Contact: Paul Carey-Kent, ext 01962 847525

1 Introduction

1.1 This report considers two issues:

· What would be an appropriate level of reserves for the Authority to hold when it becomes a precepting local authority from 1 April 2004?

· What would be the appropriate means of generating the required level of reserves?

1.2 Under the current arrangements, the constituent authorities effectively provide reserves on behalf of the Authority, which it is able to request via supplementary levies in order to deal with unexpected spending requirements. This will change when the levy is replaced by a precept. In future, any such requirements will have to be met from within this Authority's own resources. This requires reserves to be available. These should be set at a prudent level, in order to minimise the amount of public money tied up in reserves rather than in providing services or reducing council tax levels.

1.3 All the indications to date suggest that the Government does not intend to issue guidance on what is considered a prudent level of reserves, nor on how such reserves should be set up and funded.

1.4 In considering financial risks, a distinction must be made between:

· A provision, which is made for a known and quantified expectation of costs. It is usual, for example, to hold some provision in the Authority's accounts in respect of specific known claims against the Authority, which are not covered by insurance.

· On the other hand, reserves are set up against the possibilities of future costs that are not yet expected nor quantified, eg the likelihood that there will be more uninsured claims in future.

2 Level of reserves required

2.1 The approach taken in this paper is to assess the risks of increased expenditure that the Authority faces during any given year. Some adjustment is then appropriate given that:

· there is a much smaller chance that all identified risks will occur in the same year; and,

· the use of reserves is not the only means of meeting such pressures. Savings/transfers from underspent budgets are preferable, and the Authority does have some temporary borrowing powers which could be used if necessary, together with other assistance available through the flexible use of capital funding.

This paper represents an initial, rather than definitive, view of the amount required. This might change as part of the budget setting process, eg in light of further information or guidance from the Government, comparative data from other fire authorities or new trends in costs . The amount required would also be subject to review in the light of experience once the precepting arrangements are in place.

2.2 The main factors used to evaluate the main financial risks facing the Authority, together with the suggested amounts required to cover them, can be summarised as follows:

3 Pensions

3.1 Firefighters have discretion to retire with a pension when they choose to after the age of 50 (but before 55) with 25 years' service and some also retire earlier due to ill health. The budget is set based on an estimate of likely retirement numbers, informed by past trends. For example in 2003/04 pension lump sum payments of £2.3m are budgeted for, but if all firefighters who could retire did so as early as possible the cost would be £4.9m (mainly for lump sums, but also to cover the cost of paying pensions earlier). Since 2000/01 the lump sum budget has been up to 18% (£389,000) different from the estimate. It appears reasonable, therefore, to set the likely worst case situation at 25% of the difference between `maximum' lump sums and estimated lump sums, ie £650,000.

3.2 There is also some volatility in transfer values paid and received. Around £0.5m can be expected in each direction, but it depends on the balance of numbers between those leaving Hampshire for other brigades and those coming to Hampshire from elsewhere. Historically, variations have tended to increase net income, but this could change. To allow for 25% fewer transfers in and 25% more transfers out in a year would require a reserve of £250,000.

4 Inflation risk: Pay

4.1 There may be a need during the year to meet the costs of a pay award not known at the time of setting the budget. The application of formula approaches could minimise this effect, but some impact is likely with firefighters' pay awards taking effect from July, ie with a substantial first year impact but with a good chance that the figure will not be known in February when the budget is set. Non-uniformed staff pay is more likely to be known in advance, given an effective date of awards of 1 April - though, there have been occasions in recent years when the pay award has not been agreed until much later than this.

4.2 Here it is felt that a reserve equivalent to an additional 1.5% of firefighters' pay would be sufficient, ie £300,000. Any unknown factors in non-uniformed pay can be dealt with by way of a provision as part of the budget setting process if necessary.

4.3 For 2004/05 the firefighters pay award is already known. Consequently, there will be no need at this stage to include this factor in setting up an opening level of reserve, but this will need to come into play from 2005/06.

5 Uninsured risks

5.1 Although the Authority has insurance in place, there remain risks. There is a period when the Authority effectively became uninsured from April 1997 to June 2001 due to its primary insurer going into liquidation. There are also some uninsured risks, e.g. for employment practice issues; and, if there are higher than budgeted levels of insurance claims, then there will be higher excess costs to pay. This is one of the harder areas to assess, but based on the historic number of uninsured risks tending to come forward and the continuing trend towards more litigation, £600,000 is recommended.

6 Extremes of weather

6.1 Unusually hot dry summers, wet winters and storms can all lead to additional operational costs, primarily associated with increased activity by retained firefighters. This is recognised under current arrangements through a protocol with constituent authorities which builds in a budget variation for increases in the number of incidents (though with the first 5% of any increase absorbed by the Authority). Historically, the highest variation was 16.5% in 2001/02, but this was exceptional, the second-largest variation in a year being 6%, and an anticipated variation of up to 10% is considered sufficient. This would require £220,000.

7 Other inflation

7.1 There is some risk attached to non-pay inflation levels: for example, insurance and fuel costs. To allow for a possible 10% increase in these heads over and above the budgeted level of inflation would require £90,000.

8 Conclusion: level of reserves

8.1 Bringing all these factors together leads to a `maximum exposure' of £2,110,000 as set out in Table 1. However, as mentioned above, other funding sources may be available, and it is not likely that all these problems will occur in the same year. That is illustrated historically by the fact that the Authority's outturn position has very rarely resulted in an overspend. In theory it would probably be reasonable to discount the level of reserves required by 50% for the improbability of simultaneous recurrence of problems. However, with so many uncertainties under new arrangements, it is considered sensible to take a more cautious position so a reduction of only 25% is proposed. This would suggest than an appropriate level of reserve would be £1,360,000 to cover 2004/05 (firefighters' pay awards known in advance) and £1,580, 000 in the longer term when the level of firefighters pay awards are not known in advance. Given the imprecise nature of the assessment, it is reasonable to round these amounts up to £1.4m and £1.6m respectively. Naturally, the level can be kept under review in light of both experience and variations in factors such as uninsurable risks and inflation rates.

8.2 This would result in reserves at 3% of annual spend. This appears to be a somewhat lower proportion than for most other fire and rescue authorities. Even before they have the legal power to set up reserves, some fire authorities already have higher relative levels of money set aside.

8.3 This is a relevant background factor, though not a determinant of good practice as it may be for example that less strict control of budgets is in place in such authorities, and Hampshire should also gain through the `economy of scale' in spreading risks across a larger spending base than most. By way of a local comparison, Hampshire Police Authority operate at around 2% reserves on spending of over £200m, with similar pension issues.

8.4 Table 1: Summary of Factors

9 How should the build up of reserves be funded?

9.1 There are three potential resources from which to build up reserves: contributions from constituent authorities, underspends against this Authority's budget for 2003/04 and collection from this Authority's future tax base through the precept. From the point of view of the public purse, all three routes are ultimately funded by council taxpayers, but there are sensitivities involved such that an equitable division across these headings should be sought.

10 Contributions from constituent authorities

10.1 As explained above, constituent authorities effectively hold the reserves necessary for this Authority at present. However, due to the economy of scale they gain from being able to offset fire and rescue risks against the many other risks in their portfolio of services, the percentage reserve they will need to hold against fire and rescue risks will be comparatively small. An equitable solution would be to identify across constituent authorities the level of un-earmarked reserves held against total budgets (excluding schools, which are a separate case as they retain their own reserves).

10.2 The city councils, being smaller, have historically had to hold higher percentage reserve levels However, it would be difficult to reach agreement on the basis of variable percentage contributions across the constituent authorities. It is therefore proposed that all three constituent authorities contribute on the basis of the County Council's un-earmarked reserves of 1.2% of non-schools budgets. This, applied to this year's fire and budget of £51.3m would lead to a total contribution of £615,000 from the constituent authorities.

10.3 In effect, this represents the contribution by constituent authorities of the reserves now deemed to be held to cover current arrangements. The introduction of precepting makes the system of financing less efficient by reducing economy of scale, and it is reasonable that the costs of this inefficiency should fall on the Authority's budget/precept.

10.4 Whilst it would be possible to attempt, as an alternative, the historical route of identifying past Fire and Rescue Authority underspends given back to constituent authorities, constituent authorities have not retained these underspends in ring-fenced provisions, and could anyway argue that they have been used up in order to fund the increases in recent years in this Authority's levy. Such an approach is not, therefore, recommended.

10.5 This approval was agreed by constituent authorities at the meeting on 14 October.

11 Fire Authority underspends 2003/04

11.1 If any underspendings are achieved in 2003/04, it might be appropriate to agree a mechanism with constituent authorities whereby that was made available, in whole or in part, to add to balances. However, the prospects for underspending appear limited at present. The note of the consultation meeting with constituent authorities sets this out more fully.

12 Use of the precept

12.1 If a precept were to be set on the basis of this year's budget, then the requirement would be for council tax of £42.48. At that level, 49% of the Authority's budget would be funded from the council tax, and for each £1m increase (1.95%) in the Authority's budget a council tax increase of £1.68 (3.95%) would be required. Consequently, if the approach proposed were followed, a contribution of £785,000 to the opening reserve would require £1.32 (3.1%) to be included within the initial council tax precept.

12.2 Table 2: Proposed Funding (£000)

*less any underspendings available (see 11.1)

Recommendation

That it be a recommendation to the Authority that it should plan on levels of reserves as follows: 2004/05 £1.4m, 2005/06 £1.6m, and that the set up of these reserves should be funded as follows: constituent authority contributions £615,000, raised through precept £785,000 in 2004/05. £200,000 in 2005/06 (both offset by any available underspends).

Section 100 D - Local Government Act 1972 - background papers

The following documents disclose facts or matters on which this report, or an important part of it, is based and has been relied upon to a material extent in the preparation of this report.

NB the list excludes:

Published works.

Documents which disclose exempt or confidential information as defined in the Act.

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