Appendix 6

Level of specific reserves and general balance 2007/08

1 The Local Government Act 2003 requires that the Treasurer assess the financial risks faced by the Authority and makes recommendations based on this as to the appropriate levels of resources required to be held against these risks.

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, e.g. the likelihood that there will be more uninsured claims in future.

Level of reserves required

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 has a good recent record in achieving these), together with other assistance available through the flexible use of capital funding.

The main factors used to evaluate the primary financial risks facing the Authority, together with the suggested amounts required to cover them, are summarised in the following sections.

Pensions fluctuations

In previous years the reserves needed to cover potential pensions fluctuations have been set at £650,000 to allow for the lump sum impacts of firefighters retiring (as they have the discretion to retire at variable times in many cases), and £250,000 to allow for volatility in transfer values paid and received. The new financial framework for pensions, which came into force on 1 April 2006, has eliminated most of these risks. There are still some risks associated with pensions relating in the main to the number of ill-health retirements but given that they are paid over a three year period a sum of £50,000 is considered sufficient.

Inflation risk: Pay

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 firefighters' pay award takes effect from July and therefore there is 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 when the pay award has not been agreed until much later than this.

Here it is felt that a reserve equivalent to an additional 1.0% of firefighters' pay and support is sufficient, i.e. £370,000.

Uninsured risks

Although the Authority has insurance in place, there remain risks. There was 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.

Extremes of weather

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 which builds in a budget variation for increases in the number of incidents. Historically, the highest variation was 16.5% in 2001/02, but this was exceptional, and an anticipated variation of up to 10% is considered sufficient. This would equate to £250,000.

Other inflation

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 £40,000.

Regionalisation

The increasing impact of the regional agenda leads to additional uncertainties. It is hoped that this will be sufficiently covered by the specific revenue budget provision of £150,000 made in 2005/06 and largely due to be carried forward into 2006/07, and built into the base budget thereafter. This will, however, be an area to keep under review.

Capital Programme issues

Should it be agreed, the Authority will have a significant capital programme underway during 2007/08. The timing of payments and to a certain extent overall project costs are difficult to estimate. It would make sense in taking the capital programme into account when considering the level of general balance to hold. It is difficult to rationalise a formula-based approach to this, but a sum of £500,000 would not appear unreasonable.

Uncertainties in 2007/08 and beyond

The Authority is facing major changes - many of which the costs and timings are far from clear. These include IRMP, possible merger with the Isle of Wight, equal pay audit, take up of pension by retained firefighters, regional control issues, Firelink and a replacement secondary control room. Should the Authority choose to join the insurance mutual then a financial guarantee of £287,000 is required. Again it is difficult to rationalise a formula-based approach to this, but a sum of £800,000 would not appear unreasonable.

Conclusion: level of reserves

Bringing all these factors together leads to a `maximum exposure' of £2.6m 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, and recent years have produced underspends. 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, it is considered sensible to take a more cautious position so a reduction of only 25% is proposed: this can be revisited if the Authority's budget performance continues to be healthy. This would suggest that an appropriate level of reserve is £1,958,000. Given the imprecise nature of the assessment, it is reasonable to round this up to £2m. Naturally, the level can be kept under review in light of both experience and variations in factors such as uninsurable risks and inflation rates and in particular the major changes the Authority faces over the coming few years.

This results in reserves at just over 3% of annual spend, which appears to be a somewhat lower proportion than for most other fire and rescue authorities.

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. In addition this does not take account of how much risk is being carried in the revenue budget. Hampshire's budget is built on a realistic basis with prudent provision for future inflation being provided for.

Table 1: Summary of Factors

Factor	Assessed impact £000
Pensions: payments	50
Inflation: pay	370
Uninsured risks	600
Extremes of weather	250
Inflation: other	40
Capital factors	500
2007/08 uncertainties	800
	2,610
x 75%	1,958
Nearest £100,000	2,000

Accordingly, the budget for 2007/08 has been built on the basis of continuing to provide for a £2m level of reserves.