Response to queries about recovery from the Canterbury earthquakes
Dear Mr Preston
RESPONSE TO YOUR QUERIES ABOUT PUBLIC SPENDING AND REPORTING RELATED TO RECOVERY FROM THE CANTERBURY EARTHQUAKES
During the past few months, you have contacted my Office on numerous occasions to raise your concerns about public spending and reporting related to the recovery from the Canterbury earthquakes.
I acknowledge the depth of your concerns and the lengths that you have gone to in seeking answers from various organisations and raising these matters publicly.
After considerable investigation by my staff of the matters you raised, I am satisfied that there has been no wrongdoing, and that spending and reporting has been appropriate and transparent. My conclusions are:
- the Government’s use of imprest supply to incur expenditure for the purchase of properties in the Christchurch Red Zone was lawful;
- the estimates of outstanding claims liability and reinsurance receivables as at 30 June 2012 were appropriately reported by Southern Response Earthquake Services Limited;
- the scope of the 2015 disestablishment report for the Canterbury Earthquake Recovery Authority is appropriate; and
- that it is appropriate for the Department of the Prime Minister and Cabinet (DPMC) to report on the appropriations in Vote Canterbury Recovery in the DPMC annual report 2014/15.
Please note that I have decided to publish this letter on my Office’s website as a matter of public interest.
Addressing your concerns
Because of the volume of your correspondence with my Office, I have chosen to respond to you in the following format, based on the three issues that I understand to be your main areas of concern:
- expenditure incurred in June 2011 to purchase properties in the Christchurch Red Zone;
- the reporting by Southern Response Earthquake Services of the estimates of outstanding claims liability and reinsurance receivables as at 30 June 2012; and
- the scope of the 2015 disestablishment report, and related audit, of the Canterbury Earthquake Recovery Authority.
1. Expenditure incurred in June 2011 to purchase properties in the Christchurch Red Zone
We have responded to you a number of times since April 2015 about your concerns relating to the Government’s decision, in June 2011, to offer to purchase properties located in the Christchurch Red Zone.
At the heart of your concerns is the question of whether imprest supply could lawfully be used in this instance, given that the expenditure concerned was not appropriated before the end of the financial year, as required by the relevant Imprest Supply Act.
For reasons explained below, I am satisfied that the use of imprest supply in this instance was both lawful and reasonable.
Your concerns appear to centre on the interpretation of the Act that was relied on to incur the expenditure: the Imprest Supply (Second for 2010/11) Act 2010. However, your concerns also prompt broader questions about the public financial management system, and in particular the part played in that system by imprest supply. To explain why we consider the expenditure in this case was lawful, we believe that it is helpful to first set out a brief explanation of how the public financial management system works.
An overview of the public financial management system
The public financial management system supports the constitutional principle that Parliament must approve the Government’s spending of public money (covering expenses and capital expenditure), while enabling the Government to carry out the business of governing.
All expenditure must be approved by Parliament. Approval is generally given either by means of an Appropriation Act or an Imprest Supply Act followed by an Appropriation Act. Approval may be given in advance or retrospectively.
Appropriation Acts provide the Government with authority to spend particular sums of money for particular purposes. Usually two Appropriation Acts are passed during a financial year (1 July to 30 June), and one after the end of the financial year.
The first Appropriation Act of the year provides authority for the expenditure proposed in the main Estimates (the Budget). The Public Finance Act 1989 says that this main Appropriation Bill must be introduced into Parliament before the end of the first month of the financial year. In recent years, the Budget has been presented and the Bill introduced in late May of the previous financial year.
A second Appropriation Act is introduced towards the end of the financial year. It authorises other expenditure incurred (including under imprest supply) during the year after the first Appropriation Act has been approved. This second Appropriation Act is referred to as the “Supplementary Estimates”.
A third Appropriation Act, referred to as the Appropriation (Confirmation and Validation) Act, is introduced after the end of the financial year. The purpose of the Appropriation (Confirmation and Validation) Act is to confirm or validate any expenditure that has not been included in an Appropriation Act before the end of the financial year.
Imprest Supply Acts
Imprest Supply Acts authorise the Government to incur expenses and capital expenditure, in advance of the passing of an Appropriation Act, up to a specified amount. There are usually at least two Imprest Supply Acts in a financial year.
Imprest supply is required because the first Appropriation Bill for the year is not normally passed before the beginning of the financial year, and because the changing nature of government activities and unexpected demands means it is rarely possible to foresee all future expenses and capital expenditure.
Cabinet rules require any use of imprest supply to be authorised by a specific Cabinet decision. All expenses and capital expenditure incurred under an Imprest Supply Act must subsequently be approved by Parliament.
Expenses and capital expenditure incurred under an Imprest Supply Act before the preparation of the Supplementary Estimates is included in that Bill for approval by Parliament when it passes the Appropriation (Supplementary Estimates) Act.
Expenses and capital expenditure incurred under an Imprest Supply Act, but too late in the financial year to be included in the Supplementary Estimates, becomes unappropriated expenditure on the expiry of that financial year (30 June), and must be disclosed as such in the financial statements both of the Government and of the relevant department. It must also be validated by Parliament retrospectively through the passing of an Appropriation (Confirmation and Validation) Act.
An underlying principle of this system of inter-related Appropriation and Imprest Supply Acts is that all expenses and capital expenditure must be approved by Parliament before the end of the financial year in which it is incurred.
Expenses or capital expenditure that is incurred without an appropriation or other authority (such as an Imprest Supply Act) or that is incurred under imprest supply but not included in an Appropriation (Supplementary Estimates) Act, is classed as “unappropriated expenditure” and remains so until it is subsequently validated by Parliament.
Unappropriated expenditure is subject to specific requirements in the Public Finance Act 1989:
- it must be disclosed in the annual financial statements of the Government, and of the relevant administering department; and
- it must be retrospectively validated by Parliament through the passing of an Appropriation (Confirmation and Validation) Act.
- All spending of public money must be approved by Parliament.
- Parliament may authorise spending of public money either in advance or retrospectively.
- Imprest supply is a statutory mechanism by which Parliament provides the Government with the authority to incur expenses or capital expenditure in advance of appropriation.
- The purpose of imprest supply is to ensure that, in addition to funds for specific purposes under an Appropriation Act, the Government has funds available for general purposes – up to a specified amount – throughout the financial year.
- An Imprest Supply Act is authority to incur expenses and capital expenditure, but the expenditure must subsequently be included in an Appropriation Act for approval within the same financial year. Expenses and capital expenditure incurred under the authority of an Imprest Supply Act, and which is not subsequently included in an Appropriation Act within the same financial year, becomes unappropriated expenditure at the end of the financial year.
- Unappropriated expenditure must be disclosed as such to Parliament. It remains unappropriated until it is validated by Parliament.
The decision to purchase properties in the Christchurch Red Zone
The particular use of imprest supply that you have raised concerns about followed the Government’s decision, in June 2011, to offer to purchase certain properties in the Christchurch Red Zone.
The background to this decision was as follows:
On 13 June 2011, there was a series of significant aftershocks in the Canterbury region.
The following week, on 20 June 2011, Cabinet appointed a group of Ministers to make decisions about land damage and remediation issues resulting from the earthquakes. The group of Ministers included the Minister for Earthquake Recovery, who was invited to report back to Cabinet on any decisions made by the group.
On 22 June 2011, the group of Ministers decided that the Crown would offer to purchase certain properties in the Christchurch Red Zone. This decision was announced publicly on 23 June 2011 and reported to the Cabinet on 27 June 2011.
It was recognised at the time that no appropriation was available for the proposed expenditure, and that it would therefore need to be incurred under the authority of an Imprest Supply Act.
Although sufficient imprest funds were available, it was recognised that – given the timing of the decision – it was too late to include this expenditure in the Appropriation (Supplementary Estimates) Act for the 2010/11 year. Also, that the expenditure would become unappropriated expenditure on expiry of the financial year and would therefore need to be validated by Parliament after the end of the financial year.
The Cabinet minute recording the Ministers’ decision therefore noted that:
…. there is no further opportunity to obtain Parliamentary appropriations in 2010/11 and that the gross cost of purchase will need to be validated in the Appropriation (2010/11 Financial Review) Bill, but there is sufficient Imprest Supply remaining for 2010/11 to meet these expenses in the meantime.
Was it lawful to use imprest supply?
You asked whether it was lawful for the Government to use imprest supply when it offered to purchase Red Zone properties, given that it was known that it would not be possible to include the expenditure in an Appropriation Act before the end of the financial year, as required by the relevant Imprest Supply Act.
I consider that the Government’s use of imprest supply was lawful. The expenditure was incurred under sections 5 and 7 of the Imprest Supply (Second for 2010/11) Act 2010. Sections 5 and 7 are as follows:
5 Authority to incur expenses
(1) Expenses may, during the 2010/11 year, be incurred in advance of appropriation in relation to any Vote.
(2) Expenses incurred under subsection (1) during the 2010/11 year must not exceed in the aggregate the sum of $8,300 million.
7 Appropriation required
(1) All expenses incurred under section 5(1) and all capital expenditure incurred under section 6(1) must be appropriated in an Appropriation Act that comes into force on or before 30 June 2011.
(2) Until the coming into force of that Appropriation Act, those expenses and that capital expenditure may be incurred during the 2010/11 year as if they had been incurred in accordance with one of the separate appropriations specified in section 7(1) of the Public Finance Act 1989.
I understand that it is the wording of section 7(1) that has prompted your concern.
I agree that section 7(1) imposes a requirement that any expenditure incurred under those sections is included in an Appropriation Act before 30 June. However, I do not agree that, if the expenditure is not so included before 30 June, it means the expenditure was unauthorised at the time it was incurred. It simply means that, once the 30 June deadline has passed, the expenditure became unappropriated expenditure at that time.
The purpose of Imprest Supply Acts is to ensure that the Government has authority to incur expenditure – up to specified amounts – throughout the financial year, including the period between the preparation of the Appropriation (Supplementary Estimates) Bill and the end of the financial year.
Accordingly, the Government was authorised to use imprest supply to incur expenditure in relation to its offer to purchase the Red Zone properties, provided that:
- sufficient imprest funds were available (which they were); and
- the decision was authorised by Cabinet (which it was).
After the end of the financial year, the expenditure became unappropriated expenditure and was treated as such. It was disclosed in both the financial statements of CERA and the financial statements of the Government, and it was subsequently validated by Parliament in the Appropriation (2010/11 Financial Review) Act 2012.
I note your concern that this Act was not passed till May 2012, which meant that the expenditure was not validated by Parliament until 11 months after it was incurred. The records show that Financial Review Acts are generally passed by 31 March of the year following the financial year in question, but that in an election year (which 2011 was) the validation process generally takes longer. This is presumably because of the time needed for a new Government to establish itself and set its legislative programme.
Official Information Act request
You have also recently requested, under the Official Information Act 1982 (OIA), copies of all information to and from the Office of the Auditor-General regarding the Canterbury Residential Red Zone between 22 February 2011 and 30 June 2011. The Auditor-General is not subject to the OIA.
However, to the extent that you are asking about contact between the OAG and the Treasury about this matter during this period, I can tell you that my staff met with the Treasury on 24 June 2011 to discuss the accounting treatment related to the Government’s decision to purchase the Red Zone properties. It is routine for my Office and the Treasury to meet about accounting matters affecting our audits.
The outcome of this meeting was that we concurred with the Treasury’s view that the Government had incurred an obligation (and therefore an expense) in the 2010/11 financial year relating to the Red Zone properties. As a result, CERA (and therefore the Government) recorded an expense in its 2010/11 financial statements.
2. The reporting by Southern Response Earthquake Services Limited of the estimates of outstanding claims liability and reinsurance receivables as at 30 June 2012
In relation to Southern Response Earthquake Services Limited (Southern Response), you have asked us:
Why the OAG audit completed in October 2012 did not make any mention of the fact the valuation (particularly of reinsurance recoveries) used in the financial statements was materially (especially when viewing the net solvency position) different to that provided by their Independent Actuary?
If Southern Response’s financial position deteriorates further from its audited position as at 30 June 2014, can you confirm that the OAG will continue to allow Southern Response to operate in a negative equity position?
First, it is important to note that the Directors of Southern Response are responsible for reaching a view on the appropriate amounts to record in the company’s financial statements for the outstanding claims liability and reinsurance receivables. The report of the independent actuary is an input into the consideration of these amounts.
Having said that, the primary reason for the difference in the net outstanding claims liability reported in the Southern Response 2012 Annual Report, and that included in the actuary report prepared by Finity Consulting Pty Limited, relates to the respective estimates of reinsurance recoveries.
The amount of the reinsurance receivables recorded in the 2012 Southern Response financial statements was the total amount recoverable under the reinsurance treaties in place, less the actual amounts received by Southern Response before 30 June 2012. This is in contrast to the reinsurance receivables estimate prepared by Finity Consulting Pty Limited, which, in accordance with their usual practice, was a calculation of the future theoretical reinsurance recoveries based on the reinsurance treaties in place, and future forecast claims payments.
As at 30 June 2012, the amount of reinsurance that Southern Response had actually claimed and received from the reinsurers was less than the amount assumed by Finity Consulting Pty Limited. As a result, Southern Response recorded an additional $62 million in its financial statements as reinsurance receivables because this balance was due from reinsurers in respect of claims payments made up to the date of the actuarial valuation but not yet recovered from reinsurers.
The Auditor’s Report included in the Southern Response 2012 Annual Report (page 9) drew readers’ attention to notes 1, 14, and 27 of the financial statements that describe the inherent uncertainties in estimating the outstanding claims liability and related reinsurance receivables as at 30 June 2012.
In response to your second question, regarding the audit opinion of an entity where there is doubt about that entity’s ability to continue operating, the relevant auditing standard is ISA(NZ)570: Going Concern. This standard explains that the auditor’s responsibility is to obtain sufficient appropriate audit evidence about the use of the going concern assumption in the preparation and presentation of the financial statements, and to conclude whether there is a material uncertainty about the entity’s ability to continue as a going concern.
In the case of Southern Response, the 30 June 2012 financial statements recorded that the company had access to up to $500 million of additional uncalled share capital from the Crown. The Auditor’s Report also drew readers’ attention to note 1 of the financial statements about going concern and notes 36 and 37, which describe the additional funding support available to the company. This funding support had been approved by Cabinet, to provide the company with sufficient funding to meet its obligations as they fall due. The auditor reported in this way to assist readers of Southern Response’s financial statements to understand the nature and extent of the funding support available to the company.
I note that my staff wrote to you on 14 May 2014 regarding your concerns about the risk of the Crown’s liability being understated, and your concerns about a potential conflict of interest between the Chief Executive of Southern Response and the actuary for Southern Response. I also wrote to you on 3 September 2014 regarding a range of matters that you had raised, which included the basis of calculation of Southern Response’s outstanding claims liability.
I am satisfied that the Auditor’s Report on the 2012 financial statements of Southern Response was appropriate, and I do not intend to look into these matters further.
3. The disestablishment audit and the annual report of the Canterbury Earthquake Recovery Authority
In April 2015, the Canterbury Earthquake Recovery Authority (CERA) presented its report on its Departmental Activities for the seven months to 31 January 2015.
The report includes the departmental financial statements and schedules of CERA. The report does not include:
- the non-departmental activities (activities the department manages on behalf of the Crown);
- reporting against departmental and non-departmental appropriations; and
- non-financial performance reporting.
CERA’s disestablishment report was prepared because, as of 1 February 2015, CERA ceased to be a government department and became a departmental agency of the DPMC. This change in the organisational form of CERA followed decisions by Cabinet (CAB Min (14) 39/16) and associated Orders in Council. The Cabinet Minute sets out, and gave effect to, the disestablishment of CERA as a government department and the financial and reporting obligations for CERA.
We reviewed the Cabinet Minute and considered the decisions around the scope of CERA’s disestablishment report. We noted that this was the first time a government department has transitioned to become a departmental agency. The legislation was therefore being interpreted without any established precedent.
Reporting against appropriations was excluded from the scope of CERA’s disestablishment report because, after 1 February 2015, DPMC became responsible for reporting on matters relating to Vote Canterbury Earthquake Recovery. DPMC, as the administering department, will therefore report against all appropriations in Vote Canterbury Earthquake Recovery at 30 June 2015.
We concurred with the Treasury’s view that, because CERA was not the administering department for the appropriations at the date of its disestablishment report, it is appropriate for reporting on these appropriations to be included in the DPMC 2014/15 annual report. DPMC will be required to report on the appropriations for the full 2014/15 financial year.
The rationale for this position is that:
- the non-departmental activities of CERA are managed on behalf of the Crown;
- the responsible Minister remained the same; and
- the appropriations continue (that is, they did not cease and restart).
In essence, there is no difference whether CERA performs these activities as a stand-alone government department, or as a departmental agency under DPMC as the administering department.
As a result, there will be no diminution of accountability or transparency because the appropriations in Vote Canterbury Recovery will be fully reported in the 2014/15 annual report of DPMC.
My staff have spent a considerable amount of time looking into these matters. I see no reason to investigate these matters further, and I do not intend to do so. We will continue to monitor public expenditure on the recovery and rebuild in Canterbury through our ongoing audit work of the relevant public entities.
As I said in my letter to you last year, I appreciate that you have a keen interest in how the Government is managing the rebuild of Canterbury – particularly the financial aspects. You are welcome to continue to send us information that you think may be useful for us to consider in our audit work of the public entities involved in the Canterbury recovery. However, in future, we are likely to simply acknowledge your correspondence and factor the information you provide into our audit work, rather than respond to any further questions or comments from you.
Please send any information to firstname.lastname@example.org and we will make sure that it is passed on to the relevant staff to consider as part of our ongoing work.
Controller and Auditor-General