Part 4: Integrating best information and reasonable assumptions

Medium-term planning in government departments: Four-year plans.

4.1
In this Part, we look at the information provided in four-year plans, including:

the scope of four-year plans;
forecasting assumptions;
financial forecasting;
integration of financial information into a department's operational activities, and analysis of choices and trade-offs;
asset management and capital intentions; and
how to improve four-year planning.

Summary of our findings

4.2
Assumptions are fundamental to forecasting in general and to the usefulness of four-year plans. Although some plans stated the assumptions used, the assumptions were inconsistently identified, applied, and calculated and did not always provide enough information to understand the funding needed to achieve a department's objectives.

4.3
It is important that four-year plans are based on the best and most complete information available for all the Votes and appropriations administered by the department. Four-year plans currently focus primarily on the department's operations, rather than all the Votes and appropriations administered by the department.

4.4
Departments should have a good understanding of where their funding is spent, why it is spent, and how resourcing will shift to priority areas during the four years. They should have budget forecasting models for estimating future costs, service demands, resources needed to deliver services, and revenue requirements. One of the four departments we looked at had an excellent flexible budget forecasting model, but others lacked a robust forecasting system or had a system that was not well integrated throughout the department.

4.5
Information contained in four-year plans made it difficult to assess the trade-offs and prioritisation that would be needed to ensure that a department did not overspend. Departments identified cost pressures and funding shortfalls but did not always provide detailed information about how the shortfalls in funding would be addressed or the actions the department would take to address cost pressures.

4.6
Information in four-year plans on assets was generally less well developed, meaning that the plans are not yet likely to effectively identify cost pressures and risks, and the effect of these on the finances of the Government and the services intended to be delivered to the public.

4.7
Recent capital and asset management initiatives taken by the Treasury should strengthen four-year planning, allowing departments to better incorporate information about sector trends, and capital and asset management intentions.

Scope of four-year plans

4.8
The published guidance provides advice on the scope of four-year plans and the matters that should be addressed, according to their significance.

4.9
Departments are requested to include in their four-year plans information about:

all of the Votes and appropriations they administer;
the state of the sector/department's asset base and the performance of, and any issues for, the sector in managing capital assets and areas for improvement;
the Crown entities that the department monitors, including the sustainability of the Crown entity and its contribution to the department's strategic objectives; and
any sector and functional leadership roles of the department, including its contribution to the Government's priorities and cross-department objectives.

Forecasting assumptions

4.10
The published guidance does not specify the assumptions that a department should use when preparing its four-year plan. Each department is considered to be best placed to determine those assumptions. We agree that a department's assumptions should reflect the department's circumstances.

4.11
However, we found that assumptions used in four-year plans were limited. In our view, they did not necessarily provide enough information to understand the funding needed to achieve a department's objectives.

4.12
We identified several issues with the way departments used and applied assumptions, including:

Assumptions were usually about financial matters. Assumptions about other matters, such as government policy, demographics, and expected demand for services, were not always disclosed, included, or consistent with other plans or strategies.
Two of the four departments we reviewed did not allow for inflation during the period of the plan.
The description of actual assumptions used for forecasting was sometimes incomplete, meaning that it was difficult to understand the assumptions used.
Inconsistent assumptions were used in the four-year plan.
There was not enough available evidence to support or justify some assumptions.

Financial forecasting

4.13
The financial starting point for four-year plans are the baselines for Votes as at the relevant October Baselines Update. All financial information referenced in a four-year plan must be "anchored" to this starting point.⁸

4.14
In terms of the Government's budgeting cycle, this timing allows the Treasury to review individual four-year plans and for the plans to inform budget decisions made by the Executive branch of government. These decisions can then be translated back into the departmental baselines. It also means that plans need to be finalised in time to inform decisions, which is usually before the end of each calendar year.

4.15
We reviewed the information provided in plans and, generally, were able to reconcile the operating expenditure baselines in the schedules in the four-year plan to the underlying supporting financial information.

4.16
It is also important that a department be able to show that information contained in its four-year plan is consistent with other departmental information. This was not always so, and we saw one example where there was no reconciliation between funding as set out in the Estimates and internal forecast funding.

4.17
In some situations, the information contained in four-year plans quickly became out of date. For example, budget bids, successful or otherwise, were not included. Information can also become out of date because of the delay between when the four-year plan is prepared (November and December each year) and its potential publication (June or July the following year). The State Services Commission told us that it encourages departments to treat their four-year plan as a "living document" and update them when it is useful to do so.

4.18
However, when updating the information in their four-year plans, departments need to ensure that they do so accurately. We found one example of clerical and calculation errors in updated information in the plan. Although these errors were immaterial, they show the need for care when updating.

4.19
We identified some minor issues where a department's underlying information was not reflected in its four-year plan. This occurred for several reasons, including:

individual department business units adopting different methodologies to determine costs, which, in one instance, meant that some business units assumed that they had more funding than was actually the case;
not enough consideration of actual business unit costs when preparing overall forecasts; and
clerical and calculation errors when updating the four-year plan to take account of successful funding bids.

4.20
The sophistication of forecasting tools used in forecasting financial information varied.

4.21
One of the four selected departments had a flexible budget forecasting model with assumptions that could be adjusted to perform scenario modelling or sensitivity analysis. This model flowed through to a strategic finance plan that was used as a basis for much of the financial information in the four-year plan. We consider this good practice.

4.22
However, we found that budget forecasting was generally not very well developed – some departments lacked a robust financial forecasting system, or the system was not well co-ordinated throughout the department. For example:

In one department, business units assessed important projects based on their key deliverables, with individual business units preparing subsequent budgets. However, the department did not fully consider these budgets when updating its four-year plan. This meant that we were unable to reconcile the individual business costs with the total costs in the four-year plan.
We expect the forecast numbers and assumptions used in four-year plans to provide enough information to understand and assess the funding needed to achieve the department's objectives. This was not always the case. For one department, it was difficult to see how the objectives and goals of the plan were supported in the financial forecasts because the department's financial forecasts did not flow through to the four-year plan.
One department adopted a "top-down" approach to forecasting and budgeting that identified the main programmes of work to be completed during the four years. However, the department had not considered the amount of resources needed to complete the projects or whether the proposed timing for specific projects was achievable. This approach also meant that some of the assumptions underpinning the four-year plan, such as staffing levels needed to complete work programmes, were not supportable.
One department completed a prioritisation exercise to ensure that the four-year plan balanced with the existing budget. This helped the reader understand where the expected costs reductions could be in the department. However, the exercise was performed at a high level and did not provide enough detail about how and when the department would achieve its cost reductions.

Integration of financial information into a department's operational activities, and analysis of choices and trade-offs

4.23
Departments should have a good understanding of where their funding is spent, why the money is being spent, and how resourcing will shift to priority areas during the planning period. Four-year plans are designed to help inform government resource allocation and decision-making, including Budget decision-making, by demonstrating the value created with existing funding.

4.24
Accordingly, we expect an effective four-year plan to:

identify the main work streams needed to meet statutory and non-statutory obligations and allocate funding to those work streams;
set out analysis of cost pressures, including explaining the effect of cost pressures and how the cost pressures would affect the future service delivery of the department; and
provide a detailed analysis of the decisions made about investments and savings, and the trade-offs and prioritisations in service delivery that these decisions involved.

4.25
Departments provided some information on their broader sector, including the strategic intentions, financial information, and risks set out for each Crown entity the department monitored.

4.26
However, financial information for the non-departmental activities was not always presented to the same level of detail as departmental activities, and broader sector cost pressures were not always analysed in detail. As a result, plans did not always provide a thorough view of the sector's strategic goals nor the financial resources and trade-offs needed to deliver those goals.

4.27
Departments identified the main work streams and generally allocated funding to those work streams, but they could improve the way they considered the relationship between service delivery and financial forecasts.

4.28
In some plans, it was evident what a department wanted to achieve, but there was not enough consideration of the implications of this in the financial forecasting. For example, one department wanted to increase a service during the following years but had not factored the increased costs into the financial forecasts. (The department considered that any cost increases would be off-set by service revenue increases so would be cost neutral, but our view is that this should have been reflected by showing the increased costs and future revenue increases.)

4.29
We also saw some examples of departments including projects for the four-year period in their plans but no detailed information about the prioritisation of these projects or the related costs.

4.30
For example, one plan did not provide enough detail about how cost reductions would be achieved or when. Also, there was no detailed information about the work that would be removed and the implications of this on the levels of service the department could provide.

4.31
One department explained the trade-offs it was making very well. For example, it used its strategic financial model to make explicit trade-offs in business units, which we consider good practice because it allows the department, the Government, and the central agencies to understand the costs involved in each service delivery option.

4.32
However, our observation is that departments generally provided limited information in four-year plans of their service levels and any trade-offs being made in their planning. This means that it was often difficult to identify and assess the trade-offs and prioritisations taking place and circumstances where service delivery might be affected.

4.33
For example:

When four-year plans identified significant funding pressures, they did not always demonstrate how these pressures (where not covered by budget bids) would be managed. In one instance, a department indicated that it was clear that its future financial position was unsustainable and that it was working to identify areas of work that could be stopped, reduced, or redesigned. However, the department provided no further information about what this would mean in practice.
There was often limited discussion of trade-offs or alternative scenarios if proposed initiatives or budget bids were declined.
It was often unclear how planned reductions in staff numbers would affect levels of service.
Service-level forecasts did not always include likely changes to a department's or sector's operating environment, demographics, and other factors affecting its work.
Some trade-offs and prioritisations in the policy and regulatory environment appeared inconsistently – for example, in some instances, demographic changes were considered only in relation to the effect on the department's workforce retention rates and not the effect on its work programmes.

4.34
The lack of a robust assessment of the resource implications and trade-offs a department is making to avoid overspending is a significant weakness of the four-year plans we reviewed. The risks this creates include:

a department having to unexpectedly reduce service levels or the quality of its service levels because of a lack of funding; or
a department exceeding its baseline budget to deliver its agreed service levels.

4.35
We saw some good examples of departments being aware of their cost pressures and where their greatest risks were. For example, one department included general inflation increases and contract cost increases in its forecasts. The department understood that about 40% of its costs came from outsourced services and that this would place significant pressures on its operating costs in future years as its suppliers seek to renegotiate contracts. The department was aware of these future cost pressures and considered them in its forecasts.

4.36
However, we identified some issues with the way departments analysed cost pressures. For example:

There was a lack of analysis of cost pressures for non-departmental expenditure.
We were not always able to reconcile specific cost increases, such as forecast employment costs, with balances included in the overall cost pressures in the financial forecasts.
There was a lack of supporting evidence for some cost estimates.
There was a lack of description of what increased costs and spending related to.

4.37
We expected that departments that identified short-falls in funding or budget pressures would set out options for addressing these in their four-year plans. However, they did not always do so.

Information about asset management and capital intentions

4.38
Information about departments' assets was generally less well developed and we found a range of issues with information about asset management and capital intentions in four-year plans. For example:

For some departments, the four-year plan discussed asset management planning briefly and at a very high level, with little financial information.
There was little detailed analysis of asset management for Crown entities in the department's sector.
Some departments included estimated costs for new assets without providing any supporting information, such as underlying information or assumptions, to support the costs.

4.39
We consider that the information on capital and asset management currently provided in four-year plans is of limited use from a medium-term planning perspective.

4.40
Overall, the less-developed state of sector and asset information means that four-year plans are not yet likely to effectively identify sector cost pressures and risks, and the effect of these on the finances of the Government and the services intended to be delivered to the public in the future.

4.41
However, experience in central government in medium-term planning is developing, and focusing on preparing robust departmental plans has been a good first step. During the period that four-year plans have been developing, the Treasury has been introducing a suite of asset management and capital investment improvement initiatives, including recently introducing a requirement for long-term investment plans.

4.42
These capital and asset management initiatives should strengthen four-year planning, allowing departments to better incorporate information about sector trends, and capital and asset management intentions.

4.43
For the four departments we looked at, Figure 3 shows that, on average, departmental expenditure accounted for only 21% of their total expenditure and departmental assets accounted for only 29% of their total assets. As the more significant, non-departmental information reflects broader sector activities, this shows the importance of including more detailed sector information and financial analysis, to provide a view of that broader sector.

Figure 3
Departmental and non-departmental expenditure and assets for four departments

	Non-departmental total		Departmental total		% that is departmental
	Expenditure	Assets	Expenditure	Assets	Expenditure	Assets
Ministry of Transport	$3.3 billion	$97 million	$32 million	$8.2 million	1%	8%
Ministry for the Environment	$575 million	$11 million	$53 million	$17.1 million	8%	60%
LINZ	$78 million	$459 million	$104 million	$91.0 million	57%	17%
MBIE	$3.0 billion	$706 million	$582 million	$341.9 million	16%	33%
Average	$1.7 billion	$318 million	$193 million	$114.6 million	21%	29%

Source: The departments' annual reports for 2014/15.

How to improve four-year planning

4.44
To continue to improve four-year plans, departments need to:

ensure that the financial information contained in four-year plans is supported by the underlying financial information and is based on reasonable and supportable assumptions;
use a robust forecasting model that allows testing of a range of scenarios and their sensitivity; and
explain how they will achieve their objectives and strategic intentions, and any trade-offs and prioritisation.

4.45
To improve four-year plans, the central agencies need to:

continue to improve their guidance about preparing four-year plans, including guidance on standard and common financial assumptions, and how the plans are used in the context of the Government's overall financial management system; and
work to improve medium-term planning by requiring departments to include information about medium-term planning matters, such as about capital and asset management intentions, covering all Votes and appropriations the departments administer.

8: The financial starting point for 2016/17 four-year plans was the baseline for Votes as at Budget 2016.