February 7, 2000

TO: Policy and Finance Committee

FROM: Chief Financial Officer & Treasurer

SUBJECT: Administration of Reserves and Reserve Funds

Purpose:

This report establishes the general principles and rules under which reserves and reserve funds will be created, operated and closed, provides a status report on the uncommitted balances of each reserve as at November 30, 1999 projected to year-end based on the City=s financial statements as of December 31, 1998 and provides instructions for introduction of the by-law to enact the formal establishment of each reserve and reserve fund.

Financial Implications and Impact Statement:

This report has no direct funding implications.

Recommendations:

It is recommended:

(1) That Clause 11 of Report No. 6 (April 16, 1998) of the Strategic Priorities and Policies Committee entitled "Establishment of City Reserves and Reserve Funds" from the Chief Financial Officer & Treasurer adopted, as amended, by Council on April 29 and 30, 1998 be further amended as set out in the body of this report and the appendices attached hereto;

(2) That the rules for the establishment and use of reserves and reserve funds be adopted and incorporated into a Reserve and Reserve Fund By-law as follows:

(a) A reserve or reserve fund is established by Council on the recommendation of the Chief Financial Officer & Treasurer and the report must include:

(i) statement of purpose;

(ii) designation of the service area >owner=, or beneficiary program;

(iii) rationale for the appropriate level to be maintained in the account (where appropriate);

(iv) initial contribution, if any;

(v) contribution policy;

(vi) withdrawal policy; and

(vii) review cycle which would provide a periodic review to ensure a suitable level of funds, the appropriateness of the account, and conditions for closing.

(h) Annual estimates of inflows to and outflows from reserve and reserve funds shall be presented to the Policy and Finance Committee for approval as part of the annual budget process. The Treasurer, in consultation with the program area, where not contrary to law, shall determine if the use of a reserve and reserve fund is appropriate as a funding source in either operating or capital budgets or if funds should be contributed to a reserve or reserve fund from a particular source.

(i) Should funds be withdrawn from either a reserve or reserve fund for a specific purpose or capital project and subsequently it is determined that the funds are not necessary in whole or in part for that purpose (project), then these surplus funds should be returned to their original reserve or reserve fund.

In such cases where such time has elapsed that the original reserve or reserve fund cannot be traced or is no longer appropriate, the funds would be transferred, subject to compliance with any legislative restrictions, upon recommendation to Council of the Chief Financial Officer & Treasurer, to general revenues, reserves or reserve funds as appropriate. Similarly, if reserve or reserve funds are provided to acquire an asset and subsequently the asset is sold, the net proceeds would go back to the originating reserve or reserve fund.

(j) The Chief Financial Officer & Treasurer shall be authorized to make contributions to any tax supported reserve or reserve fund, where it is not contrary to law, to reduce or eliminate unanticipated changes in future years' tax rates that would otherwise occur based on changes in the surplus from year to year or to fund unfunded reserve and reserve funds. Such contributions are to be reported to Council in the next corporate variance report.

(e) That reserve and reserve fund increases and decreases should be reported as appropriations to and from reserve funds.

(f) When the purpose for which a reserve or reserve fund has been accomplished, and

it is deemed no longer necessary, the Chief Financial Officer & Treasurer, in consultation with the program area, will report to Council recommending closing the account, the disposition of any remaining funds, and the necessary amendment to the Reserve and Reserve Fund By-law.

(7) That the reserve and reserve funds identified in Appendix A (Column C) be established and incorporated into the Reserve and Reserve Fund By-law;

(8) That the Chief Financial Officer & Treasurer be authorized to administer reserve and reserve funds as set out in this report;

(9) That any changes in accounting for reserve or reserve funds which result from the adoption of the Reserve and Reserve Fund By-law as outlined in this report shall be effective from January 1, 2000;

(10) That the by-laws and resolutions of the former municipalities creating reserve and reserve funds be repealed;

(11) That the by-laws of the new city creating reserve funds from January 1, 1998 to the present be repealed;

(12) That leave be granted for the introduction of the necessary bill in Council to give effect to the foregoing; and,

(13) That effective date of the reserve and reserve fund by-law be January 1, 2000.

Background:

At its meeting of April 29 and 30, 1998 Council adopted, as amended, Clause 11 of Report No. 6 (April 16, 1998) of the Strategic Priorities and Policies Committee entitled "Establishment of City Reserves and Reserve Funds" from the Chief Financial Officer & Treasurer. That report recommended the consolidation of various corporate reserves and reserve funds, that the adequacy of reserves be reviewed, that a by-law be prepared to establish appropriate reserve funds for the City and that the Chief Financial Officer and Treasurer exercise discretion to use reserve funds for any purpose other than that for which the fund was established in matters less than $50,000.

At its meeting of December 13, 1999, the Audit Committee had before it a report (November 29, 1999) from the City Auditor which recommends, inter alia, that (1) the Chief Financial Officer & Treasurer provide Council with reserve and reserve fund continuity schedules, (2) that appropriate accounting policies and procedures relating to reserves and reserve funds be developed, and (3) that a subsequent report regarding consolidation, continuance and creation of reserves and reserve funds clearly identify changes to the April 16, 1998 report and indicate any amendments.

This report provides (1) continuity schedules to the end of December 31, 1999, (2) the underlying principles for the use of reserves and reserve funds, (3) new reserve funds created since January 1, 1998 and (4) deals with amendments to the April 16, 1998 report. A companion report will deal with the adequacy of reserves and reserve funds. The continuity schedules to the end of December 31, 2000 with be dealt with in a forthcoming report.

Discussion:

Reserves and reserve funds have designated purposes and are created through the specific authorizations of Council. The major difference between the two is that all earnings from the investment of reserve funds must form part of the reserve fund, whereas the earnings from reserves flow to the operating budget. As such, the assets of reserve funds are segregated and restricted to the purpose of the reserve funds and generally they may be combined for investment purposes.

Reserves and reserve funds form an integral part of sound financial management and planning whereby revenues from one period can be set aside to accumulate and finance planned expenditures in a future period. They are used to:

(a) anticipate potential liabilities and to provide resources, when and if, these liabilities have to be funded (such as sick pay reserve);

(b) even the flow of disbursements over a time period so that there are not significant impacts on the tax rate due to the fluctuations of large purchases (such as a vehicle replacement reserve);

(c) accumulate funds in anticipation of a large purchase (such as a major building); and,

(d) provide a pool of funds to self-finance an on-going activity (such as a building maintenance reserve).

(I) Reserves

The authorization for the creation of a reserve is governed by the Municipal Act, Section 367(3) which states in part "in preparing the estimates, the Council of a local municipality shall make due allowance for a surplus of any previous year that will be available during the current year and shall provide for any operating deficit of any previous year and for the cost of collection, abatement of and discount on taxes and for uncollectible taxes and may provide for taxes that it is estimated will not be collected during the year and for such reserves as Council of the municipality considers necessary".

A reserve is funded by contributions from the operating budget at the discretion of Council, after provision for known expenditures. It has no reference to any specific asset and does not require the physical segregation of money or assets as in the case of reserve funds. The creation or increase of a reserve should only be reported as appropriations to reserves on the Consolidated Statement of Operations of the City and not as an expenditure. Likewise, the decrease of a reserve should only be reported as appropriations from reserves on the Consolidated Statement of Operations of the City. The actual expenditure for the reserve should be reported as an expenditure for current or capital operations.

Appendix B1 provides the purpose of each reserve, source of funding and/or special rules concerning the receipt or application of the funds. Appendix B2 provides a continuity schedule for the 15 City reserve accounts which will have a projected uncommitted aggregate balance of $217.9 million as at December 31, 1999.

(II) Reserve Funds

The Municipal Act governs the establishment of reserve funds. Section 163(2) states "every municipality, local board and other entity may in each year provide in its estimates for the establishment or maintenance of a reserve fund for any purpose for which it has authority to expend funds". The section goes on to state "the earnings derived from the investment of the reserve fund form part of it," (2.3) and, "Council may by by-law provide that the money raised for a reserve fund established under subsection (1) may be spent, pledged or applied to a purpose other than that for which the fund was established" (4). As well subsection 5 states that " the auditor in the annual report shall report on the activities and position of each reserve fund established under subsection (2)". As well reserve funds are established when required by the provisions of other legislation such as the Planning Act.

There are two types of reserve funds: obligatory and discretionary.

Obligatory reserve funds are governed by legislation or agreement, and require revenue received for the special purpose(s) to be segregated from the general revenues of the municipality. They must be created whenever a statute requires revenues received for a special purpose to be used solely for the purpose described for them in the statute or agreement. Some examples would be surplus parking revenues under Clause 207(56) of the Municipal Act, funds received in lieu of land for parks purposes as set out under Subsection 42(14) and (15) of the Planning Act or funds received as development charges under the Development Charges Act, 1997.

Appendix C1 provides the purpose of each obligatory reserve fund, source of funding and/or special rules concerning the receipt or application of the funds. Appendix C2 provides a continuity schedule for 76 City obligatory reserve funds which will have a projected uncommitted aggregate balance of $258.0 million as at December 31, 1999.

Discretionary reserve funds may be established whenever a municipal council wishes to earmark revenues to finance a future expenditure for which it has the authority to spend money, and physically set aside a certain portion of any year=s revenue so that the funds are available as required in subsequent years. The Provincial guidelines suggest that "municipalities create new reserve funds or additional allocations to a reserve fund through the estimates process, defining the purpose for which the reserve fund is being created". The general Municipal Act provisions regarding reserves and reserve funds allow for a number of different purposes such as future expenditures on land acquisition, buildings, capital projects, vehicle replacement, insurance, and employee benefits.

Appendix D1 provides the purpose of each discretionary reserve fund, source of funding and/or special rules concerning the receipt or application of the funds. Appendix D2 provides a continuity schedule of the 71 discretionary reserve funds which will have a projected uncommitted aggregate balance of $452.6 million as at December 31, 1999.

Reserve fund increases and decreases should be reported as appropriations to and from reserve funds.

(III) Status of Reserves and Reserve Funds

Table 1 is a status report on the aggregate total of reserves and reserve funds for the entire portfolio. Appendices B2, C2 and D2 provide a status report on the individual funds.

TABLE 1

RESERVE AND RESERVE FUND AGGREGATE BALANCES

($,000,000)

* Refers to the application of the funds not the source

** These hold the funds transferred to the City from the Province to fund the Sheppard Subway and the TTC's state of good repair program. These are shown separately because they represent very temporary reserve funds which will be expended in the next two years.

In aggregate, the City's reserves and reserve funds have declined by the end of 1999. In particular, the reserves and reserve funds supporting the capital works program are decreasing while the reserves and reserve funds supporting the operating budget are increasing or are stable. (see Table 2)

The reserve funds contributing most to the significant reduction in reserve balances in 1999 are the Vehicle and Equipment Replacement Reserve ($38 million), Winter Control Stabilization Reserve ($17 million), Water reserve accounts ($51 million), Capital Financing Reserve Fund ($23 million), and the Insurance Reserve Fund ($11 million). Reserve and reserve funds need to be considered in the context of the City's overall financial plan. The over-all adequacy of reserves and reserve funds is detailed in a separate report.

TABLE 2

RESERVE AND RESERVE FUND AGGREGATE BALANCES

($,000,000)

* Refers to the application of the funds not the source

** These hold the funds transferred to the City from the Province to fund the Sheppard Subway and the TTC's state of good repair program. These are shown separately because they represent very temporary reserve funds which will be expended in the next two years.

(IV) Rules for the Establishment and Use of Reserves and Reserve Funds

To date, the City has had no formal policies governing the establishment and use of reserves and reserve funds. However, an annual review is undertaken of all reserves and reserve funds. Moreover, the City has followed certain Provincial requirements in the reporting of these accounts according to the Ministry of Municipal Affairs and Housing, as a guide for the use of reserves and reserve funds or special funds.

There is a need for the establishment of policies and procedures for the creation, use and closing of reserves and reserve funds to ensure compliance with legislative requirements, and compliance with the City's own guidelines. The following are the recommended policies and procedures required for good stewardship that are to be included in the Reserve and Reserve Fund by-law:

(A) Creation of Reserve and Reserve Funds

1

(1) A reserve or reserve fund can only be established through a report to Council, either authored by the Chief Financial Officer & Treasurer or co-authored by same which must include:

2

(a) statement of purpose,

(b) designation of the service area >owner=, or beneficiary program,

(c) rationale for the appropriate level to be maintained in the account (where appropriate),

(d) initial contribution, if any,

(e) contribution policy,

(f) withdrawal policy, and

(g) review cycle which would provide a periodic review to ensure a suitable level of funds, and the appropriateness of the account .

Normally reserves and reserve funds would be created as part of the annual budget process, and each such account would be established through its own by-law (as noted above in the guidelines set out by the Ministry). The by-law would set out the purpose of the reserve and any conditions on its application or funding as well as any special provisions not covered in the general policies of the City with respect to reserves and reserve funds.

The budget is the financial result of an operating plan and as such the need for an additional reserve and the funding of same is the logical result of the planning process which should be presented to the Policy and Finance Committee at the time of the overall budget.

(B) Budgeting for Reserves and Reserve Funds

(1) The projected year-end levels of, inflows to and outflows from reserves and reserve funds shall be reported to the Policy and Finance Committee as part of the budget process - capital or operating depending on the nature of the flow. There will be no direct recording of revenue to, or expenditures from, a reserve account except for funds provided from third parties, i.e. inflows and outflows involving City funds would normally flow through income statement accounts.

(2) The Chief Financial Officer & Treasurer, in consultation with the program area, where not contrary to law, shall determine if the use of a reserve and reserve fund is appropriate as a funding source in either capital or operating budgets or if funds can be contributed to a reserve or reserve fund from a particular source.

(3) Should funds be withdrawn from either a reserve or reserve fund for a specific purpose and subsequently it is determined that the funds are not necessary in whole or in part for that purpose, then these surplus funds should be returned to their original source. In such cases where such funds were provided from the operating budget or where such time has elapsed that the original source cannot be traced or is no longer appropriate, the funds would be transferred, upon recommendation of the Chief Financial Officer & Treasurer, where not contrary to law, to general revenues, capital accounts, reserves, or reserve funds as appropriate. Similarly, if reserves or reserve funds are provided to acquire an asset and subsequently the asset is sold, the net proceeds would return to the originating source or to a capital reserve or if from the operating budget, to an account to be used for capital purposes, subject to compliance with any legislative restriction.

(C) Year End

The Chief Financial Officer & Treasurer shall be authorized to make contributions to any tax supported reserve or reserve fund, where it is not contrary to law, to reduce or eliminate unanticipated changes in future years' tax rates that would otherwise occur based on changes in the surplus from year to year. This would be reported to Council either through the normal budget process or in conjunction with the quarterly variance report.

(D) Closing of Reserves and Reserve Funds

When the purpose for which a reserve or reserve fund has been accomplished, and it is deemed no longer necessary, the Chief Financial Officer & Treasurer, in consultation with the Program will, if appropriate, report to Council recommending closing the account, the disposition of any remaining funds, and an necessary amendment to the Reserve and Reserve Fund By-law.

(E) Reserve and Reserve Fund By-law

Appendix A sets out a list of the reserves and reserve funds of the former municipalities as at December 31, 1997 (Column A), the list of these funds as outlined in the April 16, 1998 report (Column B) and the list which is being recommended for inclusion in the new by-law (Column C). It also sets out a list of reserve funds created since January 1, 1998 and the Casa Loma Capital Maintenance Reserve Fund authorized in the 2000 Capital Budget. Appendices B1, C1, and D1 set out the purposes of the reserve and reserve funds which are being recommended for inclusion in the Reserve and Reserve Fund By-law.

The report (April 16, 1998) was an initial effort to amalgamate the former municipalities' reserves and reserve funds. The report attempted to divide the reserves and reserve funds into two groups - those accounts which should be continued into the new city and those which should be consolidated. The major thrust of the report was an attempt to consolidate accounts with similar purposes - primarily 'corporate' reserve and reserve funds. The former municipalities had set aside funds for very similar purposes such as employee benefits or insurance provisions. In these cases, because the purposes are quite similar, there is no need to have separate accounts segregated by the former municipality.

Since the April 16, 1998 report, more analysis has been undertaken concerning the purposes of the reserves and reserve funds of the former municipalities. As well, new decisions have been made concerning the appropriateness of the designation of reserve or reserve funds to certain accounts. The result is the need to adjust the classifications in the April 16, 1998 report. The first section of Appendix A lists the recommended adjustments to the April 16, 1998 report. The second section lists the accounts consistent with the April 16, 1998 report and the third section is a list of accounts created by Council since the April 16, 1998 report.

A set of new accounts will be created for accounts which are being recommended for consolidation and for the continuation of wide range of unique accounts of the former municipalities as set out in Column C of Appendix A. The aggregate balances to the consolidated accounts will be transferred to the new accounts. For the accounts which are to be continued the balances will be maintained. An illustration of this latter situation for example would be the Ridley Road Maintenance Reserve Fund (North York) or International Office Reserve Fund (Toronto) or Racquet Sport Reserve Fund (Scarborough). It should be noted that the starred legacy funds will only be maintained until their balances are reduced to zero, at which point the Treasurer will be recommending to Council to close the accounts and amend the Reserve and Reserve Fund By-law accordingly since new funds with similar purposes are being created by the by-law and this report.

As well, the Financial Control By-law deals with the authority of the Chief Financial Officer & Treasurer with respect to spending authority for the capital and operating budgets. Given that authority and the rules set out in this report, there is no need for additional reserve and reserve fund spending authority.

All previous by-laws and resolutions with respect to reserves and reserve funds of the former municipalities would be repealed and the new by-law would either create new ones with similar purposes or provide for the continuance of the existing by-laws until all funds are spent. Any changes in accounting for reserves or reserve funds which result from the adoption of the by-law should come into force as of January 1, 2000. It is recommended that the City Solicitor be authorized to introduce a bill into Council for the creation of a Reserve and Reserve Fund By-law effective January 1, 2000 based on Column (C) of Appendix A with the purposes provided in Appendices B1, C1, and D1.

Conclusion:

Reserves and reserve funds form an integral part of financial management and planning. It is important to ensure that these accounts are established, funded and managed in a way that enhances the City=s capacity to anticipate and manage risk. This report has set out some rules to be followed in the operation of all reserve and reserve funds. Direction is provided to the City Solicitor to enable the creation of a by-law setting out the reserves and reserve funds for the City and the rules. Future reports will outline the adequacy of specific reserves and reserve funds to protect the City against the appropriate risk and a strategy to fund the reserve or reserve fund if the current level should prove to be inadequate.

Contact:

N. Donald E. Altman, Manager, Financial Planning

Phone: (416) 397-4220, Fax: (416) 397-4555; E-mail: daltman@ city.toronto.on.ca

Len Brittain, Director, Treasury and Financial Services

Phone: (416) 392-5380, Fax: (416) 397-4555; E-mail: lbrittai@toronto.ca

W.A. Liczyk

Chief Financial Officer and Treasurer