Council’s Risk Management Role

Are the risks you’re taking ones that you can afford?

by Robert Inzer

Risk management is one of those topics that is not important until it is important, and then it can be critical. It is the same as no one wants government until there is a problem, then government becomes critical. Look at any of the natural disasters including the pandemic, and you will see that even those individuals most critical of government will be right in line, shoulder to shoulder, for government services and support beside those individuals who understand the importance of government in their daily lives.

The mayor/commission is ultimately responsible for managing the risk of the organization, and yet this is one area in which most elected officials have no background or training. No one expects commissioners to be an expert in insurance, self-insurance, risk controls, etc. … but your citizens expect you to take such action as necessary to protect them. Government is the ultimate safety net for society. The world we live in today requires us to be dependent upon others for our energy, water, sanitation, food, safety and the other necessities of a civilized society. One of your jobs as elected officials is to make sure all of these services continue to work smoothly and seamlessly.

Nothing in life is certain (except death and taxes). We live with uncertainty and cannot avoid taking risks. Your objective is to know and understand the risks you are taking and make sure that they are risks you can afford to take. If they are too large, then you need to transfer those risks (purchase insurance) or mitigate the risks through reserves, policies, regulations, etc. An axiom of good risk management is: never take a risk where you can’t cover your losses. In our private lives, we buy auto, property and life insurance to protect us from those risks we can’t afford to accept. That same thought process should be applied to your government responsibilities. The problem is that understanding and measuring those risks are much harder.

Risk management starts with you. You set the tone for your organization through your policies, votes and communications. Risk management is not just about buying insurance but includes the following:

‣ Programs to ensure employees and citizens are protected.

‣ Essential services provided especially during disasters and other emergencies.

‣ Regulations adopted and enforced to mitigate flooding and other environmental disasters.

‣ Investments that provide adequate protection against loss of principal and provide adequate liquidity.

‣ Debt management programs that control the level and structure of debt.

‣ Adequate cash reserves for emergencies.

It is analyzing all of your programs to examine the risk, determine whether those risks are acceptable and determine how to eliminate or mitigate those risks.

Let me give you a few examples of some of the problems when risks have not been properly managed. One recent example is the winter storm in Texas when lives were lost, citizens were without power or water and economic losses are estimated to exceed $50 billion. What happened was not an accident but a conscious decision by policymakers to accept a high level of risk. They assumed the risk for severe weather was so low that it didn’t warrant making the investment to mitigate these risks. They bet on short-term savings versus long-term mitigation of risks. Texas chose, through their regulatory actions and the management of their facilities, not to harden them against loss and protect them from severe weather. They chose to keep costs low by not incurring these costs. Keep in mind that other states were hit with this same unusually cold weather but with very different results. The other states had made investments to mitigate their risk, and those decisions paid huge dividends when disaster hit.

Make no mistake, good risk management practices involve incurring costs for the government or the businesses you regulate. But just like the old FRAM Oil Filter commercial said, “You can pay me now or pay me later.” The costs of not practicing good risk management are periodic, not regular or predictable. These costs are subsequently measured in terms of dollars, lives and disruption of municipal services, and they can be very significant. Effective risk management practices generally involve higher costs today, but they mitigate the large emergency expenditures in the future, and more importantly, they provide your citizens with stable dependable services when they need them most.

EXAMPLES OF POOR RISK MANAGEMENT

There are many other examples. In 2011, Jefferson County, Ala. (Birmingham), the wealthiest county in the state, declared bankruptcy. The city had $3.14 billion in variable rate debt and did not fully appreciate the risk associated with the potential escalation in the interest rate on their debt. The city was aggressively expanding their sewer systems, issuing billions of dollars in new debt and had entered into some exotic debt instruments involving interest rate swaps to minimize their current interest expense. They had moved from having 95% of their debt at a fixed rate to 93% in synthetic variable rate debt. When the debt market imploded on these synthetic securities, the interest rates the county was forced contractually to pay increased to the point that the county could not afford to pay the interest when due. They enjoyed initial debt service savings, but ultimately they took risks beyond their ability to cover.

In 1994, the treasurer for Los Angeles County ran a pooled investment program in which local governments in California could participate. For years it was a highly successful program generating returns well above the market. He used the assets on deposit in the pool to borrow funds and invest those borrowed funds in securities with substantially higher yields. The program worked well as long as interest rates were flat to falling, but when interest rates rose, his borrowing rates greatly exceeded his investment returns. He had leveraged the portfolio by over 200%, meaning he had borrowed and reinvested funds more than twice his asset base. The county eventually had to borrow over $1.6 billion to cover his losses.

Stockton, Calif., is the largest city to declare bankruptcy. It is a city of 315,000 but is a relatively poor city with per capita income about 30% below the California median income. The cause of its bankruptcy was committing to enhancements in police and fire pensions and post-retirement health care that they could not afford. The city was struggling to balance its budget and also negotiate with its fire and police unions. It chose to settle with the unions by not giving large salary increases but committing themselves to future pension costs that were not sustainable. Stockton was in the middle of a housing boom they thought would continue to generate large increases in tax revenues to support these changes. When the housing bubble burst, they had no option but to declare bankruptcy. Their decision to commit themselves to long-term future pension and health care costs to balance the current budget assuming the housing bubble would continue was an unacceptable risk.

Each of these situations demonstrates the government’s failure to manage risk. They were trying to reduce costs to the taxpayers today by avoiding expenditures today or increasing earnings. They miserably failed in managing risk.

LEAGUE PROGRAMS DESIGNED WITH RISK CONTROLS

Your Florida League of Cities has continually worked to develop programs for its members that are cost-effective and designed specifically to meet the needs of Florida cities. The leadership of the League is well aware of the risks cities face and problems when those risks are not managed. The programs are designed with risk controls in place to ensure that your city, your employees and your citizens are protected. Good risk management costs money today but avoids or mitigates large losses in the future. For that reason, you may find other providers at lower costs today but probably none that provide a better combination of low costs and high quality.

This is your League, and these are your services. They are designed to meet your needs, controlled by Florida municipal leaders and monitored by trained professionals. As an owner, you should be familiar with them and how they can help your city. Over the next several months, we will highlight each program and the risk controls built into that program that protect you and your city. In the next issue, we will highlight the Florida Municipal Insurance Trust and review the various risk control measures to protect participants. The following issue, the Florida Municipal Investment Trust will be our focus, and again we will review the structure of the program and the risk mitigation tools employed. Lastly, the Florida Municipal Loan Council will be the focus, and we will review how it is designed to provide easy access to the debt markets while limiting the risk to your city. While you may be able to find other service providers, none are more committed to protecting the safety and security of your city and your citizens than the League.

Robert Inzer is an advisor to the Florida League of Cities. He has 46 years of municipal finance experience that includes 30 years with the City of Tallahassee, 20 years of which was spent as city treasurer-clerk.