We should listen to the NAO's warning on unrealistic optimism

28 Nov 18

Optimism bias is a common problem that threatens local government’s financial sustainability. Risk assessments need to be credible, transparent and thoroughly stress tested, says CIPFA’s Jo Pitt.

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“Her Majesty’s Treasury spending teams alongside departments’ finance teams need to defend plans against unrealistic optimistic assumptions.” This was one of the comments in this week’s National Audit Office report Improving government’s planning and spending framework.

Optimism is often seen as very positive trait. Being the kind of person who faces life with a glass half full rather than half empty is great. However, in the rather conventional world of local government finance, over optimism can lead to a number of problems, and we see its consequences played out in a number of reviews.

Take the well know case of Northamptonshire County Council. The LGA’s peer review In September 2017 highlighted the “very optimistic bias” underpinning Northamptonshire’s future financial plans and the savings it expected to realise via its transformation model.

CIPFA’s own resilience reviews have also found optimism bias to be a common theme. The insight we published last year, Building Financial Resilience, pulled together conclusions from several resilience reviews and highlighted the sustainability issues facing authorities. The key messages resonate throughout the sector.

Signs of financial stress for authorities include:

  • a rapid decline in reserves where organisations are using this money to provide temporary relief;
  • a failure to deliver savings where organisations were over optimistic on what could be delivered in the time;
  • a failure to plan ahead where organisations medium- and long-term financial planning horizons were reducing.

 

Just seeing the signs of stress does not mean there is an instant cure. For Section 151 officers seeking longer term sustainability there is an ever-constant pressure of trying to balance the budget while also securing public services.


To avoid any accusations of optimism bias an authority must carry out a credible and transparent assessment of risk in its finances


Perhaps the recent statement by MHCLG permanent secretary Melanie Dawes to the Public Accounts Committee helps with that balance. She said the government’s definition of financial sustainability among councils is whether statutory services can be delivered locally. Of course, delivery of statutory services varies considerably across the country and Dawes’s comment may spark a healthy debate in the sector about what exactly is meant by this.

What of examples such as East Sussex County Council, which has stripped services back to a ‘core offer’? What happens if communities do not want all designated statutory services to be delivered locally?

However this discussion proceeds, the facts remain the same. Whatever services need to be delivered, the financial figures supporting it must be based on clear evidence and well-founded research, underpinned by strong analytical forecasting.

This takes us back to the NAO report and its comment about optimism. To avoid any accusations of optimism bias an authority must carry out a credible and transparent assessment of risk in its finances. Assumptions should be tested against best and worst case scenarios covering a wide range of financial, demographic and social challenges. The authority should also use independent objective measures to assess the risks to its financial sustainability.

Even within these rules an organisation is not risk free. All that is guaranteed is that the starting point for budgeting is a firm one, and can be justified, providing the best possible background for any decision maker.

Perhaps in these turbulent times that is as good as it gets.

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