Revenue reserves

Report: 6
Date: 15 June 2006
By: Treasurer and Commissioner

Summary

This report sets out a review of the likely reserves prior to closing the 2005/06 accounts. It also provides the basis for the review of reserves for the 2007/08 budget cycle as part of the new approach to the financial framework. The report postulates that the general reserve should be increased, within a range of 1.5-2% of net revenue expenditure when conditions permit, identifies the financing source for the £24 million planned assistance to the 2006/07 budget and brings into focus for the first time the £17 million agreed reimbursement to reserves in 2007/08 and the likely reserve position to 2009.

A. Recommendations

That members

1. Consider the proposed policy of increasing the general reserve within a range of 1.5 – 2% of net revenue expenditure as and when conditions permit;
2. Approve the use of the 2005/06 underspend and other reserve adjustments to finalise the transfer to reserves (in paragraphs 13-21) as the basis for closing the 2005-06 accounts; and
3. Note early predictions that there may be flexibility in the 2007/08 reserves totals to assist the revenue budget preparation.

B. Supporting information

Introduction

1. When preparing its 2007/08 annual budget and reviewing the medium term financial plan the Authority should consider the establishment and maintenance of reserves. This paper is complementary to that improvement programme, increasing visibility of reserves and placing consideration of their use for the 2007/08 budget round at the forefront of the decision making process. 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. 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

3. 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.

4. 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.

5. 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

6. Present policy, agreed when the Authority was set up in 2000, is that a general reserve of 1% (£28m) could be regarded as a minimum if there were 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.

7. 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 financial year has proved that unprecedented costs of the July bombings/attempted bombings and the SE Asia tsunami now 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.
• What are the longer-term prospects? The latest indications from the Chancellor’s budget announcement indicate that increases in government funding over the medium term will be below the likely rate of increase in expenditure.
• 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.

8. In the circumstances it is felt that it would be appropriate and prudent to consider increasing the general reserve within a range of 1.5 – 2% of net revenue expenditure as and when conditions permit, and that a start be made this year. It is essential that an annual review of the adequacy of this approach is undertaken to ensure that the General Reserve is appropriate and reasonable. This will ensure that it is neither too low leaving the Authority exposed, or too high drawing away resources unnecessarily from other policing activities. As can be seen from paragraph 14 there is capacity to increase the General Reserve and the sum identified is £48.97 million (1.7% of net revenue expenditure) and still satisfy the need to sustain and create new ‘earmarked’ reserves. This figure is within the range identified above and would be a good start to increasing the level of the General Reserve. The precise final figure will be subject to completion of the accounts closure process, but is unlikely to be markedly different.

Earmarked reserves

9. 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.

10. Again it is appropriate that a level of ‘earmarked’ reserves be held by the Authority. A number of appropriate purposes for the creation of earmarked reserves have already been identified in previous years. Appendix 2 sets out the current reserves and their rationale.

Budgeted reserves position for 2006/7 and future years.

11. The agreed budget planned to draw £24 million from earmarked reserves in 2006/07 to support the budget, including within this figure £7 million from the projected underspend in 2005/06. To replenish this, a sum of £17 million was then planned to be transferred to reserves the following year (2007/08) from the revenue account. There were no budgeted movements to or from the general reserve in 2006/07. The following table sets the previously agreed budgeted position:

Clearly, a key part of reviewing the reserves now is to ensure that there is capacity to enable the transfer of £24 million from reserves to assist the budget in 2006/07.

Latest outlook for revenue underspendings 2005-06

12. The latest forecast for the 2005-06 revenue outturn identifies a £7.5 million underspend after allowing for contribution to reserves of £7 million to aid the budget in 2006/07 and £3 million for the creation of a new dilapidations reserve.

Proposed use of reserves directly from the underspend

13. MPS Investment Board has recently approved the following requests for appropriation to reserves, subject to committee approval; a detailed description is attached at Appendix 3:

Other adjustments and reserves

It is essential that existing reserves are reviewed to ensure continuing need and adequacy. Any identified surplus funds can then be used elsewhere. The following reserves have been identified as requiring adjustment.

14. Budget Resilience Reserve. This reserve was established to provide assurance in complying with the 2005/06 budget. There were a number of emerging budget pressures in 2005/06 requiring additional funding. The intention was to review the position regularly during the year releasing funds for priority areas, once confidence was achieved around budget management. The expectation would normally have been that the reserve would be fully utilised in 2005/06 and then closed. The reserve however formed the backbone of the temporary arrangements for financing the additional cost of the bombing/attempted bombings. it is however proposed to close the reserve down and transfer the majority of the balance to the General Reserve. The General reserve will now be more readily able to absorb unexpected shocks now that it is above 1% of Net Revenue Budget.

15. Pension Reserve. The pensions budgets in the revenue account now comprise three main elements (2006/07 budgets shown in brackets):

• Injury payments to officers and, wef April 2006, survivors’ injury awards (£23.0m).
• Capital equivalent payments for ill-health retirements (£4.725m)
• Reimbursements to the pensions account of abated pension payments to officers on the 30+ scheme (£0.75m).

In theory these payments are all discretionary (which is why they are required to be met from the revenue account rather than the Home Office based pensions account). However there is a large legacy element in the injury payments and for practical purposes it would be prudent to regard this element as fixed, with a fair degree of certainty around the level of expenditure. The main volatility is likely to be around the number of ill-health retirements. The number of ill-health retirements has been relatively stable over the last 3 years, around 60 per annum although 2005/06 was very low at only 36. The budget for 2006/07 was based on 64 ill-health retirements at an average cost of £74k. An increase of 20 retirements would therefore cost an extra £1.5m. 30+ numbers are obviously controllable although recruitment plans depend on retaining a number of officers on the scheme in view of their experience. The cost is only around £6k per head. A pension reserve of £5m is therefore likely to be sufficient although it must be stressed that there are some unknown quantities around these new accounting arrangements. An increase in the general reserve will obviously also give some flexibility and security here.

16. It is therefore proposed that the Pension Reserve, which presently stands at £23.5 million should be reduced to £5 million, which in the opinion of the Treasurer is assessed as adequate to deal with any risks from unusual volatile discretionary pension payments. The new pension financing arrangements have now placed the risks associated with pensions and lump sum volatility with the Home Office through the new pensions account. The level of the pension fund will be further carefully reviewed as more experience is gained over the coming years about the profile of payments. The cash so released can in the main part be utilised for ensuring the £24 million aid to the revenue budget is carried through, but it also enables some smaller opportunities for adjustment and establishment of new reserves.

17. Legal Costs. It is proposed to ensure sufficient reserves are available for unbudgeted legal costs. It is proposed that a further £1.0 million (in addition to the £0.5 million above) is transferred for this purpose and that this reserve be under the control of the Deputy Chief Executive and Solicitor to the Authority.

18. Pump Priming Fund. Possibilities of encouraging new, more efficient and/or effective ways of doing business where there is a need for either ‘repayable’ pump priming monies or start up support. At present there are no such reserves or balances available, but members may wish to consider supporting the benefits of an innovative approach in this area. Any proposals would need a clear business case and need member approval for any allocations from the reserve, which would be repayable over an agreed period. An initial sum of £2 million is suggested as a start.

19. Personal Insurance Indemnity Reserve. Finance Committee agreed on 19 January 2006 to create a Personal Insurance Indemnity Reserve, funding it at the rate of £0.17 million per annum from insurance premium savings resulting from the creation of the MPA/MPS personal insurance indemnity.

20. Airport Cost Recovery Reserve. This is a reserve to provide for external assistance to support cost recovery. A sum of £0.1 million is proposed.

21. Budget Smoothing Reserve. This reserve is created to provide the £24 million required to balance the budget in 2006/07; £7 million has already been identified from the 2005/06 underspend leaving a requirement for £17 million which is sourced from the adjustments reported above at paragraph 16.

Summary of reserve movements

22. A simplified summary of the reserves proposals after the various adjustments and transfers are shown below and in more detail in Appendix 1, highlighting balances at 31 March 2005 and 2006. Also coming into focus now for the first time is the trend in reserves over the three planning years which provides the following pattern of reserves:

Two main trends are worthy of comment. The first is the run down of earmarked reserves over the period, which is consistent with expectations reflecting planned spending. The second is the flexibility during 2007/08 to either return some element of reserves to aid the budget, or else to build up earmarked reserves for future events. This is particularly marked by the predicted size of the general reserve, which at some 2.3% might be considered excessive – a reduction to 2% would free up £8.2 million, or more if a general reserve slightly less than 2% were maintained. Members may wish to take this into account when considering the financial envelope report elsewhere on the agenda. The issue can be returned to later in the budget cycle.

C. Race and equality impact

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

D. Financial implications

Financial implications are set out throughout this report.

E. Background papers

None

F. Contact details

Report author: Ken Hunt, Treasurer, MPA

For more information contact:

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

Appendix 1

Analysis of proposed revenue reserves 2005-2006

Figures subject to accounts closure and audit

Appendix 2

Explanation of existing reserves at March 2005

Budget Resilience Reserve. This reserve was established to provide assurance in complying with the 2005/06 budget. There were a number of emerging budget pressures in 2005/06 requiring additional funding. The intention was to review the position regularly during the year releasing funds for priority areas, once confidence was achieved around budget management. The expectation would normally have been that the reserve would be fully utilised in 2005/06. The reserve however formed the backbone of the temporary arrangements financing the additional cost of the bombing/attempted bombings.

Budget Pressures Reserve - This reserve was to meet specific unbudgeted pressures in 2005/06 and should normally expected to be fully utilised by year-end. The outturn report on the current agenda has identified £0.6 emerging budget pressures as being supported. Accordingly the reserve is being maintained at £2.3 million (including the £0.6 million) to provide further flexibility.

Budget Smoothing Reserve – this reserve will need to be created to provide the initial £24 million required to balance the budget in 2006/07.

Central operations tasking – This reserve had been set up to provide funding for central tasking in the central operations groups, the costs of which were previously met through grant. The reserve was be fully utilised in 2005/06.

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 2006/07.

Efficiency and Effectiveness/Service Review – The reserve was created following the 3 year Efficiency and Effectiveness programme from 2000, and later the MPS Service Review. The reserve will now be closed.

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).

Legal costs - This reserve is to provide for the cost of potential lawsuits.

MPA - The reserve supported accommodation costs of office moves, and Independent Custody Visitors – organisational scheme management. The reserve was fully utilised in 2005/06, although it is proposed to top the reserve up in 2006/07.

OCU Carry Over. The reserve has now closed.

Operational costs - The reserve provided for a number of operational activities planned for 2005/06. The expectation would normally have been that the majority of the reserve will be used in 2005/06, with the balance being required in the medium term.

Pandemic response – the reserve is to be used for the cost of anti-viral drugs in order to maintain essential services.

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 2005/06, with the remainder required in the medium term.

Police Pensions - The Authority previously maintained a reserve to make adequate provision for lump sums payable on retirement to officers who at the end of the financial year have completed 30 years service or are aged 55 years or above and can retire at one month’s notice. Following changes to the financing of police pensions the principal reasons for maintaining the reserve are (i) the MPA’s responsibility for the costs of ill health retirements and the need for a reserve to smooth the costs year on year and (ii) assistance in dealing with any net deterioration in the Authority’s financial position re the new pension financing arrangements. For the former it is anticipated that a sum of £5 million will be suitable and should be held to cover possible liability over the coming years, topped up as necessary upon annual review and a substantial part transferred to the general reserve. The latter risk of further adverse movement in the MPA’s revenue budget is assess as low risk and does not need to be provided for. This reserve was a major part of being able to finance the bombings/attempted bombings.

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 2005/06 with the balance required in the medium term. The reserve has been topped up in 2005/06.

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 2005/06, but some residual spend will be undertaken in 2006/07.

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.

Systems – The reserve contributes to the cost of developing financial systems. This will be required in 2005/06 and 2006/07.

Vehicle recovery services – This reserve was established to contribute towards the expansion costs of the vehicle recovery service. It will be fully utilised in 2006/07.

Appendix 3

Information on requests for reserves agreed by Management Board:

• Safer Neighbourhoods: Project slippage has occurred in 2005/06 due to delays in finding suitable accommodation and obtaining planning approval. It is necessary to carry over the funding for the revenue implications of that slippage.
• NSPIS Case and Custody Project: The aim of this project is to allow the MPS to work towards the government targets for joined-up criminal justice. Project delays in 2005/06 have occurred as PITO (Police Information Technology Organisation) have been unable to confirm the level of external funding.
• TRIS (Traffic Reporting Information System) Project: This project within the Central Traffic Criminal Justice Unit is to support centralisation of traffic prosecution work at Marlowe House. The current work of the unit is seriously hampered by the need to use inefficient legacy IT systems involving multiple keying of the same information.
• Met Forensics: this project is to provide a Forensic Case Management System giving a complete audit trail of forensic evidence. The project has suffered significant delays due to supplier under-performance against the contracted plan.
• MPS Insurance Strategy: This is to safeguard the MPS against the risk of increased premiums in 2006/07. In recent years the MPA and MPS have sought to reposition the organisation’s insurance strategy, reflecting the volatile and changing environment the MPS is operating within.
• Potential legal costs: This is required to provide for potential legal/settlement costs in case litigation moves against the MPS/MPA.
• Citizen Focus Policing Programme: This relates to a delay in undertaking plans due to a necessary re-direction of activity in 2005/06. The funding will be used to support 3 key areas i.e. MPS Citizen Focus Policing Programme, MPS Single Equalities Scheme and Legislative training requirements.

MPA Projects: This is to support the local Crime and Disorder Reduction Plan and generate partnership working. The funding will not be used to deliver general borough operations but for example is to allow pilot of other activities that would not otherwise be undertaken.

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