the MPS the justification for the retention of a proportion of an underspending within the Commissioner's delegation. Given that an underspending on pensions will have contributed to an overall underspending it would be appropriate to give priority for any available balance to enhance the pensions reserves.

16. Next year's budget management will be difficult. However it will be essential to continue the identification of savings which can contribute to budget requirements for 2003/04. To the extent that such savings can be initiated during 2002/03 and if they are not needed to support the budget in next year they would provide further opportunities to build the Authority's reserves. The Authority should give high priority to ensuring that the general reserve is at least at its minimum level and that the conditions supporting that level are met as quickly as possible. Those conditions include having appropriate accounting provisions and earmarked reserves. The Authority should also consider its reserve requirements in the context of budget proposals for future years.

C. Financial implications

The implications of proposals to add to reserves will have to be addressed in the context of the Authority's financial position when making decisions in relation to each year's accounts.

D. Background papers

• External auditor's annual audit letter 2000/01.
• MPA 2000/01 annual accounts

E. Contact details

Report author: Peter Martin, MPA.

For information contact:

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

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