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Investment statement

2014 Investment Statement: Managing the Crown's Balance Sheet

The 2014 Investment Statement fulfils a fiscal reporting requirement set by Parliament when it amended the Public Finance Act 1989 late last year.

It provides information on the shape and health of the Crown's portfolio of assets and liabilities at the end of the last full financial year. It outlines how the balance sheet has changed in recent years and it includes forecasts on its anticipated composition and size through to 30 June 2018. It also describes the performance of the Crown's major asset and liability classes and discusses frameworks for good balance sheet management to underpin New Zealanders' living standards.

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Preface

The 2014 Investment Statement fulfils a fiscal reporting requirement set by Parliament when it amended the Public Finance Act 1989 late last year.

It provides information on the shape and health of the Crown's portfolio of assets and liabilities at the end of the last full financial year. It outlines how the balance sheet has changed in recent years and it includes forecasts on its anticipated composition and size through to 30 June 2018.

Individual agencies' non-financial asset management performance information cited in this Statement was collated in 2013 and early 2014.

Based on the information available, this Statement provides a general assessment of how closely the Crown's balance sheet composition aligns with governments' service delivery objectives. It assesses where the main risks lie in terms of governments' ongoing ability to provide the public goods and services that New Zealanders expect of their governments.

Owning the right assets, managing them well, funding them sustainably, and managing risks to the Crown balance sheet are all critical to the provision of high-quality and cost-effective public services. That means that the quality of balance sheet management is vital to maintaining New Zealanders' living standards now and in the future.

Yet one of the key findings of this Statement is that the information available to assess whether Crown assets are fit for purpose and being cost-effectively managed is not as consistently strong as it should or could be across the public sector.

That is why creating systems for better information collection and evaluation will be a priority for the Treasury in its work with agencies in the years ahead. The next Investment Statement, required to be presented to Parliament no later than four years from now, will outline progress made on the areas of focus identified in this Statement and highlighted in the Executive Summary.

In preparing this Statement, the Treasury has used its best professional judgement.

Gabriel Makhlouf
Secretary to the Treasury

20 March 2014

Executive Summary

The 2014 Investment Statement is the first to be produced by the Treasury since the recent amendments to the Public Finance Act 1989. It examines the composition and state of the Crown balance sheet - what the government owns and owes - and discusses the principles of efficient balance sheet management. It builds on the existing suite of government publications designed to bring transparency and accountability to the public sector.

New Zealand has long been recognised as a world leader in public sector management, and this extends to management of its balance sheet. In recent years there has been a growing emphasis on Crown balance sheet management resulting in better practice, but there is still room for improvement. The major conclusions of the Statement, and areas identified as requiring further work, analysis or improved management, are summarised in this Executive Summary.

Effective balance sheet management underpins living standards

Every year New Zealanders make a significant contribution to support government activities through the taxes and levies that they pay. Last year tax receipts were around $58 billion. In addition the core Crown borrowed around $14 billion through the issuance of Government bonds - this, plus interest, must be repaid by future taxpayer contributions. A significant portion of these funds go to supporting the Crown's balance sheet.

With over $240 billion in assets, $170 billion in liabilities and $70 billion in equity, the Crown's balance sheet is large - assets alone are worth more than a full year of total output from the economy. That means many families' indirect share of the Crown's assets and liabilities would typically be second only in value to the family house and mortgage.

The size of the balance sheet reflects the growth in the role of government over time. The balance sheet has changed significantly in the last 20 years and will continue to change in the future. It will grow as the economy grows and, in particular, as holdings of financial assets increase as a result of governments' efforts to partly prefund the future costs of superannuation. Those assets will form a relatively greater proportion of the Crown's portfolio of assets over time. The Crown's contingent and implicit liabilities will also grow with time. Recent events have shown the effect these can have on the Crown balance sheet.

The implications of these changes will require ever more astute management. Flexibility will need to be maintained to ensure the balance sheet remains fit for purpose and risk management issues will need greater attention than in the past.

It is this outlook that makes it increasingly important to ensure that the balance sheet underpins living standards for New Zealanders. This is about value for money. More efficient balance sheet management would open opportunities for governments to either spend more on raising the quality and quantity of services - such as education and healthcare - or alternatively to lower the Crown's tax take, which would mean more money in taxpayers' pockets.

Strong balance sheet management, with the use of performance targets, can also complement efforts to raise the economy's productive performance. This can be done through promoting macroeconomic stability by helping to manage risks to the wider economy, and by increasing the availability of resources to the private sector by using assets more productively. It also allows governments to achieve an equitable distribution of benefits, costs, and risks across current and future generations and helps with the management of looming long-term fiscal challenges due to population ageing and demographic change.

Area of focus:
  • Governments should consider the use of specific performance targets in meeting the requirements under the Public Finance Act to outline a strategy for managing the Crown's capital and balance sheet.

Governments need to be efficient and effective in the use of resources 

Governments have limited resources with which to deliver on their objectives. The capital employed in asset ownership is never free and assets need to provide benefits greater than the inherent costs of ownership.

Governments need to clearly identify the outcomes sought, and subject investment alternatives and delivery mechanisms to rigorous evidenced-based evaluation of costs, benefits and risks.

Public ownership needs to be assessed against its ability to deliver on outcomes and value for money, and should not be seen as the default setting. Different interventions have led to very different balance sheet outcomes. Governments have used different methods to advance public policy objectives over the years. For example, while a majority of schools are owned by the Crown, early childcare education has a large element of publicly funded private provision.

Ineffective management of assets and liabilities has real costs to New Zealanders. Poor investment decision making not only reduces the resources available to fund priorities directly, but also can result in unnecessary additional operating expenditure.

Changes to society and demographics will occur in the future. Flexibility in balance sheet management is needed to ensure that as circumstances change, the composition of the balance sheet remains appropriate and value for money is still assured.

While there has been a significant improvement in balance sheet management practices in recent years, the information collected for this Statement suggests that these practices are still not as good as they should be across the public sector. Significant Crown investment occurs without being subject to a formal process that ensures it aligns with overall government priorities. That means while individual agencies may be making investment decisions that reflect their own priorities, assets may be better deployed to reflect governments' long-term priorities.

The analysis in this Statement suggests there may be a case for greater coordination in asset performance and investment decision making, and stronger settings in the form of guidance, direction, or monitoring to sharpen incentives and improve balance sheet management practice. In some cases it may be necessary to review decision making arrangements to facilitate more coordinated cross-sector capital investment to better align agency priorities with governments' long-term priorities.

Areas of focus:
  • Ensure settings bring about more rigorous capital investment decision making and support asset management practice to improve alignment between investment and governments’ long-term priorities.
  • Explore how capital could be recycled to meet changing demands and priorities without incurring unnecessary costs.

More systematic collection and use of information is necessary

New Zealand is a leader in fiscal transparency and financial reporting and has well- developed systems to support this. However, the Crown's understanding of non-financial performance and risk information could be improved.

Better information is needed to support decision making that takes into account the Crown's aggregate balance sheet position. High quality information is vital to implementing more rigorous investment decision making and balance sheet management from a whole of Crown perspective.

This Statement has attempted to collate a significant amount of information. This process was challenging and ad hoc, as the Crown currently does not have the systems and processes in place to capture the information needed in a robust manner.

Area of focus:
  • Develop a structured, systematic and robust mechanism for the collection of better information required to support more rigorous investment decision making and deliver on actions discussed in this document.

The balance between devolution and coordination

A theme of this Statement is the balance between fostering accountability for agency performance through a devolved operating model, and the need for greater agency coordination and understanding of the impacts of discrete decisions in aggregate.

This Statement outlines a number of areas where balance sheet management could improve. There may be a need for greater central understanding of Crown assets, for more coordinated investment decision making, and for a more efficient and well understood financial risk management system. To improve outcomes the balance between devolution and coordination might need to be adjusted through greater use of central capabilities.

This would be consistent with recent developments. Parliament's decision to amend the Public Finance Act and the State Sector Act1988 was designed to facilitate greater coordination between agencies to work collaboratively towards achieving government outcomes.

Greater coordination is being introduced on an issue by issue basis, where it makes sense to support chief executives or to get the best outcome for New Zealanders. For instance, this greater coordination is being applied through the pursuit of the Better Public Services Key Results, and the use of functional leads in areas of procurement, property and ICT.

Decisions on the proposed steps towards coordination to improve balance sheet management should draw on lessons from other changes and an understanding of the impact on the whole operating model.

Area of focus:
  • Assess whether further system level capability can adjust the balance between accountability and coordination to achieve better outcomes.

Owning the right assets: performance challenges and opportunities 

This Statement represents a comprehensive assessment of the utilisation of Crown assets and their effectiveness in meeting public policy objectives. The focus of this analysis was Crown property, plant and equipment. This includes the bulk of the physical assets governments use to deliver social outcomes.

There is evidence that in many areas these assets are ageing, not well maintained, underutilised or no longer fit for modern purposes. For example, many schools, courts, and social houses are over 40 years old, which can have implications for ongoing operating costs or may soon require material replacement capital. In addition, there may be significant misalignment of capacity in large parts of the social sector. This may reflect the implications of demographic changes since these assets were built.

Measuring and monitoring the contributions of assets and new investment to outcomes must improve, and better performance measures need to be developed across the whole of government. Without that, there could continue to be asset underutilisation, misalignment with needs, and age-related functionality and cost problems.

Area of focus:
  • Further develop and utilise metrics for the measurement and monitoring of the performance of Crown assets in meeting government objectives.

Managing risk: understanding the financial implications of aggregate risk

Risk affects governments' ability to deliver on their objectives cost effectively. Effective financial risk management underpins living standards by increasing the Crown's resilience to shocks. This maximises the benefits and minimises the costs of publicly provided goods and services, and improves economic growth and social outcomes.

Beyond the financial risks it faces on its own balance sheet, the Crown plays a vital role in bearing risk on behalf of New Zealanders. These risks are some of the largest the Crown faces. Implicit and contingent financial liabilities require careful management to ensure they do not have unintended negative fiscal, economic or social consequences.

The Crown's current financial risk management framework generally involves holding agencies responsible for the risks that they individually face, subject to some central guidance, and with coordination for risks with broader national implications. Resilience is supported through low debt levels and a strong balance sheet.

This model works well although it may be less efficient and effective than it could be - more coordinated financial risk management may improve this. There is a need to have a better aggregate view of Crown financial risk to ensure that total risk is consistent with governments' risk appetites.

The financial risk implications of a larger balance sheet, more heavily weighted to financial assets, will need careful consideration in the future.

Areas of focus:
  • Build a fuller understanding of aggregate Crown financial risk.
  • Investigate whether efficiencies can be achieved within the current financial risk management framework.
  • Continue to develop policy to manage the Crown’s contingent and implicit liabilities to help ensure economic stability, fiscal resilience and social outcomes are maintained.

Fiscal sustainability: building buffers and liability management

The Crown needs to maintain an adequate fiscal buffer that can sustain government activities in the event of a major shock. The worth of this approach was clearly demonstrated by the global financial crisis and the Canterbury earthquakes. Repaying the core Crown debt raised to deal with these two events should have a high priority as surpluses eventuate.

Once prudent core Crown debt levels are reached the Crown could look to fund future obligations and contingencies through further saving. This would help the Crown cope with the fiscal implications of projected demographic pressures. Saving has social implications as costs are borne by the same generation that receive the benefits of interventions.

Many of the liquid assets owned by the Crown are not available in the event of a severe shock. There might be merit in having access to a general pool of assets to augment the Crown's fiscal buffers against a range of contingencies.

Areas of focus:
  • Investigate whether improvements could be made to the Crown’s current arrangements for contingency funds and reserves.
  • Continue the focus on strengthening the Crown’s balance sheet buffers in a timely way to further improve resilience.

Part 1: Introduction to the Balance Sheet

This section discusses the purpose of the 2014 Investment Statement (hereafter referred to as either the Statement or the Investment Statement), including its contribution to New Zealand's fiscal transparency. It examines the importance of the balance sheet, and its management, to supporting the public policy priorities of governments. In particular, it discusses the importance of efficiency and effectiveness in providing the right services and value for money for taxpayers, and the balance sheet's role in supporting macro-economic stability and economic performance.

Chapter 1: Introduction

The Public Finance Act 1989 (PFA) sets out the requirements of this fiscal accountability document. These are to describe and value the Crown's assets and liabilities and to outline how they have changed, and will change, over time.[1]

This Statement goes beyond the minimum statutory requirements and also discusses:

  • the performance of the Crown’s major assets and liabilities
  • how effective ownership and stewardship of assets can complement governments’ public policy objectives
  • Crown risk management issues, and
  • the importance of fiscal sustainability.

The Statement is divided into three parts. Part One outlines the purpose of the Statementand provides strategic context. Part Two describes the current size and composition of Crown assets and liabilities and examines a range of non-financial indicators of performance. Part Three examines many of the principles of efficient and effective balance sheet management and assesses the performance of the public sector management system against those principles.

Improving transparency in the public sector

New Zealand is a leader in public sector transparency. This Statement is one of a number of publications that the Treasury produces to provide transparency around the Crown's finances. Other reports include the Financial Statements of the Government of New Zealand (FSGNZ), the Economic and Fiscal Updates (EFU) and the Statement on the Long-term Fiscal Position (LTFS).

Sources of information

Information contained in this Statement is based on a variety of sources.[2]

Historical financial data are based on the FSGNZ for the year ended 30 June 2013, with some additional supporting information collected by the Treasury. Forecasts and projections on the size and composition of the balance sheet are based on the 2013Half Year Economic and Fiscal Update (HYEFU) and 2013 LTFS respectively.

The detailed non-financial performance analysis cited in Chapter Four is based on management information that was provided to the Treasury by various Crown agencies. While some of this information may have been previously disclosed publicly, some of it was provided, or created specifically, for this Statement.

Notes

  • [1]See section 26NA of the PFA.
  • [2]Unless otherwise stated, all information is based on June financial years.

Chapter 2: The Importance of Balance Sheet Management

...Taxpayers make a large investment through the Crown balance sheet.  Efficient and effective balance sheet management supports the delivery of government objectives, economic growth and social outcomes, now and in the future.  This improves living standards...

  • Introduction
  • The Crown balance sheet
  • Importance of the balance sheet in meeting government objectives
  • Balance sheet management
  • Structuring government to meet objectives
  • Looking to the future

Introduction

Governments have a myriad of social and economic policy objectives. These evolve over time as governments respond to ever-changing expectations around the appropriate role of the state in the provision of public goods and services.

From a public policy perspective, there is general agreement that governments should focus on objectives where private sector provision is unlikely to be adequate. It is also accepted that governments have a vital role in policy setting to create an environment that supports economic growth and stability.

All public policy objectives have a number of ways of being delivered on and these have financial implications. Public sector financial reporting was developed to inject transparency and accountability to these activities, and to allow for more informed decision making. The New Zealand public sector has long been a leader in this regard, being the first to produce a comprehensive sovereign balance sheet according to independent accounting standards.

This transparency and accountability has had many benefits. The production of the first balance sheet in the early 1990s acted to highlight the size of the challenge to sustainably manage the Crown's finances. This led to further proactive measures to prudently manage Crown debt and other liabilities. These measures assisted the Crown in achieving a strong financial position from which to respond to subsequent international economic and financial crises, and natural disasters at home.

The Crown balance sheet

The Treasury produces the FSGNZ ten times a year. As part of these accountability reports, a Statement of Financial Position (balance sheet) is produced in conjunction with other financial reporting, in particular the Statement of Financial Performance (operating statement).

The Crown's balance sheet represents an account of what it owns and owes, and the net worth attributable to taxpayers at a point in time. At 30 June 2013, the Crown's balance sheet consisted of $244.4 billion of assets, $174.4 billion of liabilities and $70.0 billion of equity. Total assets alone were worth more than the output of the entire economy in a year.

The balance sheet reflects the decisions and financial performance of successive governments, partly through its relationship with the operating statement (see Figure 2.1). It is large and complex, consolidating the effect of activities, assets and liabilities from a wide variety of Crown-controlled entities.[3] Assets and liabilities of agencies including departments, Crown Entities, State-owned Enterprises (SOEs) and stock exchange-listed Mixed Ownership Model (MOM) companies are all accounted for in the Crown balance sheet.

The standards by which FSGNZ are produced, called Generally Accepted Accounting Practice (GAAP), define the criteria for measurement and qualification for recognition in the accounts. The balance sheet and its associated notes help provide a detailed picture of the strengths and weaknesses of the Crown's finances.

However, the Crown's balance sheet does not always recognise assets or liabilities that may be intangible, contingent, prospective or implicit and therefore may fall outside the accounting recognition criteria set by GAAP. Unrecognised items are generally policy commitments that are not contractually binding, such as superannuation or welfare benefits. The ability to tax, which is likely to be the Crown's largest intangible asset, is similarly not recognised. These matters are discussed more fully in Box 2.1.

Figure 2.1 - The balance sheet and the operating statement
Figure 2.1 - The balance sheet and the operating statement.
Source:  The Treasury

Box 2.1 - The “comprehensive” balance sheet

GAAP seeks to establish the financial information that is most relevant for accountability and decision making purposes and that best represents economic reality, within the constraints of cost and materiality. For these reasons, it is the best set of rules and conventions for the Crown to measure its assets and liabilities.

However, there are many other known (and unknown) items that may also be seen to be Crown assets or liabilities that do not comply with GAAP conventions. The fact that something is not recognised in the formal financial statements does not mean that it should be ignored.

The impact of future cash flows and contingencies

A comprehensive balance sheet seeks to address GAAP limitations by recognising a wider range of items that represent the net present value of expected future income and expenditure streams. This provides a greater understanding of the financial impacts of running current fiscal policy into the future, which are often very large given the role that the Crown plays in raising taxes and spending on welfare, health and education over time. Other contingent or implicit assets and liabilities may also be recognised. The Crown's comprehensive balance sheet position is not routinely reported on, nor is it part of the FSGNZ.

The comprehensive balance sheet could be an important tool for the management of Crown finances. Considering the balance sheet in this manner could show a more comprehensive net worth position that better reflects whether the Crown will be able to meet its obligations as they occur in the normal course of events. A significant positive balance would suggest that there is scope to reduce tax or to increase public services, whereas a significant negative position would imply a clear signal that the opposite is the case. The comprehensive balance sheet can also support better management of the large array of risks that can potentially impact on the Crown's finances.

Providing effective stewardship - a closer look at Crown-owned land

The balance sheet provides a snapshot of the assets, liabilities and equity of an entity and an important function of it is to give an account of the financial stewardship of that entity. This can be difficult due to the inherent difficulties in valuing many ‘off-balance sheet' assets. This in turn leads to difficulties in fully assessing the implications of policy decisions on comprehensive net worth.

Conservation land provides a useful example of the implications of valuation challenges. Crown-owned conservation land makes up around a third of New Zealand's land mass and is valued at around $6 billion in the FSGNZ. However, this does not consider the value of the minerals held beneath or on the land, nor does it attempt to include the social, cultural and economic benefits of the estate, such as for recreation and tourism purposes. Considering these elements when assessing value could markedly increase the overall value of conservation land.

While the extraction of resources from the estate to realise this value may have significant benefits to GDP, it does not provide a full account of the consequences of such activity. This depletion of mineral stock reduces future benefits for subsequent generations. For accountability reasons, policy decision makers need to weigh the current implications of such policy decisions, both benefits and costs, against the opportunity costs for the future, which could be assisted by considering the comprehensive balance sheet.

Notes

  • [3]A small number of assets are recorded as equity investments. Local authorities are not represented in the Crown's financial statements because they are separate entities not controlled by central government.

Importance of the balance sheet in meeting government objectives

Effective management of the balance sheet has a key role to play in supporting governments to meet their objectives. A well-managed balance sheet is one which both supports the provision of state-funded services while also underpinning the overall economy's performance, and contributes to increasing living standards.[4]

The state sector and government policy

Governments act on behalf of all New Zealanders to deliver services as efficiently and effectively as possible. Effective balance sheet management supports this objective by minimising the cost and maximising the benefits of holding assets and liabilities. The importance of providing value for money is discussed further in Box 2.2.

Effective management of the balance sheet allows the government to achieve an equitable distribution of benefits, costs and risks across current and future generations. Debt allows the cost of investments to be spread over their useful lives meaning that those that benefit contribute to the cost. Saving through the balance sheet also allows for the cost of future expenses to be met by those who benefit from them.

Box 2.2 - The importance of value for money

Crown assets come with an ongoing cost. Based on the public sector discount rate the opportunity cost of Crown asset ownership is around $25 billion per annum. This does not include the costs of utilisation, or upkeep. Capital is not free. Capital that does not provide benefits greater than the costs of ownership incurs costs on citizens.

To put the Crown's balance sheet size into context, there were approximately 4.5 million people living in New Zealand at the end of the last financial year. That means the Crown owned about $54,000 worth of assets and owed $39,000 in debt on behalf of every New Zealander at that time. That means many families' indirect share of the Crown's assets and liabilities would typically be second only in value behind the family house and mortgage.

People expect governments to make the best use of these assets and to manage liabilities to minimise costs. Achieving this allows for more and better public services - more schools or better healthcare for example - or lower taxes, which increases incomes.

Economic growth

An efficiently managed balance sheet saves taxpayer dollars. It also supports a productive public sector and reduces the chances of public spending reducing private sector activity. Productivity is critical to economic growth, increasing national wealth and living standards. With the Crown contributing approximately one fifth of New Zealand's national output each year, even a small improvement in public sector productivity would have a significant positive effect on the wider economy.[5]

A stable economic environment is one of the basic requirements for strong economic performance. Managing public finances well has clear links to this goal. A strong and well managed balance sheet supports fiscal policy by allowing the effects of economic cycles to be met without the need for destabilising tax or expenditure changes. At a minimum, operating revenues should equal operating expenditure over the economic cycle, with debt being used only to fund investment.

Governments with a strong balance sheet have more flexibility to manage the investment cycle in alignment with the wider economic cycle. For example, a number of infrastructure projects were brought forward supporting economic growth during the recent economic slowdown as a result of the global financial crisis. On the other hand, too much stimulus as the economy reaches capacity could push up interest rates, put upward pressure on the exchange rate and increases pressure on the tradable sector.

A strong balance sheet supports a favourable credit rating and lowers the cost of capital for government and domestic borrowers, which helps support increased productive investment. Even after the effects of the global financial crisis and the Canterbury earthquakes, both of which resulted in an increase in Crown debt, New Zealand's credit rating remains strong and it is one of the highest rated sovereigns in the world (see Figure 2.2).

A strong Crown balance sheet can also help manage the effects of shocks that may otherwise have a major destabilising effect on a country. It also allows for the sharing of consequences among individuals and across generations that would otherwise fall unevenly.

Figure 2.2 - Foreign currency sovereign credit ratings
Figure 2.2 - Foreign currency sovereign credit ratings   .
Source:  The Treasury

Imbalances and structural problems in the economy can be assisted by balance sheet management. For example, New Zealand has a relatively high net external debt position, primarily reflecting that the private sector, including households, on average spend more than they earn. Also, New Zealand's sources of foreign earnings are relatively narrow, mainly from commodity based exports. These factors make the economy susceptible to any abrupt changes in demand or in perceptions about economic resilience. Governments' fiscal policy settings have generally been set to offset high private sector borrowing in recognition of these risks.

Notes

  • [4]http://www.treasury.govt.nz/abouttreasury/higherlivingstandards
  • [5]This represents central government's operating and capital output, but excludes Crown expenses such as transfers, depreciation and debt servicing.

Balance sheet management

Balance sheet management refers to a number of actions, including:

  • managing the assets and liabilities that make it up, including making decisions about what assets to buy or sell or liabilities to incur or retire
  • managing Crown finances appropriately through fiscal policy settings, using Crown debt to help manage the impact of economic cycles and/or to bring forward or defer spending
  • managing off-balance sheet assets and liabilities, including the impacts of policies on future balance sheets and contingent or implicit liabilities, and
  • utilising the balance sheet to meet public policy objectives, such as saving now to meet future expenses or vice versa.

Effective balance sheet management requires an overarching strategy that brings together these actions in a cohesive manner. The use of specific performance targets can bring further discipline to this process.

Structuring government to meet objectives

The Crown is a large and complicated collection of organisations that serve many different purposes.[6] A key objective is to create institutional arrangements which maximise agency performance while aligning with government priorities. This has implications for agency autonomy.

Government organisations operate under different Acts according to their circumstances and have different governance structures. Government departments or ministries perform core government roles that generally require greater Ministerial involvement.[7] Crown entities, SOEs and MOM companies are legally separate from the core Crown and typically have more discretion in their operations.[8]

The performance of the balance sheet therefore reflects decisions made by a diverse range of entities. Ministers have differing degrees of control over Crown organisations, which has implications for balance sheet outcomes.

Cost centres and revenue centres

The characteristics of public sector organisations have implications for the way their performance is understood.

A cost centre is part of an organisation that does not produce direct profit but does add to the cost of running the organisation. It either adds value indirectly or fulfils another purpose that cannot be measured using only financial results. Private sector examples of cost centres include research and development departments, help desks and customer service/contact centres.

A revenue centre is accountable for revenues and costs, and hence profits. Profit centre management essentially means running a stand-alone business, and financial results are an important signal of good performance.

On these definitions, much of what the Crown delivers is done through cost centres. For example, the provision of health and education services are largely funded centrally, and those working in these areas are not expected to earn revenue from their operations.

A rule of thumb is that the closer proximity a function is to the core Crown the more likely it is that it will be delivered by a cost centre.

In turn, this means that measures other than financial results are needed to assess their performance. The requirement to have good non-financial performance information is echoed in the findings of this report. This is not just a public sector issue; it is a common problem in large corporations with internal cost centres.

Notes

  • [6]See Appendix one for a list of the entities included in the Crown balance sheet.
  • [7]Some departments have specific functions that must be performed independently of Ministers such as the IRD making decisions on individual cases.
  • [8]http://www.treasury.govt.nz/publications/guidance/publicfinance/pit2011

Looking to the future - preparing for demographic change

In its 2013 LTFS, the Treasury projected the scale of the Crown's long-term fiscal challenges arising from major changes in population size and structure.[9] In particular, it highlighted the growing pressures on future health sector and superannuation expenditure from a changing population and income increases.

Current policy settings to partially prefund this future increase in New Zealand superannuation through the New Zealand Superannuation Fund (NZSF) will result in a larger Crown balance sheet, which makes the quality of its management even more important. In particular, the Treasury projects that Crown financial assets will continue to grow and form a greater proportion of the Crown balance sheet in the decades ahead. These financial assets are projected to constitute well over $600 billion, or 45% of GDP, in 2057/58 (see Figure 2.3). This will have major implications for the Crown balance sheet as well as for the wider economy.

Figure 2.3 - Projected financial assets
Figure 2.3 - Projected financial assets   .
Source:  The Treasury

Beyond accumulating financial assets, the LTFS highlights the need for continued prudent fiscal management so future governments are in a better position to manage these cost pressures. A well managed balance sheet can help reduce these fiscal pressures through providing services at a lower cost. As the LTFS shows, small changes now can have large effects in the future. Managing the balance sheet well now can have a material effect on future welfare. See Figure 2.4 for net government debt projections under three different fiscal strategy scenarios.

Figure 2.4 - "What if" paths for net government debt
Figure 2.4 -
Source:  The Treasury

Area of focus

  • Governments should consider the use of specific performance targets in meeting the requirements under the Public Finance Act to outline a strategy for managing the Crown's capital and balance sheet.

Notes

  • [9]http://www.treasury.govt.nz/government/longterm/fiscalposition/2013

Part 2: The Balance Sheet by Numbers

This section provides a detailed description of the composition of the Crown's balance sheet and discusses how it is expected to change in the future. The substantial component, Balance Sheet Performance, examines the composition and quality of Crown assets and liabilities, and their effectiveness at meeting government objectives, from a sector by sector perspective.

Chapter 3: The Crown Balance Sheet

  • Introduction
  • The Crown's balance sheet position
  • Evolution of the Crown balance sheet

Introduction

The Crown's balance sheet is split into assets (the things the Crown owns or has a right to) and liabilities (things the Crown owes, is obligated to pay for or has agreed to assume). The difference between the two represents the Crown's equity.[10]

At 30 June 2013 the value of the Crown's assets totalled $244.4 billion, of which the main asset types were:

  • property, plant and equipment (PP&E), such as land and buildings ($109.8 billion)
  • marketable securities and share investments ($61.4 billion), and
  • tax receivables and student loans ($16.5 billion).

Meanwhile, the value of the Crown's $174.4 billion of liabilities primarily consisted of:

  • borrowings ($100.1 billion)
  • insurance liabilities ($37.7 billion), and
  • retirement liabilities ($11.9 billion).

Table 3.1 sets out the Crown's balance sheet as at 30 June 2013, the forecast movement in the balance sheet through to June 2018, based on 2013 HYEFU assumptions, and the balance sheet as at 2003 and 2008 to provide historical comparisons.

What this shows is that over the past ten years the value of the Crown's assets rose by $144.6 billion, or 145%, while its liabilities increased by $98.3 billion, or 129%. Over the forecast period this growth is expected to plateau and remain at a more constant level.

Notes

  • [10]“Net worth” and “equity” may be viewed as the same concept.

The Crown's balance sheet position

Table 3.1 describes the Crown's past, present and forecast balance sheets.

Table 3.1 - The Crown's balance sheet
  2003
Actual
$m
2008
Actual
$m
2013
Actual
$m
2014
Forecast
$m
2015
Forecast
$m
2016
Forecast
$m
2017
Forecast
$m
Assets              
Cash and cash equivalents 2,732 3,804 14,924 10,221 9,535 9,236 9,117
Receivables 10,143 14,158 19,883 18,968 17,909 18,191 18,642
Marketable securities, deposits and derivatives in gain 16,572 41,189 44,000 44,522 40,429 45,246 53,732
Share investments 4,734 12,964 17,359 21,289 23,044 24,747 26,511
Advances 6,300 12,948 22,613 24,359 26,268 28,188 29,780
Inventory 840 964 1,140 1,148 1,189 1,296 1,267
Other assets 576 1,663 2,295 2,268 2,366 2,404 2,385
Property, plant and equipment 52,667 103,329 109,833 113,277 115,464 117,316 118,833
Equity accounted investments 4,212 8,065 9,593 9,876 10,130 10,331 10,478
Intangible assets and goodwill 1,075 1,751 2,776 2,878 2,872 2,829 2,788
Forecast for new capital spending - - - 206 773 1,589 2,539
Top-down capital adjustment - - - -450 -625 -800 -925
Total assets 99,851 200,835 244,416 248,562 249,354 260,573 275,147
Liabilities              
Issued currency 2,895 3,530 4,691 4,936 5,084 5,237 5,394
Payables 9,208 10,895 11,160 11,955 12,103 13,238 13,971
Deferred revenue - 1,292 1,714 1,695 1,733 1,740 1,746
Borrowings 38,285 46,110 100,087 104,354 104,608 110,532 117,271
Insurance liabilities 9,155 20,484 37,712 33,430 31,140 30,848 31,738
Retirement plan liabilities 13,857 8,257 11,903 10,880 10,501 10,192 9,925
Provisions 2,670 4,753 7,138 6,417 6,176 5,939 5,866
Total liabilities 76,070 95,321 174,405 173,667 171,345 177,726 185,911
Total assets less total liabilities 23,781 105,514 70,011 74,895 78,009 82,847 89,236
Net worth              
Total net worth attributable to the Crown 23,687 105,132 68,071 69,165 72,242 77,040 83,401
Net worth attributable to minority interest 94 382 1,940 5,730 5,767 5,807 5,835
Total net worth 23,781 105,514 70,011 74,895 78,009 82,847 89,236

Classifying the Crown balance sheet

Figure 3.1 - Crown balance sheet by functional class
Figure 3.1 - Crown balance sheet by functional class   .
Source:  The Treasury

For the analytical purposes of this Statement, components of the accounts have been classified into one of three broad functional classes - Social, Financial, or Commercial - selected to capture the primary purpose for holding the asset or liability.

This classification, while useful, is somewhat arbitrary as some assets or liabilities may have multiple purposes. For example, student loan assets have been classified as being social assets because they fulfil a social purpose to facilitate access to tertiary education, even though they may be seen as being of a financial nature.

Social

Assets and liabilities held by the Crown primarily to provide public services or to protect assets for future generations.  These include, for instance, roads, schools, and the national parks.  For the purposes of this document, social assets also include tax receivables and student loans managed by the Inland Revenue Department, and Crown companies that do not have purely commercial objectives such as Crown Research Institutes.

Financial

Assets and liabilities held by the Crown to finance or prefund government expenditure and to recognise the obligation for future expenditure.  This category is comprised of the Crown Financial Institutions (CFIs), the Reserve Bank of New Zealand, and government borrowing via the Treasury's New Zealand Debt Management Office.[11]

Commercial

A portfolio of companies held by the Crown with commercial objectives.  The companies are largely self-sustaining entities operating in openly competitive environments.  This category is comprised of all the MOM companies and SOEs, excluding the land held within New Zealand Railways Corporation which is classified as a social asset.  TVNZ and Public Trust are treated as commercial entities due to their primary purpose being commercial in nature.

Notes

  • [11]CFIs include New Zealand Superannuation Fund, Accident Compensation Corporation, Earthquake Commission and the Government Superannuation Fund.

Evolution of the Crown balance sheet

The Crown's balance sheet size and composition has evolved through time in response to changes in economic conditions and government objectives. Not only has the total value of assets and liabilities grown over time, the split between Social, Financial and Commercial portfolios has also changed.

Assets

The Crown's asset base has grown significantly since the first balance sheet was produced in 1992, both in value and as a percentage of GDP. This is largely as a result of increases in the carrying value of Crown-owned land and buildings, and growth in financial assets, such as marketable securities and share investments.

Figure 3.2 - Crown assets
Figure 3.2 - Crown assets   .
Source:  The Treasury

The Social asset portfolio has traditionally been the largest, and this remains the case. Social assets are predominantly the property, plant and equipment used to meet government objectives. The increase in the value of land and buildings held was due to acquisitions as well as changes in the valuation of existing assets. The effect of revaluations can be seen in the asset revaluation reserve held on the balance sheet, reflecting the impact of non-cash changes in asset values, which has increased by $41.4 billion since 2003.

The value of financial assets increased primarily driven by changes to the NZSF and Accident Compensation Corporation (ACC). Over the past decade there has been a significant increase in the value of financial assets due to the prefunding of future policy driven expenses through the CFIs. NZSF began investing in 2003, and the asset portfolio of ACC has increased as it focused on becoming fully funded. Financial assets are of a different nature to Social assets and expose the Crown to a different range of risks that it had previously not needed to consider or respond to.

The Crown's investment in Commercial assets is the smallest of the three functional classifications and consists largely of property, plant and equipment in the electricity sector, and financial assets held by Kiwibank. The value of property, plant and equipment has increased through acquisitions and revaluations, while Kiwibank assets have grown in line with their customer base. It is important to note that the Government Share Offer Programme has reduced the Crown's interest in the MOM companies.[12]

Liabilities

Crown liabilities consist of government borrowings, commercial borrowing by SOEs, insurance liabilities and contractual retirement obligations.

Government borrowings make up the greatest proportion of liabilities. Government borrowing is used for capital acquisition and financing operating deficits. The Crown uses a fiscal indicator, net core Crown debt, as a key measure of fiscal performance and resilience.[13] At 30 June 2013 net core Crown debt stood at $55.8 billion (26.3% of GDP).[14]

Figure 3.3 - Net core Crown debt
Figure  3.3 - Net core Crown debt  .
Source: 

The Crown's debt position has changed significantly over time due to fiscal policy and economic conditions. There was a 20 year period of increasing debt (1972-1992) which was followed by a long period of debt reduction (1992-2008). Over the past five years the debt-to-GDP position of the Crown has been weakening following the global financial crisis (GFC) and Canterbury earthquakes, albeit from a strong position in 2008 (5.5% of GDP).

Insurance liabilities have increased as a result of growth in the ACC scheme and the Canterbury earthquakes. The Government Superannuation Fund (GSF) has remained relatively constant due to the scheme being closed to new members since the early 1990s. In aggregate, commercial entity borrowings make up a small proportion of Crown liabilities.

Net worth attributable to the Crown

Net worth attributable to the Crown (NWAC) is an alternative measure of the Crown's long-term solvency and financial sustainability. NWAC is calculated as being the Crown's total assets less its total liabilities and minority interests, and includes many assets and liabilities that are not considered as part of the net core Crown debt measure.

The Crown's NWAC turned around from a negative position in 1993, up until the impacts of the GFC started to be felt on the Crown's balance sheet from 2009. This was driven largely by the growth in core Crown debt to fund operating deficits. The 2013 financial year saw NWAC increase for the first time since 2008, primarily due to gains in financial assets.

Figure 3.4 - Net worth attributable to the Crown
Figure 3.4 - Net worth attributable to the Crown   .
Source:  The Treasury

The balance sheet in the future

Over the next five years, the total net worth of the Crown is expected to grow by $28.2 billion driven by operating surpluses and financial asset revaluations. By 2018, assets are forecast to grow by $35.5 billion and liabilities $7.3 billion.[15]

Figure 3.5 - Crown total net worth: 2013-2018
Figure 3.5 - Crown total net worth: 2013-2018   .
Source:  The Treasury

Social assets are expected to grow by $10.7 billion which can be attributed largely to an increase in the value of the state highway network and Inland Revenue Department (IRD) receivables. Generally, social assets are largely funded through tax revenues or Crown borrowing, however state highway related expenditure is also funded through levies and road user charges. Recently there has been a focus on recycling capital from the balance sheet. The Future Investment Fund will be used to fund capital spending on social assets through to Budget 2016.[16]

Financial assets are expected to grow by $17.5 billion reflecting investment growth in CFIs - mainly the NZSF and ACC. Expected returns on investment will support NZSF and ACC growth. In the case of ACC, levy revenue will also fund asset purchases.

Within the Commercial portfolio there is expected to be an increase in both assets and liabilities that largely offset each other. These primarily relate to the continued growth in Kiwibank mortgages funded through increases in third party funding such as customer deposits.

The Crown's financial liabilities are also expected to increase, as borrowing increases to meet the Crown's cash deficits over this period. These are partially offset by a reduction in EQC liabilities as the claims resulting from the Canterbury earthquakes are expected to be settled by 2018.

Future investment

The majority of Crown capital (and operating) spending is funded from the general pool of Crown revenue, including tax income and the proceeds of Crown borrowing. This makes it difficult to directly apportion specific funding sources towards specific projects. In certain circumstances, money collected will be allocated directly to certain expenditure areas - this can be most clearly seen with transport and ACC funding.

Table 3.2 outlines forecast investment expenditure by type and the manner in which the Crown is expected to accumulate the funding required.

Table 3.2 - Capital expenditure funding
  2014
$b
2015
$b
2016
$b
2017
$b
2018
$b
Opening cash balance 14.9 10.2 9.5 9.2 9.1
Foreign exchange losses on opening cash (0.3)    -    -    -    -
Cash flows from operations 1.1 4.1 7.7 9.9 11.7
Cash flows from financing activities 7.1 1.4 6.5 7.1 (4.7)
Government share offer programme 2.5 0.6    -     -     - 
Cash available for investment 25.3 16.3 23.7 26.2 16.1
Net purchase of physical assets (7.4) (6.5) (6.1) (5.5) (5.1)
Net purchase of intangible assets (0.6) (0.5) (0.4) (0.4) (0.4)
Net purchase of shares and securities (5.3) 2.4 (5.8) (9.0) 0.8
Net issues of advances (2.1) (1.9) (1.6) (1.5) (1.4)
Other investing activities 0.3 (0.3) (0.6) (0.7) (0.7)
Net cash flows from investing activities (15.1) (6.8) (14.5) (17.1) (6.8)
Closing cash balance 10.2 9.5 9.2 9.1 9.3

Table 3.3 provides a breakdown of the forecast gross additions to physical assets by their respective sectors.

Table 3.3 - Property, plant and equipment additions - by sector
  2014
$b
2015
$b
2016
$b
2017
$b
2018
$b
Transport 2.6 2.5 2.5 2.5 2.6
Economic 1.3 0.7 0.8 0.9 0.8
Education 0.7 0.8 0.7 0.7 0.7
Health 0.7 0.6 0.5 0.5 0.4
Defence 0.5 0.6 0.4 0.5 0.5
Other 2.1 1.8 2.0 1.5 1.4
Total forecast additions 7.9 7.0 6.9 6.6 6.4

Further information on asset movements can be found in the following chapter.

Notes

  • [12]Reflected in the growth in net worth attributable to minority interests.
  • [13]This is calculated by taking the net position of gross Sovereign-issued debt and the core Crown's financial assets excluding advances and the NZSF's financial assets.
  • [14]The government has stated its objective is to lower net debt to no higher than 20% of GDP by 2020.
  • [15]Over the forecast period, assets are expected to decrease from 115% to 104% of GDP and liabilities are expected to decrease from 82% to 67% of GDP. However, EFU forecasts do not include the impact of revaluations on PP&E which in the past have been significant. See HYEFU 2013 for the Treasury's forecasting assumptions.
  • [16]Funded from the proceeds from the Government Share Offer Programme.

Chapter 4: Balance Sheet Performance

...Improving the understanding of assets and liabilities will enable the Crown to maximise their performance and improve outcomes...

  • Overview
  • Measuring performance
  • Social assets
  • Financial assets and liabilities
  • Commercial portfolio

Overview

This chapter describes the financial and non-financial performance measures of the Crown's assets and liabilities, broken down into the primary functional classification of the entities which hold them. Each section details the consolidated value of the assets and liabilities that make up each sector at 30 June 2013 as per the FSGNZ. They also discuss the usage, performance, expected trends and opportunities and challenges facing the Crown's assets and liabilities.

Understanding what the Crown owns and owes, and how it uses those assets and liabilities to provide services, enables improved performance, more informed views on whether past resource allocations remain appropriate, and better decisions to be made for the future.

Globally, public sector organisations struggle to develop robust means to measure asset and liability performance, and New Zealand is no exception. There needs to be an improvement in the type of information collected around the balance sheet, and how that information is used to make effective decisions.

While Financial and Commercial entities are largely assessed against their returns, Social agencies have traditionally been more focused on operating expenditure and outcomes and need better non-financial performance information. A better understanding of Crown asset and liability contributions to government objectives will improve management of the Crown's balance sheet.

Measuring performance

Why measure performance?

Robust performance measurement is vital to effective asset management. It allows an organisation to assess how well it is meeting its expectations and objectives, at both an organisational and an asset level. It provides a method of comparing performance across entities, and a tool for identifying and assessing areas for improvement. This can lead to greater utilisation of Crown assets and helps ensure that assets meet needs more effectively. This in turn will allow governments to provide more services at lower cost.

Ideally, a single set of performance measures would allow for comparison across the different areas of government to enable better allocation of resources to the areas of highest need. Realistically this is difficult due to the diverse nature of Crown assets and liabilities and the different objectives they are used to meet. It is therefore more important to align performance measures with the asset or liability's purpose. ‘Good' performance will differ across asset and liability types and, even where assets may have similar characteristics, what may be important for an asset providing one type of service may be different for an asset providing an alternative service. For example, police cars are of little value unless in use while military equipment confers national security benefits whether usage is high or low.

This chapter focuses on how performance aligns with the purpose of ownership, and where possible draw links between asset usage and outcomes. These links can be difficult to determine due to assets often being held for the indirect purpose of enabling service provision - a means to an end - rather than being directly responsible for achieving outcomes.

The level of analysis in this chapter is restricted by the quality of agency asset management and the information that they are capable of providing. It may not necessarily reflect the analysis that would best serve better decision making.

Measuring performance

Performance measures broadly fall under three areas: Capacity, Capability and Financial Performance.

  • Capacity reflects the productive potential of an asset and can be assessed against current and expected demand needs. Indicators of asset availability and utilisation enable an organisation to determine how well an asset is being used compared to its potential use, while measures of economic life provide information around the expected useful lives for assets to provide services.
  • Capability represents the ability of an asset to provide a level of service. The main indicators for capability generally fall under classifications of functionality - whether the asset fits the purpose it is intended for - and condition - the physical state of the asset.
  • Financial Performance relates to the incomes and expenses directly associated with holding an asset or liability.
Figure 4.1 - Social asset reporting framework
Figure 4.1 - Social asset reporting framework   .
Source:  The Treasury

Measures and indicators should not necessarily be reviewed in isolation, and the interaction between different measures can provide a deeper understanding of asset performance.

How well do public sector agencies do?

Financial and commercial assets are assessed directly against their returns to the Crown. Social agency performance measurement has largely focused on operating expenditure and its relationship to government service provision. Measuring and understanding the performance of social assets has been a relatively weak area for the public sector.

While benchmarking against other countries could provide a useful indication of performance, difficulties arise due to a lower level of transparency from administrations in other countries. Where information is available it is not necessarily an accurate comparison due to differences in demographic and geographic conditions, or different policy settings. This in itself shows that New Zealand is not alone in finding this challenging.

Many measures are input based, meaning that the focus is placed on the effort that is put into using the assets. A lot of the measures outlined in this chapter reflect this. Output based measures focus on what is achieved as a result of using the assets, and provides a better understanding on the effectiveness of having particular assets. This allows for better decisions around prioritising and rationalising what is owned and how it is used.

Asset ageing and expected future replacement timeframes enable the government to adequately plan capital expenditure needs over the medium to long term. While many agencies currently have such an understanding of these aspects of their assets there are still a few who had some difficulty in providing this basic information.

There is some information around asset utilisation, but there is significant room for improvement. Without understanding utilisation, it is difficult to determine whether assets are surplus to requirements or whether additional expenditure is likely to meet demand effectively or create surplus stock.

The understanding of the functionality of the Crown's assets, and how well they fit their intended purpose, is weak. Functionality shows how well placed an item is to meet needs. With an ageing asset base there is a risk that assets may be out of date to meet current and future service requirements.

Future directions

At an agency level, there needs to be a much greater understanding of their assets, how they are currently being used, and how they are likely to be used in the future given changes in demand. This will require a higher level of information being collected at a detailed asset-specific level, with a stronger understanding of what metrics are suitable. This will then require a strategy on how to use that information to make more effective capital related decisions. A greater understanding of the impact that the capital base has on operating costs may also lead to greater cost savings in the long term.

Central agencies, and Ministers, need to improve their understanding of asset performance at a high level, through better monitoring and analysis of asset related information and an understanding of the implications for capital allocation across the wider state sector.

Future Investment Statements need to be able to provide a much richer view of balance sheet related performance. It is not until it is understood how the Crown's assets are contributing to meeting objectives that value for money can be assured.

Area of focus

  • Further develop and utilise metrics for the measurement and monitoring of the performance of Crown assets in meeting government objectives.

Social Assets

Purpose

Social assets are mainly managed by government departments and Crown entities.[17] They are held to support the delivery of core public services and to achieve government outcomes.

Government objectives change with time and it is important to regularly assess whether existing social assets are required or meet the needs that they are intended for. Due to their characteristics - predominantly relatively specialised property, plant and equipment - these assets may not be easy to divest where needed.

It is important to note that holding a social asset in itself does not guarantee that a public policy outcome is fully achieved as holding assets is not an end in itself - they are held to act as a platform to enable agencies to operate more effectively and to facilitate the advancement of public policy outcomes.

Notes

  • [17]The social portfolio includes a small number of liabilities, such as accounts payable, mainly as a result of government department or Crown entity business operations.

Current holdings

As at 30 June 2013, the total value of the Crown's social assets was $124.5 billion. Figure 4.2 outlines the composition of the social asset portfolio under the definitions used for financial reporting.

Figure 4.2 - Social assets by type
Figure 4.2 - Social assets by type   .
Source:  The Treasury

Other assets primarily consisted of inventory and other receivables.

Figure 4.3 provides a breakdown of the value of social assets by sector. Almost half of the Crown's social asset portfolio is held in three areas - transport, social housing, and primary and secondary schools.[18] The “Other” assets consist largely of cash holdings and PP&E across other social agencies. “Other” liabilities include current accounts payable balances and employee entitlement provisions.

Figure 4.3 - Social assets and liabilities by sector
Figure 4.3 - Social assets and liabilities by sector  .
Source:  The Treasury

Notes

  • [18]Transport assets primarily relate to state highways, but also include $3.3 billion of rail network land.

Future holdings

Social assets are expected to grow from $124.5 billion in 2013 to $135.2 billion in 2018, an increase of 9%.

Figure 4.4 - Forecast movements 2013-2018
Figure 4.4 - Forecast movements 2013-2018  .
Source:  The Treasury

The major movements leading to this increase in the social assets are in four major areas:[19]

  • A $4.9 billion increase in the state highway network. This investment is expected to contribute 46% of the growth in social assets, primarily due to spending on Roads of National Significance.
  • A $2.5 billion increase in the value of IRD and Customs related receivables, due to higher expected tax revenues.
  • A $1.1 billion increase in the Tertiary Education Institutions, due to the capital expenditure programmes aimed at repairing and replacing existing assets.
  • A $0.9 billion increase in health investment primarily relating to expenditure on the Christchurch Hospital rebuild.

Long-term fiscal projections beyond 2018 suggest that the composition of social assets is likely to need to change over the next 30 years due to the implications of demographic changes.

This is likely to result in a greater need for healthcare facilities, although this may be offset by the implications of technological advances. There is expected to be greater demand for tertiary education facilities, while maintaining a relatively consistent level of primary and secondary schools.

A declining crime rate and changes in the justice system will have implications for the size and composition of assets in the sector. There will also be a need to increase defence force assets in the 2020s, as key strategic assets in the existing stock reach the end of their useful lives.

The geographical distribution of assets on the balance sheet is also likely to change, with increased urbanisation requiring reconfiguration of the existing stock - such as state houses and schools - from more provincial communities to cities to meet the shift in demand.

Summary of performance

The majority of the Social assets are held to provide the Crown with a platform to deliver public services, and the performance of these assets is measured in terms of the capacity and capabilities that these assets give an agency to operate in an efficient and effective manner.

Historically, measurement and reporting of asset performance has been weak, but it has been improving across government recently. Agencies are gradually improving their asset measurement capabilities, some more so than others, but there is a need to integrate the understanding obtained from measuring performance into making better capital decisions, and how they relate to operating spending pressures.

Some key observations and issues identified relating to the social asset portfolio are:

  • Changes in demographics have had a significant impact on the development and use of Crown assets in the past, and are likely to have significant implications in the future. Historically New Zealand’s population was split across a wide array of smaller towns and cities, resulting in a need for a large number of smaller assets to provide services. Increased urbanisation has led to the Crown having assets that are surplus to needs, and resources could be more effectively used if the asset base is rationalised and aligned with demand expectations.
  • The age of the social assets means that there is a specific need for careful asset management over the next 10-20 years. Capital spend on the back of the post-war baby boom has left New Zealand with a large number of old assets, and decisions will need to be made on whether these assets will need to be maintained or replaced to meet future service needs.
  • Many Crown assets are not being utilised effectively. Under-utilisation is likely to lead to additional expenditure that could have otherwise been avoided, and can be remedied through a reprioritisation of assets to other uses or through divestment.
  • Agencies may need to consider alternative methods to achieve outcomes. This could include using existing assets in a different manner, increasing cooperation with other agencies, or considering arrangements other than asset ownership.

The remainder of this chapter assesses the Crown's major social assets in greater detail.[20]

Notes

  • [19]These movements do not include the impacts of possible future asset revaluations.
  • [20]Note that the headline charts describing the values for some sectors differ from the values in Figure 4.3 because they describe PP&E and intangibles which are the major asset types in that sector. This applies to State Highways, Social Housing, Schools, Conservation Estate, Defence, Healthcare, and the Justice Sector

State Highways

State Highways
State Highways   .

Asset profile[21]

State highways are those roads that are strategically important in moving people and goods nationwide and are a key element of New Zealand's transport infrastructure. The state highway network is managed by the New Zealand Transport Agency (NZTA) and consists of 10,894 kilometres of state highways and 4,230 bridges, making up around 12% of New Zealand's roads and accounting for around half of the 40 billion kilometres travelled on New Zealand roads each year.

These roads are Crown-owned, and exclude local roads which are managed by local authorities and serve the purpose of moving goods and people within a region.

Performance

The performance of the state highway network is assessed against the ability to move people and freight efficiently and effectively throughout New Zealand. This involves managing the capacity and reliability of the network to meet demand.

Figure 4.5 - Road condition to standard
Figure   .
Source:  NZTA
Condition

The condition of the roads is assessed by the NZTA through a number of measures:

  • Smooth ride: the percentage of travel on the network that is made on a surface smoother than a defined roughness standard
  • Rutting:the proportion of the network that has rutting shallower than 20mm, and
  • Skid Resistance: the percentage of travel on the network that is on a surface above a specified skid threshold based upon meeting surface texture standards.

Most travel in New Zealand occurs on smooth surfaces and meets skid resistance standards. Over the past five years there has been a slight improvement in the level of rutting over the road network.

Capacity utilisation

Capacity utilisation examines the level of use of the road network and can provide an indication of pressure on the network. It can be measured as the number of vehicle kilometres travelled (VKT) per network kilometre. Over the past ten years the trend shows an initial slight increase in utilisation, largely due to an increase in VKT outside of the Auckland and Wellington regions, but from around 2006 onwards the pressure on the network has been relatively constant.

Figure 4.6 - VKT:Centre-lane index
Figure 4.6 - VKT:Centre-lane index  .
Source:  NZTA
Congestion

Congestion also provides a reflection of the ability of the road network to meet traffic demand pressures. The congestion levels are measured in the five major metropolitan areas - Auckland, Hamilton, Tauranga, Wellington and Christchurch - based on the seconds delay per kilometre travelled.[22] Over the past ten years, there have been fluctuations across the five areas, with the notable improvement being in Auckland since 2009, where travel times have decreased despite population increases.

Figure 4.7 - Seconds delay per kilometre - by region
Figure 4.7 - Seconds delay per kilometre - by region  .
Source:  NZTA
Road safety

While it plays a significant part in road safety, management of the road network is not the only contributor to lower deaths and injuries. The Safer Journeys strategy launched in 2010 focused on creating a road system that was increasingly free of fatalities and serious injury by creating safer roads and roadsides, safer speeds, safer vehicles and safer road use.

Figure 4.8 - Fatalities or serious injuries per 100,000 people
Figure 4.8 - Fatalities or serious injuries per 100,000 people  .
Source:  NZTA

The level of fatalities or serious injury in crashes provides a measure of how safe the road system is. While there are significant differences between regions, overall there has been a declining trend over the past ten years.

Opportunities and challenges

In the future the population will be larger and, on average, be older than it is today. In addition, the population will be more urbanised and made up of a larger number of smaller families living in close proximity to each other. These trends, if they play out, will be felt most strongly in New Zealand's major metropolitan areas, especially in Auckland, Waikato and the Bay of Plenty, and are likely to increase overall demand for transport solutions in these areas.

The state highway network is expected to be the biggest area of growth in the social asset portfolio in the short term largely due to proposed expenditure on the Roads of National Significance programme. With any large capital works project of this nature, there is a need to ensure that there will be adequate realisation of benefits in light of the costs incurred.

Notes

  • [21]Note that land and state highway values were not distinguished separately in 2008.
  • [22]Based on the annual March surveys of morning peak periods. This measure has not been applied to Christchurch subsequent to the earthquakes.

Social Housing

Social Housing
Social Housing   .

Asset profile

Social housing provides accommodation for people who qualify under the social allocation system criteria. Generally this captures those who face multiple disadvantages in attempting to access housing in the private rental market.

Figure 4.9 - Age profile of house portfolio
Figure 4.9  - Age profile of house portfolio  .
Source:  HNZC

Housing New Zealand Corporation (HNZC) manages its housing portfolio on behalf of the Crown. It receives a market rent for its tenanted properties, made up of a rental income contribution from tenants and an Income Related Rent Subsidy (IRRS) from the Crown for eligible tenants.

HNZC managed 68,710 properties at the end of the 2013 financial year, almost half of which are located in Auckland. The portfolio consisted of 65,528 owned properties and 3,179 properties leased from private investors. HNZC's housing stock has an average age of 41 years, which is broadly comparable to the average age of the housing stock of New Zealand (42 years).

Performance

HNZC has a number of key performance requirements, with the general focus relating to providing housing to those most in need for the duration of their need in the most efficient and effective manner. There are a number of structural factors which are changing the need profile of social housing. Some of these are demographic - such as an increasing elderly population. Others are geographical - such as the growth of cities such as Auckland and Manukau. HNZC needs to constantly refresh its portfolio and future asset management strategy to ensure that it is providing value for money to the Crown.

Access to housing

As tenants' needs and circumstances change over time, existing tenants may no longer be those with the greatest need for that housing. Over the past ten years there has been a steady improvement in the proportion of priority applicants being housed each year. In 2011 the criteria for access to social housing were changed, with only those who qualify as A or B being given access to housing.[23] This helps explain the increase in the number of priority access households in the portfolio.

Figure 4.10 - Priority A&B applicants housed
Figure 4.10 - Priority A&B applicants housed  .
Source:  HNZC

This measure does not take into account those existing tenants whose circumstances may have improved since initial settlement, and could therefore be housed through other means. HNZC is introducing a new measure as reviewable tenancies are extended to all tenants which calculates the percentage of tenants who are either receiving an IRRS (in financial need) or live in a modified property (ie, have a disability). For 2012/13, this was 94%.

Appropriate housing

To ensure that HNZC can service its customers properly, it needs to have a mix of state houses of the right type and in the right location. The nature and location of tenant demand has changed significantly from when the majority of the existing portfolio was acquired, resulting in a mismatch between the current state house portfolio and current and emerging customer need. According to its last asset management strategy, HNZC believes that 50% of its portfolio is in the ‘right place' and of the ‘right type', and meets HNZC's standards to meet future need.

Figure 4.11 - Property supply relative to demand
Figure 4.11 - Property supply relative to demand  .
Source:  HNZC

To check whether the portfolio holds assets in the right location, HNZC assesses the supply of houses relative to demand by region. Auckland has a shortage of houses, while the rest of the New Zealand has too many houses to meet demand. Parts of the Christchurch housing stock require significant remedial work to bring the houses up to a satisfactory condition for tenants.

One of the ways in which HNZC determines the suitability of its current housing portfolio is by assessing whether it is overcrowded or underutilised. 89% of the stock is matched to tenants' needs, however for those properties that are not, Auckland is more likely to be overcrowded, whereas for the rest of the country houses are underutilised.

Figure 4.12 - Property configuration relative to need
Figure 4.12 - Property configuration relative to need  .
Source:  HNZC

There are limitations to this measure because bedroom need is assessed against an allowance of having one surplus bedroom, or having a shortfall of one bedroom, compared to tenant need. A tighter definition of suitability aligned directly with need would highlight that 58% of properties either have an unutilised room or rooms (41%) or need another room or rooms (17%).

Vacant property

Vacant property is an indicator that the housing stock is being underutilised. This is assessed by HNZC through two methods - the percentage of properties being let, and the turnaround time from when a property becomes vacant to when it is let to new tenants.

Figure 4.13 - Property vacancy
Figure 4.13 - Property vacancy   .
Source:  HNZC

From 2009 to 2012, around 98% of properties were being let to tenants, however this decreased to 95% in 2013. Average turnaround time has deteriorated over recent years, with the average turnaround time in the 2013 financial year being 101 days.

Increased vacancy levels are due to a number of factors. Firstly, the methodology for measuring vacancy changed which reduces comparability against prior periods. In addition to this, HNZC conducted more maintenance on properties prior to letting, and are undergoing a reconfiguration of their asset portfolio leading to properties being left vacant while they are awaiting sale or being redeveloped. The Canterbury earthquakes also had an impact on the properties in that region.

Maintenance

Most maintenance spend is performed on those houses older than 20 years and the average spend per house peaks for houses 30-50 years old. Older houses require more maintenance, however as they reach the end of their useful lives often less maintenance is performed as the property is more likely to be replaced.

Figure 4.14 - Maintenance spend
Figure 4.14  - Maintenance spend  .
Source:  HNZC

Opportunities and challenges

HNZC has owned many properties over many decades, and increases in property prices over time have resulted in significant growth in the value of housing assets. However, a portfolio of older assets can put pressure on capital and operating expenditure needs, due to a greater need for maintenance and or structural works to keep assets fit for purpose. It is likely that costs to maintain properties will start to increase to the point where the benefits of meeting these ongoing costs may be outweighed by those of selling or redevelopment. HNZC are aiming to meet this challenge by looking to divest properties that are not needed to meet demand, or that have reached the end of their useful lives. This in turn should improve vacancy and utilisation rates, and provide capital to further develop in those areas of greatest need.

The social housing portfolio provides shelter for many vulnerable New Zealanders, but as their needs change over time the portfolio has to change with it. At present there is a distinct mismatch between the size and location of the existing housing portfolio and the current and forecasted demand for state housing. The challenges for HNZC are in the active management of existing non-priority A and B tenants who have lower needs into non-state housing, as well as reconfiguring the portfolio to meet existing and expected demand. To meet these challenges, HNZC plans to increase the number of fit for purpose properties by 9,000 over a 10-year period, through a combination of redevelopment, upgrades, sales and acquisitions.

The government is currently working through a social housing reform programme. This will make a number of changes to the policy settings pertinent to the portfolio. Providers other than HNZC will be able to access the IRRS - and this should encourage providers other than HNZC to deliver social housing. Tenants will also have their need for housing reviewed; meaning that demand for social housing will more effectively mirror need. Both of these changes are likely to alter the future location and method of social housing provision.

Notes

  • [23]The Social Allocation System (SAS) has four possible scores for any applicant, A,B,C,D. Since 2011, applicants with scores of C or D no longer qualify for social housing. Some applicants who were scored C or D prior to this change were grandparented onto the new system.

Schools

Schools
Schools   .

Asset profile

The Crown currently holds school property to provide education for around 647,000 students, consisting of 347 secondary schools and 1,714 primary schools. The property includes around 6,900 hectares of land and 35,000 classrooms.

Figure 4.15 - Average age of school buildings profile
Figure 4.15 - Average age of school buildings profile  .
Source:  Ministry of Education

The Ministry of Education (MoE) is responsible for holding the Crown's ownership interest in school property, ensuring that there is sufficient capacity to meet demand, and that it supports principals and Boards of Trustees as custodians of school infrastructure.

Many of New Zealand's schools were built from the 1950s to the 1970s, giving an average age for the portfolio of 42 years. There are a high proportion of small schools in the education portfolio, with 28% of schools having less than 100 students. These are primarily in rural communities. While larger schools tend to occur in urban centres, each urban centre has a range of school sizes.

Figure 4.16 - School size by type
Figure  4.16 - School size by type  .
Source:  Ministry of Education

Performance

There are significant benefits to managing the utilisation of the property portfolio effectively. In addition, it is important to maintain the functionality and condition of the school property to a level that best meets the needs of a modern learning environment (MLE) to support and enable better educational performance.

Utilisation and network efficiency

Changes in demographics put pressure on the school utilisation and network efficiency. As demographics shift there is a need for the school network to move accordingly to meet changes in demand over time. This requires schools to have ‘buffers' in place to meet growing demand, but also to ensure that where there is a long-term decline in demand they do not maintain a greater level of property than is required.

Figure 4.17 - Classroom utilisation
Figure 4.17 - Classroom utilisation   .
Source:  Ministry of Education

Based on current school roll size compared to available classroom space, a school with more than four surplus classrooms is deemed to have a ‘large' surplus which could be managed more effectively. In 2013, approximately 355 schools had surplus classrooms (5% of total classrooms), and there were approximately 421 schools requiring additional capacity. The Ministry manages demand for new capacity using funding allocated for roll growth to supply new classrooms and anticipates the level of demand for new classrooms to remain relatively static.

Figure 4.18 - Surplus and deficit classrooms
Figure 4.18 - Surplus and deficit classrooms  .
Source:  Ministry of Education

Functionality[24]

School functionality is assessed against MLE standards, and schools are required to assess and prioritise improvements to functionality alongside the condition of the property. While most school buildings were constructed over 20 years ago, both building standards and teaching standards have changed significantly since that time. Accordingly, the ageing property needs to be updated to meet modern educational needs and safety standards, both to prevent functional obsolescence and to assist in improving educational performance.

Figure 4.19 - Meeting modern learning environment
Figure 4.19 - Meeting modern learning environment   .
Source:  Ministry of Education
Figure 4.20 - 10-year costs by school size
Figure 4.20 - 10-year costs by school size   .
Source:  Ministry of Education
Condition

State schools have been in the process of performing condition assessments, and measuring the condition based upon the expected ten-year cost per square metre of maintenance - taking into account weather-tight remediation and earthquake strengthening impacts. This is best viewed on the basis of the age of the assets and the size of the school. In general there are greater costs associated with older assets and with smaller school sizes - which is characteristic of New Zealand's school property portfolio.

Figure 4.21 - 10-year costs by school age
Figure  4.21  - 10-year costs by school age  .
Source:  Ministry of Education

A building older than 30 years is expected to have costs at least 78% higher on average than that of a building less than ten years old, and a school with more than 500 students is likely to have a ten year cost around $50-$100m2 lower than that of a smaller school.

Opportunities and challenges

Changes in demographics and demand can make effective long-term capital allocation decisions complex and challenging. Many schools currently have surplus or deficit classrooms based on past decisions and expected future needs, and managing network efficiency can be expensive. Under existing policy this may lead to building classrooms where there are more cost-effective alternative solutions.

Figure 4.22 - Distance to alternative schools for schools with classroom deficits
Figure 4.22 - Distance to alternative schools for schools with classroom deficits   .
Source:  Ministry of Education

For example, for those schools with a deficit of classrooms, over 45% of primary schools are within three kilometres, and over 53% of secondary schools are within five kilometres, of an alternative school with surplus capacity that can meet their capacity needs. With construction costs for a new classroom starting at around $200,000, but rising to over $300,000 in land-constrained urban centres, by utilising property more effectively, such as through the use of transportable classrooms and enrolment zones, it would free up considerable resources to meet other educational priorities.

In addition to the configuration of the property network, the characteristics of an individual school's property can have a significant bearing on running costs. Therefore, funding for the maintenance and modernisation of buildings may need to better consider the age, condition and size of schools to reduce variation across schools in their funding relative to property needs. This would improve New Zealand's school capital as a whole, which would help enable the education system to improve outcomes.

Notes

  • [24]MLE data is based on a representative sample of 38% of schools.

Conservation Estate

Conservation Estate
Conservation Estate   .

Asset profile

Public conservation land (PCL) is owned by the Crown and managed by the Department of Conservation (DOC) to preserve the common heritage of current and future New Zealanders, while fostering recreation and tourism. It consists of around 8.5 million hectares (M Ha) of land, 34 marine reserves (1.28 M Ha), and six marine mammal sanctuaries (2.4 M Ha). This includes 14 National Parks, a network of 14,000 kilometres of walking tracks, 9 Great Walks, 970 huts, and more than 1,750 toilets. On this network are approximately 13,500 bridges, boardwalks and other structures.

Figure 4.23 - Public conservation land
Figure  4.23 - Public conservation land  .
Source:  Department of Conservation

A majority of the value in the conservation estate relates to PCL which provides ecosystem services such as biodiversity, species protection, topsoil retention, nutrient cycling, flood protection, climate regulation, water capture and purification, landscape values, recreational access and wellbeing. PCL makes up around 33% of New Zealand's land mass and is largely found in the higher and middle altitude parts of New Zealand (1.4 M Ha and 4.9 M Ha respectively). Indigenous forests cover about 58% of the PCL.

The conservation values that are determined for PCL vary, with some areas being regarded as having much higher conservation values than others, according to their contribution to natural (including rarity) and historic heritage, and recreational outcomes. Any consideration of PCL needs to take into account that there will be current functional value, and a future potential value, given the dynamic state of New Zealand's biodiversity and the changing nature of cultural heritage. In addition, it is not always beneficial to rely on the same geographical area to contribute to multiple functions, and there may be trade-offs that need to be made between achieving different conservation estate outcomes.

The other major category of assets relates to a broad mix of 22,300 individual Visitor Assets ($359 million). These include structures such as bridges, viewing platforms, barriers and boardwalks, which have a life of between 25-100 years and buildings which have an expected life of 35-65 years and consist of huts, toilets, shelters, and sheds.

Figure 4.24 - Asset age profile by type
Figure 4.24 - Asset age profile by type  .
Source:  Department of Conservation

Performance

There are environmental, economic and social benefits from healthy functioning ecosystems and recreational activities. The performance of the conservation estate is considered in relation to maintaining and restoring New Zealand's natural heritage, the condition of the Visitor Assets, and how conservation assets are used for recreational purposes.

Pest control and ecosystem condition

To ensure the diversity of New Zealand's natural heritage, there is a need to maintain and restore ecosystem composition and structure, manage the natural ecosystem function, and prevent declines of, and improve, New Zealand's native populations. DOC examines the dominance of indigenous wildlife, the types of species present, and the representation of different ecosystems and currently directly spends $82 million per annum on land maintenance, equating to around 1% of the land value.

Figure 4.25 - Land under sustained control
Figure 4.25 - Land under sustained control  .
Source:  Department of Conservation

New Zealand's native species face constant pressure from introduced plant and animal pests, and managing these pressures over a large land and marine area is a major challenge. DOC undertakes an extensive pest control programme covering both public and private land. Over the past five years, DOC has maintained the land under sustained control for weeds and animal pests at a relatively constant level. The annual work programme varies across weeds and pests as it is dependent on a cyclical work programme.

Figure 4.26 - Visitor assets meeting service standard
Figure 4.26 - Visitor assets meeting service standard  .
Source:  Department of Conservation

DOC has recently changed the approach to species management to focus on species security at a national level. This is done by assessing the increases in the number of species managed for persistence (2012/13: 111) and ecosystems managed for ecological integrity (2012/13: 151) under active management, and the security level of those species under active management programmes (2012/13: 212 species with improved security levels).

Visitor asset standard

DOC directly spends around $49 million per annum on maintenance expenditure for visitor and historic assets (13% of the total asset value) and assesses the performance of visitor assets against a desired service standard.

Over the past five years, structures have been tracking around or just below the expected standard. However, huts have been consistently below the expected standard, while tracks are significantly ahead of standard. DOC also assesses user satisfaction of the facilities, with 88% of New Zealand users being satisfied or very satisfied with the DOC facilities used in the past year.

Use of the conservation estate

PCL provides a significant resource for New Zealanders to use to meet their recreational needs, and is also a significant contributor to tourism - one of New Zealand's biggest industries - with around 33% of all visitors to conservation areas coming from overseas.

Figure 4.27 - Recreational use of conservation areas
Figure  4.27 - Recreational use of conservation areas  .
Source:  Department of Conservation

One of DOC's objectives is to use the conservation estate to increase participation rates of New Zealanders in recreational activities. The most recent annual data shows the most popular activity enjoyed by people visiting conservation lands are the short day walks, normally close to urban centres, while there has been no significant increase in the use of national parks. This may be a result of perceived improving domestic economic conditions, resulting in an increasing number of New Zealanders taking their holidays overseas.

Opportunities and challenges

DOC manages a significant suite of facilities across the country which is likely to be more than can be adequately maintained in the future. Over time, the size of the land that DOC are responsible for managing has increased, leading to a need to prioritise spending more effectively, identify alternative ways to fund and manage the estate and the suite of facilities.

This has led to a need to optimise investment in species and ecosystem management with a focus on high priority sites important to ecological representation, and an increased focus on achieving value for money activities. There may also be an opportunity for DOC to free up resources by changing the management of land or parting with land with little or no conservation value to enable higher investment in areas where conservation values are high.

DOC has been trying to increase conservation efforts by working more effectively with businesses, communities and iwi to take conservation beyond DOCs traditional boundaries and out on to farms and into communities. There has been an increase in engagement with the commercial sector by entering into new partnerships and building on established relationships with businesses to utilise the estate more effectively and provide greater opportunities for people to engage with the estate.

Figure 4.28 - Third party revenue trends
Figure 4.28 - Third party revenue trends   .
Source:  Department of Conservation

New Zealand's geography and urban population distribution influence people's recreational choices, along with changing leisure preferences. This means that DOC must understand and respond to what people are wanting now and are expected to want in the future. Existing visitor assets may not necessarily fit the purpose of meeting the future needs of the public to increase participation and satisfaction of visitors, resulting in changes in priorities when allocating their resources in the future.

Defence

Defence
Defence   .

Asset profile

Defence assets are managed by the New Zealand Defence Force (NZDF) and are held to secure New Zealand against external threats, protect sovereign interests, and to be able to take action to meet contingencies in strategic areas of interest.

The majority of Defence assets consist of specialised military equipment (SME) ($3.1 billion) and the Defence estate ($1.9 billion).

Figure 4.29 illustrates the period of service of existing SME assets and their estimated remaining economic lives under current capability plans.[25]

Figure 4.29 - SME service period
Figure 4.29 -  SME service period   .
Source:  NZDF

The Defence estate primarily consists of nine bases across the country, consisting largely of buildings serving a variety of purposes, broadly classified into:

  • living accommodation (eg, barracks and houses)
  • working accommodation (eg, headquarters, offices, storage facilities, workshops)
  • non-working accommodation (eg, canteens, messes, ablutions)
  • specialised facilities (eg, communications, armouries, bunkers, explosive stores), and
  • training facilities.
Figure 4.30 - Remaining estate economic lives
Figure 4.30 - Remaining estate economic lives  .
Source:  NZDF

A large proportion of the estate is either past its useful life, or is expected to reach this point within the next 15 years. Older facilities are less likely to be fit for purpose and can put pressure on operating expenditure through higher asset related costs such as repairs and maintenance.

Performance

NZDF uses SME to produce outputs under three main areas:

} Prepared – maintenance of military capability that can be deployed, sustained, recovered and regenerated at the scales of effort required to meet the Government’s strategic objectives

} Protect – conduct of operations and provision of security and other services to protect New Zealand and New Zealanders, and

} Project – deploying Armed Forces overseas at Government's direction to conduct military operations and other tasks.

This section focuses on the Prepared and Protect outputs for the SME, and the condition of the Defence estate.

Prepared

This measure reflects the operational capability of the NZDF to provide the Government with options to respond to security events. It covers maintenance of a conventional warfighting capability, incorporating the capability of combat, support and enabling functions, and shows how prepared the NZDF is to project and sustain deployed forces in the event of a contingency.

Figure 4.31 - Operational preparedness
Figure 4.31 - Operational preparedness   .
Source:  NZDF

Military capability is measured against a directed level of capability (DLOC), reflecting a level of capability sufficient to allow operational standards to be met within a prescribed response time. While it is currently within acceptable parameters of DLOC, significant capital expenditure will be required over the next 20 years to maintain capability to a level that will meet government objectives.

Protect

The NZDF measures the availability and utilisation of military capabilities to both defend New Zealand's sovereign territory and for domestic tasks such as the management of marine resources, drug interdiction, illegal migration, smuggling, trafficking, quarantine evasion, terrorism and environmental degradation. This performance is currently measured on an input basis - how many flying hours or sea days are made available to perform protect tasks compared to their budgeted band for flying hours or sea days.[26]

Figure 4.32 - Utilisation of Protect assets
Figure 4.32 - Utilisation of Protect assets  .
Source:  NZDF

Utilisation of the various protect capabilities is largely influenced by the needs of other agencies - such as MPI, Customs, Police and MFAT - as part of their operational activities.

There are limitations to this measure, primarily because when based against an expected level it may not necessarily take into account how useful the time has been spent performing a task, or how aligned it was to achieving other agency outputs. As a result, the NZDF continues to work with other agencies to refine performance measures.

Estate condition

The NZDF sets acceptable condition standard, usually average or above average level, depending on asset type, and the function that it serves.

Figure 4.33 - Estate asset condition
Figure 4.33 - Estate asset condition   .
Source:  NZDF

Over the 5,000 estate assets there are significant differences in asset condition, which can be due to the level of maintenance spend on the assets over time, as well as the age and relative importance of the base where they are located. Living and Non-Working accommodation is generally meeting the expectations, however Specialised facilities and Working accommodation is generally not meeting expectations and may have an impact on service delivery.

Opportunities and challenges

Due to the size of New Zealand's defence force, the challenge is in maintaining sufficient capability for a range of independent tasks and the ability to contribute to operations with key strategic partners without over committing capital in an unsustainable manner.

A large proportion of Defence assets relate to SME, the maintenance of which is largely dictated by policy settings. Greater certainty over long-term resourcing intentions enables the NZDF to manage its capital base more effectively. The Defence White Paper, along with the recent Defence Mid-point Rebalancing Review, provides direction for the long-term capital decision making.[27] It outlines the trade-offs between defence capability, policy, and funding implications, and the challenge for the NZDF is ensuring that they can manage their resources within this plan.

Over the next 15 years there will be a large number of key SME items that need to be replaced, including the frigates, and transport and patrol aircraft. Due to the size of the initial spend, as well as the related ongoing costs, the acquisition and introduction of these replacement capabilities will need to be prioritised, scheduled and well managed within relatively tight budget constraints and increasing costs.

For the NZDF estate, there are a large number of older buildings on a significant land area. There is an opportunity to rationalise this estate through some functional consolidation within and between bases, new acquisitions and divestment in order to improve the overall estate. This may improve functionality, create operating cost efficiencies and free up resources to meet other Defence requirements.

Notes

  • [25]Asset age is based upon the initial acquisition date for the SME type however some SME assets have been upgraded, or had additional acquisitions of a similar nature after the initial acquisition date.
  • [26]Measurement based upon actual performance compared to the lower (underutilisation) and upper (over-utilisation) budgeted band limits.
  • [27]http://www.defence.govt.nz/reports-publications/defence-white-paper-2010/contents.html

Healthcare

Healthcare
Healthcare   .

Asset profile

New Zealand's healthcare services are largely publicly funded but are provided by a mix of public and private organisations. The majority of expenditure by the New Zealand government on healthcare flows through 20 District Health Boards (DHBs), grouped into four regions:

Northern Region

Auckland DHB
Counties Manukau DHB
Northland DHB
Waitemata DHB

Midland Region

Bay of Plenty DHB
Lakes DHB
Tairawhiti DHB
Taranaki DHB
Waikato DHB

Central Region

Capital and Coast DHB
Hawke's Bay DHB
Hutt Valley DHB
MidCentral DHB
Wairarapa DHB
Whanganui DHB

Southern Region

Canterbury DHB
Nelson Marlborough DHB
South Canterbury DHB
Southern DHB
West Coast DHB

DHBs provide funding to the private primary care sector, including aged residential care and community care, but deliver most secondary services directly, and collectively manage around $5.5 billion worth of property, plant and equipment. The majority of these assets relate to land and hospital buildings consisting of:

  • seven major hospitals in Auckland (3), Hamilton, Wellington, Christchurch and Dunedin
  • 20 general hospitals
  • 35 sub acute hospitals, and
  • 24 specialist facilities providing dedicated services including rehabilitation, rest home care, birthing and psycho-geriatric services.

While DHBs are primarily responsible for making operational and capital investment decisions, governments retain decision making rights on significant capital investment programmes and projects.

There were 8,197 hospital beds (6,798 public medical and surgical beds, 1,399 private beds) and 388 theatres (236 public theatres, 152 private theatres) in the latest asset stock take that was undertaken by the Ministry of Health in May 2013.

Figure 4.34 - Hospital beds by region
Figure 4.34 - Hospital beds by region  .
Source:  Ministry of Health
Figure 4.35 - Theatres by region
Figure 4.35 - Theatres by region   .
Source:  Ministry of Health

Performance

The performance of the public healthcare assets can be measured in terms of how well the assets are utilised and meet demand pressures, and how well they fit their purpose.

Available capacity

The capacity within the health system is measured by assessing the assets available to meet expected service needs.

Figure 4.36 - Beds per 1,000 people
Figure 4.36 - Beds per 1,000 people.
Source:  Ministry of Health
Figure 4.37 - Theatres per 10,000 people
Figure 4.37 - Theatres per 10,000 people.
Source:  Ministry of Health

The Northern region services more people with each bed and theatre than any other region in New Zealand. The Southern region has the highest ratio of beds per capita despite having the lowest proportion of theatres outside of the Northern region.

Demographic changes are going to have an impact on the demand for healthcare services and will require careful consideration of the size and type of future capital spend, or alternative methods of providing healthcare services.

Length of stay

Traditionally, hospital utilisation has been based on the number of nights that medical and surgical hospital beds were used in the year compared to their potential use at full capacity. However, over time the provision of health services has changed significantly. It is now recognised that a longer stay for medical and surgical treatment can potentially reduce patient wellbeing and is likely to increase the cost of care. Beds may get used more than once throughout a day while not necessarily being used overnight (and not being counted in bed night data). For example, between 2002 and 2012 there was an increase in the proportion of all surgical procedures that were carried out as day case procedures (from 53 to 58 percent), which is in line with international trends.

Figure 4.38 - ALOS and readmission rate trends
Figure 4.38 - ALOS and readmission rate trends  .
Source:  Ministry of Health

The average length of stay (ALOS) for both medical and surgical treatment has decreased over the past ten years. From 2002 to 2012, the average length of stay for surgical procedures decreased from 5.6 to 5.0 days, and decreased from 3.8 to 3.5 days for medical procedures.

However, there is a challenge in ensuring that the lower length of stay does not reduce the quality of care provided. The readmission rate provides a view on how successful patient treatment has been and may be affected by both the length of time spent in hospital, and the care received after release. From 2002 to 2012 there was an increase of around 1% in the number of patient readmissions to hospital.

Facility condition

Facility condition is a reflection of the overall status of facilities and will be impacted by factors such as structural composition of the buildings, age, management and maintenance.

Figure 4.39 - Hospital condition by region
Figure 4.39 - Hospital condition by region   .
Source:  Ministry of Health

There are significantly different levels of condition across regions. The Northern and Midland regions both have the majority of their assets at a good to very good condition. The Northern, Midland and Central regions all have over 80% of their assets at least an average level of condition. In contrast, most of the Southern regional assets are at an average condition or below, which is largely a reflection of the cycle of asset redevelopment, with most Southern Region DHBs intending to upgrade facilities over the next ten years.

Opportunities and challenges

Demographic pressures will have a significant impact on future healthcare provision needs. For example, despite recent investment by Northern region DHBs, they still have the lowest number of beds and theatres per capita. Conversely, as the population becomes more urbanised in major cities, the provision of healthcare services in smaller towns and rural communities is likely to need to change and take advantage of technology more effectively.

Future capital planning will require substantially better information on assets and their use to ensure that the overall network is fit for purpose and meets future population needs. The DHB capital planning model needs to take into account national and regional service planning to ensure that the physical network enables better health service provision.

As the population ages, the type of services required will change and therefore the composition of healthcare assets will need to change too. With an older population there will be a greater need for many elective surgeries, such as hip replacements, and a flatter demand for maternity and paediatric care. This is likely to lead to changes in the type of theatres and the plant and equipment required to treat patients.

Technological advances also have a significant role to play in determining the size and type of asset base required to provide healthcare services. Over time, treatment and recovery times have significantly improved, resulting in lower demand for long term stays at hospitals and requiring an ever changing approach to how hospital space is used. While it may be difficult to predict how technology will impact on care in the future, any investment will need to be more flexible and adaptable to meet changing needs than it has done in the past.

Justice Sector

Justice Sector
Justice Sector   .

Introduction

Justice Sector assets are held within three agencies: New Zealand Police (Police), the Ministry of Justice (MoJ) and the Department of Corrections (Corrections). These agencies are discussed together rather than individually in recognition of the ‘pipeline' through the criminal justice system and the impacts that they have on each other's operations.

The ‘pipeline' extends from the investigation, arrest and prosecution of a crime, through to court processes, sentencing and rehabilitation. The policy and operational activities of one agency will therefore have flow-on effects to the other agencies in the sector. For example, a reduction in Police prosecutions will ultimately reduce offender volumes for Corrections.

Asset profile

Across the sector, land and buildings make up around 88% of the total value of property, plant and equipment.

Figure 4.40 - Ageing profile of police stations
Figure 4.40 - Ageing profile of police stations  .
Source:  NZ Police

Police assets predominantly consist of stations ($0.7 billion), houses, and vehicles. There are 370 police stations, both owned and leased, consisting of:

  • 59 large stations
  • 106 small stations, and
  • 205 Community Police Centres.

In addition there are a number of other buildings, such as training facilities.

The Police fleet consists of 3,138 road vehicles and eight maritime vessels. The road-going fleet is largely made up of large sedans and station wagons, but also includes motorbikes, vehicles with off-road capability and specialist uses. This equates to around one vehicle for every 2.8 police officers.

Figure 4.41 - Ageing profile of courthouses[28]
Figure 4.41 - Ageing profile of courthouses .
Source:  Ministry of Justice

Courthouses are the primary asset held by the MoJ. These are largely owned by the Crown, excluding a few cases where they are leased. The MoJ property portfolio, excluding the leased assets, consists of:

  • 36 District Courts
  • Two High Courts
  • 15 Shared High and District Courts
  • One Court of Appeal, and
  • One Supreme Court.

Corrections hold the bulk of assets in the Justice Sector, operating 19 prison sites and 173 non-custodial sites such as offices and Community Corrections sites. While the Crown owns all prison sites, some of which were built over 100 years ago, they lease around 79% of their non-custodial sites.

Performance

There are a wide variety of performance measures relevant to the sector that are dependent on the function that each asset serves.

Police response times

While not directly linked to individual asset performance, how well the police assets are being used collectively to meet public safety objectives can be measured through the length of time that it takes to respond to an event where there is a real threat to people or property. The methodology for this measure changed in 2011/12, making historical comparisons unreliable. However, in the past year there was a slight improvement in police response times from a year earlier. Police plan further work on understanding the utilisation of existing police stations and the impact their size and location has on Police performance.

Figure 4.42 - Police response time
Figure 4.42 - Police response time   .
Source:  NZ Police
Court building utilisation

Court buildings include Court rooms, hearing and mediation rooms, holding cells, and office space for case management and administrative functions. Because these serve different functions, it is difficult to devise a single overall utilisation measure.

Measuring Courtroom utilisation by comparing actual use against availability has inherent difficulties due to a range of factors outside of MoJ's control, such as judicial availability and scheduled cases not using space as expected.

Office space utilisation is measured by examining the building footprint used for case management and administrative functions. MoJ is currently well placed when compared with other agencies, however is in the process of consolidating more efficiencies by re-planning spaces and consolidating functions to allow further reduction of its footprint.

Court condition

Over half the courts are assessed as having average or above average condition, based on their expected level of standard. Those below standard are generally District Courts which are older and more likely to have suffered wear and tear, as well as being more difficult and costly to maintain to a reasonable standard.

Figure 4.43 - Court condition by court type
Figure 4.43 - Court condition by court type   .
Source:  Ministry of Justice
Prison capacity and utilisation

Prison capacity and utilisation is reflected in the number of prisoners compared to the number of prison spaces available. Total capacity needs to include a reserve buffer to allow for resilience and flexibility in the system for prisoner transfers and external events such as natural disasters.

Figure 4.44 - Prison capacity
Figure 4.44 - Prison capacity   .
Source:  Department of Corrections

Corrections is reviewing its approach to measuring prison capacity (including the buffers) and utilisation due to the increased focus on prisoner rehabilitation.

Opportunities and challenges

The main challenges for the Justice Sector are managing the implications of a declining rate of crime and the impact of demographic changes.

Figure 4.45 - Prison population forecast (2013)
Figure 4.45 - Prison population forecast (2013)  .
Source:  Ministry of Justice

If the level of offending resulting in prosecution and incarceration plateaus or decreases as forecast, there will be fewer people processed through the system resulting in lower court utilisation and additional surplus capacity in the prison network.

Modern policing requires access to timely and relevant information. There is an opportunity for Police to develop new and innovative methods through the use of information technology to deliver better services at lower fixed costs. This has potential to change the composition of the police assets, in particular the number and size of future stations and a greater level of ICT infrastructure.

The MoJ needs to carefully balance demographic growth pressures in some regions against the court modernisation programme that is currently under way. There are a number of viable options, one of which may see a smaller number of multi-purpose courthouses in main urban areas and a better use of alternative facilities and technology to meet the needs of people based further away from the main centres. These changes are likely to lead to improved utilisation, allowing MoJ to lessen the time cases take to be disposed of by the judicial system. Many court buildings need modernisation to improve the operational effectiveness and functionality needs of users, and to allow for greater flexibility in the use of building facilities. Reinvestment should be focussed on the core strategic sites, which align to the major population centres, and alternative procurement used to meet other needs where possible.

The primary focus for Corrections has moved toward rehabilitating offenders and away from the historic focus on incarceration. Many prison and non-custodial sites may not have the required functionality to meet rehabilitation needs, which was not a requirement when initially built. Capital expenditure over the medium term should be focused on bringing the existing asset base up to a level that more adequately meets their requirements to reduce reoffending. Prison capacity needs are also likely to change, to ensure that the regional capacity better aligns with demand needs.

Overall, the Justice Sector has had some significant changes in demand, with a lot of older assets that are no longer needed or are not likely to be needed in the future while in their current state. To obtain better value for money from Justice Sector assets there will be a need for better alignment with demand expectations and functionality needs. For example, MoJ and Police recognise productivity benefits from having Police custodial facilities in the same building as the Courthouse, and is actively progressing this in Auckland. This is expected to improve court utilisation and reduce the time defendants spend in Police cells.

Notes

  • [28]For the purposes of the asset ageing profile, where court houses have had additions or extensions the age of the oldest asset has been used.

IRD and Customs Receivables

IRD and Customs Receivables
IRD and Customs Receivables   .

Asset profile

Receivables represent outstanding debt due to the Crown that is administered by the Inland Revenue Department (IRD) and Customs. They predominantly relate to tax obligations (ie, income tax, PAYE, GST, and other taxes) but also include KiwiSaver contributions, overpaid Working for Families tax credits, interest and penalties. Due to the relative size of the receivables, this section will focus on IRD-related receivables.

Figure 4.46 - Gross IRD and Customs receivables
Figure  4.46 - Gross IRD and Customs receivables  .
Source:  IRD

Tax receivables arise either when a taxpayer has earned assessable income, or when an assessment is filed. Receivables are classified as being past due when the debt has not been paid by the taxpayers' due date. This includes debt collected under instalment, debt under dispute, default assessments and the debts of taxpayers who are bankrupt, in receivership or in liquidation.

Figure 4.47 - Age of IRD receivables
Figure 4.47 - Age of IRD receivables   .
Source:  IRD

Over the past five years there have been fluctuations in IRD receivables, largely driven by movements in tax revenues, but overall gross overdue debt has only increased marginally from $4.8 billion to $5.3 billion. Tax receivables as a percentage of tax revenues were 22.7% for the past financial year, which is relatively consistent with previous years.

Performance

The IRD has three main strategies unpinning the output performance measures used for their receivables:

  • early intervention improves the IRD’s ability to collect outstanding amounts due
  • successfully managing customers who have not been in debt previously will improve their future compliance behaviour, and
  • to make the best use of resources, there is a need to focus on the cost of services provided.

Accordingly, the most indicative measures of asset management performance for the IRD are debt turnover, debt ageing, and timeliness of debt case resolution.

Debt turnover

Debt turnover measures the value of the debt cleared during the year as a percentage of total debt, and is a reflection of debt collectability. The higher the debt turnover period, the less total debt will grow. Debt turnover tends be around 100%, excluding 2012/13 when debt turnover was impacted by the timing of debt paid through tax pooling in the last quarter.

Figure 4.48 - Debt turnover
Figure 4.48 - Debt turnover   .
Source:  IRD
Overdue debt

The IRD's focus on early intervention and on new debt has seen a significant drop in debt aged less than two years, with debt reducing in this category by 8.1% over the past year. Focusing on early intervention does however affect IRD's ability to achieve targets in collecting older overdue debt, which is harder to recover and has grown over the same period.

Figure 4.49 - Age of overdue debt
Figure 4.49 - Age of overdue debt   .
Source:  IRD
Timeliness of case resolution

Timeliness of case resolution is measured by the IRD by examining the percentage of debt cases resolved within three months, and the percentage of debt value resolved for those who did not have a debt at the start of the year (new debt resolved). Around two-thirds of all debt cases are resolved within three months of arising, and around 70-80% of debt is resolved during the period for those who did not previously have a tax debt.

Figure 4.50 - Timeliness of cases resolved
Figure 4.50 - Timeliness of cases resolved   .
Source:  IRD

Opportunities and challenges

The IRD's approach to managing receivables is aimed at preventing taxpayers from going into debt, intervening early where necessary and focusing collection efforts on the cases that have the greatest prospect of cash collection. The IRD is adopting a mix of new interventions to reduce debt growth - reminder letters, text messages and online advertising have been used to engage with customers before their due date. In addition, outbound calling campaigns are used to intervene early when customers do not pay on time.

Combined with new investment from the Crown, there has been success in reducing overdue debt growth - particularly for newer debt. However, there will still be challenges in managing resources across new and aged debt to meet both early intervention expectations as well as the targets for aged debt management.

Over time, the services that the IRD has performed have increased significantly, both because of demographic changes, such as population growth, and the impact of new policy decisions such as Working for Families or KiwiSaver. This puts pressure on the largely ICT-based infrastructure of the IRD, and as demand for the level and type of services increases, so do the risks that assets will no longer be fit for purpose. The IRD has signalled a need to upgrade its ICT infrastructure to meet current demand and provide for more flexibility to meet future pressures. Due to inherent risks in ICT system implementation, and the expected size of the IRD investment, this is likely to create a significant challenge for the IRD over the short to medium term.

Student Loans

Student Loans
Student Loans   .

Asset profile

The Student Loan Scheme aims to enable a wide range of people to access tertiary education, gaining knowledge and skills that enhance the economic and social wellbeing of New Zealand. The primary outcome of the scheme is to provide a long-term, affordable loan scheme for students and taxpayers that will enhance the human capital and labour skills of New Zealand as whole.

The student loan scheme is intended to provide a cost-effective means of enhancing access to tertiary education. As a result, decisions have been made to charge no interest on loans to New Zealand residents, to require no repayments from those with very low incomes and to write-off loans of those who die or become bankrupt.

The value of the scheme is also sensitive to assumptions such as borrowers' future income, and general economic factors such as interest rates, unemployment levels, salary inflation and the consumer price index. The student loan scheme therefore comes at an ongoing cost to the Crown from a purely financial perspective.

Figure 4.51 - Student loan value (2009-2018)
Figure 4.51 - Student loan value (2009-2018)   .
Source:  IRD

The scheme is administered by three government agencies:

  • Ministry of Education – policy advice and lead responsibility for scheme
  • Ministry of Social Development (Studylink) – information, assessment and payment, and
  • IRD – responsible for loan management and collection.

Since the scheme began, around 1.15 million people have taken out a student loan. This represents about 33% of the New Zealand population aged 15 years or over. As at 30 June 2013, the nominal value of loans was $13.6 billion with a carrying value in the Crown accounts of $8.3 billion (reflecting the present value of the expected recoverable amount of the nominal value). At June 2013, $636 million of the outstanding loan balance reflected repayments that are overdue.

There were 710,968 borrower accounts held by the IRD at 30 June 2013, and a median loan balance of $13,307. New Zealand-based borrowers made up 85% of borrowers and their loans are 79% of the total nominal value with a median loan balance of $12,440. The overseas borrowers comprised 15% of borrowers and 21% of the total nominal value, with a median loan balance of $19,370.

Figure 4.52 - Student loan borrower profile
Figure 4.52 - Student loan borrower profile  .
Source:  IRD

Performance

Student loan performance measures are similar those of the IRD receivables, and are treated as part of IRD's debt management operation. The key performance measures are the loan repayment times, the collectability of the loan, and the lending costs.

Loan repayment

The loan repayment measure is based upon the amount of time it will take borrowers to pay their loan in full. Repayment times fluctuate year on year, and are influenced by a variety of factors, such as government policy, the strength of the labour market, the type of study undertaken, and whether borrowers move overseas.

The median repayment time for borrowers has been decreasing over time with those who left study in 1999 having a repayment time of 7.8 years, compared to a forecast 7.1 years for borrowers who left study in 2009. New Zealand-based borrowers make faster repayment progress, for example the forecast median repayment time for borrowers who left study in 2009 who remained in New Zealand was 6.7 years compared to 12.1 years for those not always based in New Zealand. This is primarily due to loan collection being performed through the tax system.

Lending costs

The cost of lending measure shows how much of new lending is treated as an expense by the Crown, and how much is treated as an asset. The cost of lending a dollar via the scheme varies a lot over time, and is driven by shifts in interest rates and factors that affect the value of the loan scheme such as the forecast repayment rate.

Since 2009, there has been a decrease in the cost of lending over the year, largely due to the increase in the repayment obligation, forecast interest rates, and a technical change in the approach to the calculation of the cost made to improve its accuracy.

Figure 4.53 - Cost of lending
Figure 4.53 - Cost of lending   .
Source:  IRD
Loan collectability

IRD measures loan collectability by assessing the ratio between the carrying value and the nominal value of the loan. It reflects the IRD's best estimate of how much of the gross outstanding loan value is expected to be collected. At 30 June 2013 this ratio was 61.1%, and is expected to ease to 59.2% by 2018. Because the ratio is affected by interest rates and other factors, this measure reflects other factors in addition to collectability.

Figure 4.54 - Nominal to carrying value ratio
Figure 4.54 - Nominal to carrying value ratio   .
Source:  IRD

Opportunities and challenges

The nominal value of the student loan scheme is expected to grow by over $2 billion over the next four years. Managing the carrying value of this scheme remains an ongoing challenge, primarily due to the subsidised nature of the scheme.

Loan repayment is hindered by difficulties in collection from overseas-based borrowers, and the disincentives that the interest-free policy creates for early repayment of outstanding balances.

There have been measures undertaken since 2010 to reduce the cost of the loan scheme, including:

  • policy changes aimed at reducing repayment times, such as freezing the repayment threshold and increasing the repayment obligation
  • improving efficiency in the management of New Zealand-based borrowers, and
  • initiating a programme for collection from overseas borrowers.

Tertiary Education Institutions

Tertiary Education Institutions
Tertiary Education Institutions   .

Asset profile

Tertiary Education Institutions (TEIs) are treated as equity accounted investment in the Crown accounts that reflects the equity that the Crown holds in:

  • eight universities
  • 18 institutes of technology and polytechnics (ITPs), and
  • three wananga.

The TEIs are Crown entities, with approximately half of their revenue coming from government funding and the remainder coming largely from student fees and research income. Most TEI capital expenditure is not funded by the government.

Figure 4.55 - TEI asset profile
Figure 4.55 - TEI asset profile  .
Source:  Tertiary Education Commission

TEIs collectively own or manage property, plant and equipment with a book valuation of around $8.1 billion.[29]The majority of these assets are held by universities ($6.3 billion) followed by ITPs ($1.7 billion) and wananga ($0.1 billion).

The net book value of assets owned or managed by TEIs is forecast to increase to around $10.4 billion in 2021. This increase is due to a large capital programme over the next ten years to refurbish and replace existing buildings.

Performance

As an equity investment, the performance of TEIs can be measured by examining the return they generate on net assets. In addition to this, the capital intensiveness of the TEIs is measured through the value of PP&E per equivalent full time student (EFTS).

Return on net assets

Three-year average and annual forecast returns on net assets are forecast to improve steadily from just over 7% in 2012 to just over 8% by 2021.[30] This is due to a forecast increase in revenue from international students and greater research income.

Figure 4.56 - Return on net assets
Figure 4.56  - Return on net assets  .
Source:  Tertiary Education Commission

PP&E per EFTS

The value of PP&E per EFTS was $33,901 in 2012 and is expected to increase to $42,991 in 2021. This anticipated increase reflects TEIs resolving a backlog of deferred maintenance as well as a capital expenditure programme aimed at repairing and replacing existing assets, with small amounts aimed at increasing capacity and improving the functionality of the assets to meet changing teaching and research needs.

Figure 4.57 - PP&E per equivalent full time student
Figure 4.57 - PP&E per equivalent full time student  .
Source:  Tertiary Education Commission

Opportunities and challenges

Since 2010 there has been a significant improvement in the level of centrally held information about TEI asset management capability. In early 2013 all universities and ITPs were asked to obtain assessments of their asset management capability from an independent asset management specialist. These assessments produced tailored improvement plans that outlined steps that those TEIs could take to improve value for money from assets and planned capital expenditure. The Tertiary Education Commission will monitor TEIs' progress implementing recommendations from these reports over the next several years.

Figure 4.58 - Capital expenditure and required borrowing facilities
Figure 4.58 - Capital expenditure and required borrowing facilities  .
Source:  Tertiary Education Commission

Over the short to medium term, TEIs are expected to make significant capital investment. Many TEIs forecast that to undertake planned capital expenditure they may require new debt facilities to maintain adequate levels of liquidity. This will require careful management.[31]

Notes

  • [29]TEIs report on a calendar financial year.
  • [30]Return on net assets calculated on the basis of operating surplus/deficit before interest (expense and revenue), tax, depreciation, amortisation and one-off abnormal items (also known as EBITDA) measured against total net assets.

[31]Information on affordability and debt is indicative only. It does not take into account the treasury decisions of TEIs regarding concurrently held long-term debt and has not been moderated by confidence ratings in the quality of forecasts provided by different TEIs.

Financial Assets and Liabilities

Purpose

Financial assets and liabilities are held for prudent fiscal management purposes. The Crown acquires financial assets to the extent that they serve a management purpose, such as funding Crown liabilities associated with contractual obligations and policy commitments, and/or to build buffers against adverse events.

Liabilities represent borrowing by the Crown to fund investment or operating deficits, insurance obligations or other contractual obligations such as defined benefit retirement schemes. The financial portfolio contains the majority of Crown liabilities.[32]

Figure 4.59 - Financial assets and liabilities by entity
Figure 4.59 - Financial assets and liabilities by entity   .
Source:  The Treasury

Specific examples include:

  • Funds under management, and their associated liabilities (where applicable), to meet the future costs from demographic pressures (NZSF), personal accidents (ACC), natural disasters (EQC) and defined benefit pension schemes (GSF).[33]
  • Crown borrowings and associated assets, managed by the Treasury’s Debt Management Office (NZDMO) to meet financing and liquidity requirements.
  • The Reserve Bank of New Zealand’s (RBNZ) assets and liabilities for financial system liquidity management and crisis intervention.

Notes

  • [32]Other liabilities are debt issued by SOEs or MOM companies, and minor obligations incurred as part of government operations, such as accounts payable.
  • [33]Collectively designated as the Crown Financial Institutions (CFIs).

Current holdings

The composition of the balance sheets of the entities managing financial assets and liabilities vary significantly. Most financial assets are held in three entities - NZSF, ACC and the RBNZ.[34] Almost half of financial liabilities are comprised of core Crown borrowings, with the other significant liabilities relating to personal accident liabilities and defined benefit schemes.

As at 30 June 2013 the financial assets and liabilities held under the definitions used for financial reporting are set out in Figure 4.60 and Figure 4.61 respectively.

Figure 4.60 - Financial assets by type
Figure 4.60 - Financial assets by type   .
Figure 4.61 - Financial liabilities by type
Figure 4.61 - Financial liabilities by type   .
Source:  The Treasury

Notes

  • [34]Note the NZSF liabilities are netted against their assets for management purposes.

Future holdings

Over the next five years the net position of the financial assets and liabilities is expected to strengthen by $17.5 billion. On a gross basis, assets are expected to increase by $16.1 billion, with liabilities decreasing by $1.4 billion.

Figure 4.62 - Forecast movements 2013-2018
Figure 4.62 - Forecast movements 2013-2018   .
Source: 

Movements in the financial assets and liabilities reflect:

  • A $10.2 billion increase in the NZSF asset portfolio due to forecast investment returns. The Crown is not expected to make contributions to the NZSF over this period.
  • A $2.4 billion improvement in ACC’s net position as its asset portfolio continues to grow at a faster rate than the outstanding claims liability.
  • A $3.0 billion reduction in the net liability of EQC, representing decreases in its assets ($3.8 billion) and liabilities ($6.7 billion) as the majority of claims relating to the Canterbury earthquakes are settled.
  • A slight decrease in core Crown borrowings over the period.
Figure 4.63 - Projected financial assets
Figure 4.63 - Projected financial assets  .
Source: 

Long-term fiscal projections beyond 2018 indicate the trend is for a growing financial portfolio.[35] The increasing level of financial assets will expose the Crown to different risks than it currently faces.

Notes

  • [35]Refer the 2013 LTFS.

Performance

Some key observations and issues identified relating to the financial asset portfolio and related liabilities are:

  • Equity investments performed poorly in the years immediately following the GFC. However, over the past few years these have outperformed other investments leading to significant growth in those portfolios.
  • While financial assets have grown, there is a need to continue rebuilding buffers to meet future pressures and liabilities. There is a significant shortfall in the GSF portfolio in meeting its obligations, and the impacts of the Canterbury earthquakes have removed all assets from the Natural Disaster Fund (although it remains guaranteed by the Crown).
  • Without adequate provisioning for future pressures, the Crown runs the risk of imposing costs on taxpayers who do not benefit.
  • Continuing to lower sovereign debt is vital to underpinning resilience in the Crown’s balance sheet.

The remainder of this section looks at major financial assets and liabilities by entity in more detail.

New Zealand Superannuation Fund

New Zealand Superannuation Fund
New Zealand Superannuation Fund   .

Profile

The New Zealand Superannuation Fund (NZSF) began investing in 2003 with the purpose of part-prefunding the future costs of New Zealand superannuation in order to smooth the costs of an ageing population across generations. Government contributions to the NZSF were put on hold in 2009, and are projected to resume in the 2019/20 fiscal year. Distributions from the NZSF are not expected to commence until 2029/30 and the NZSF will not peak in size until around 2080.

Figure 4.64 - NZSF asset portfolio
Figure 4.64 - NZSF asset portfolio   .
Source:  The Treasury

The NZSF predominantly invests in growth assets, around 91%, with 66% of its portfolio consisting of equities at 30 June 2013. There has been a decrease in the proportion of bonds held in the portfolio compared to 2008. At 30 June 2013, the NZSF had $3.4 billion invested in New Zealand assets.

Because of its long-term investment horizon, the NZSF invests largely in growth assets which can lead to greater variability in performance, but the higher risk also means that there are greater return expectations for the portfolio. There is also a lesser need for liquidity in the portfolio, which allows the NZSF to invest in relatively illiquid assets, such as forestry, that would be expected to deliver a premium over time.

Performance

The NZSF is managed on an active basis and its performance is measured against a passive reference portfolio, based upon a weighted average indexed return. Performance is also measured against the New Zealand Treasury Bill return, as a proxy for the cost to the Crown of contributing to the NSZF instead of paying down debt. Over rolling 20-year periods the NZSF is expected to outperform the Treasury Bill return by at least 2.5% per annum.

Figure 4.65 - NZSF returns index
Figure 4.65 - NZSF returns index  .
Source:  The Treasury

Over the past five years the NZSF outperformed its reference portfolio by 1.7% and its long-term expectation by 1.8%. This is largely due to a strong performance in the recent years, after negative returns during the period of the global financial crisis.

Opportunities and challenges

Investment management can expose the Crown to downside risks. The challenge for the Crown is determining the level of risk appropriate to meet its needs in funding future superannuation.

The NZSF is heavily invested in growth assets, which brings with it higher risks through market volatility. The impacts of adopting such a position can be seen in the performance over the 2008-2010 period where there was a significant downturn in the world economy. There is also the potential for a significant upswing, as can be seen in recent results, and it is important NZSF's performance is considered on a long-term basis due to its long-term investment horizon.

The NZSF is growing more quickly than New Zealand's equity markets. While the value of the NZSF's local investments will increase as the NZSF grows, it is likely that the proportion of the NZSF that is invested locally will decrease. Investing globally is an important way of reducing exposure to New Zealand economic risk and reducing concentration in New Zealand investment.

Accident Compensation Corporation

Accident Compensation Corporation
Accident Compensation Corporation   .

Profile[36]

The Accident Compensation Scheme, which is managed by the Accident Compensation Corporation (ACC), was established to provide personal injury cover for all New Zealand residents and visitors. The scheme seeks to ensure adequate provision for future costs of claims resulting from injuries already incurred, and holds an asset portfolio with the objective of fully meeting those obligations. These assets have been funded through levies and reinvested returns.

Figure 4.66 - ACC asset portfolio
Figure 4.66 - ACC asset portfolio  .
Source:  The Treasury

Over the past five years, ACC's assets have typically had a 60:40 split between fixed income and riskier assets such as equities and property. The ACC asset portfolio is relatively low risk, due to its high weighting of less risky bond investments.

Figure 4.67 - Outstanding claims liability profile
Figure 4.67 - Outstanding claims liability profile   .
Source:  ACC

The main ACC liability is the $27.2 billion Outstanding Claims Liability (OCL), which reflects an actuarial estimate of the future expenditure relating to injuries which occurred prior to balance date. A significant increase in the OCL occurred from 2008 to 2009, relating to changes to more appropriate methods for the calculation of parts of the OCL.

The OCL is split into five different accounts, with each providing a specific type of cover, that are funded either through levies (Work, Earners, and Motor Vehicles accounts), government appropriation (Non-Earners account), or a mixture of both levies and government funding (Treatment Injury). The main drivers of movements in the OCL balance relate to assumptions around discount rates, inflation, and rehabilitation rates.

Performance

Performance of ACC can be measured on an asset, liability and outcomes basis. This Statement focuses on asset and liability performance. Assets are measured against two primary objectives, to provide returns and to match the future obligations of the liability. The size of the OCL liability is reviewed, along with the performance of the key liability value drivers that can be influenced by ACC.

Return on assets

An objective for ACC's asset portfolio is that the returns are greater than 0.5% above a market passive benchmark, being a weighted average return of sector indices. ACC's annualised cumulative return over the past five years was 9.3% per annum, which outperformed its objective by 0.9% per annum over the same period.

Figure 4.68 - ACC returns index
Figure 4.68 - ACC returns index  .
Source:  The Treasury
Solvency

The solvency of ACC is assessed by measuring the net assets available to each account as a percentage of the account's OCL. Those accounts funded from levies have a legislative requirement to be fully funded by 2019, and at June 2013 the Work and Earners accounts had achieved full funding.

Figure 4.69 - ACC solvency - by account
Figure 4.69 - ACC solvency - by account  .
Source:  ACC

The Non-Earners account and the portion of the Treatment Injury account funded by non-earners do not have a full funding target, and are unlikely to achieve full funding until the pre-2001 claims that are funded on a pay-as-you-go basis meet maturity.

Liability obligations

There are a number of key assumptions applied in determining the value of the OCL, some of which are within ACC's control (such as case management and rehabilitation), and others outside of their control (such as discount rates). For performance purposes, ACC focuses on those elements of the valuation that they are able to influence.

ACC assesses its long term effectiveness of the rehabilitation of injured claimants by using a range of measures including the Durable Return to Work Rate (DRTWR), which measures the percentage of workers who return to work and have remained at work. This assesses how effective and sustainable the rehabilitation practices are, with a stronger rehabilitation rate reducing the long term costs to ACC and with it the total OCL.

Figure 4.70 - Durable Return to Work Rate
Figure 4.70 - Durable Return to Work Rate  .
Source:  ACC

The benefit of using the DRTWR is that it allows for meaningful comparisons with other schemes that use similar measures, such as the ten Australian workers' compensation schemes. Other than 2005/06, in the past 11 years ACC has consistently performed better than the average of the Australian workers' compensation schemes.

Opportunities and challenges

One major challenge for ACC relates to managing the alignment of the asset portfolio to the OCL, within an environment that can see relatively small changes in valuation assumptions, such as a discount rate movement, result in large impacts on ACC's net worth.

Investment priorities may also need to change as the fund becomes fully funded. ACC's liabilities are very long term so there is difficulty in matching the term of investments with the liability due to the unavailability of investment options with a very long term maturity profile.

The asset portfolio is funded primarily through levies, as well as returns on assets, which means that as ACC becomes fully funded, valuation changes may lead to changes in the level of levies charged to the public. There is a need to ensure that there is stability in the level of levies to retain confidence and reliability, and reduce potential impacts on the economy.

Notes

  • [36]Note that the total ACC asset portfolio value differs from the value of the ACC asset portfolio to the Crown due to the elimination of New Zealand Government Bonds on consolidation.

Earthquake Commission

Earthquake Commission
Earthquake Commission   .

Profile[37]

The Earthquake Commission (EQC) is responsible for the management of the Natural Disaster Fund (NDF). EQC premiums are paid into the NDF and EQC's costs, including insurance claims for natural disaster damage, are paid from it. EQC has a Crown guarantee, so the Crown has to provide additional funding in the event that the NDF, coupled with reinsurance purchased in the international market, is insufficient to settle claims against the EQC.

Figure 4.71 - EQC asset portfolio
Figure 4.71 - EQC asset portfolio   .
Source:  The Treasury

There have been significant changes in EQC's balance sheet over the past five years, primarily due to the impacts of the Canterbury earthquakes. Prior to June 2012, EQC held between 20% and 30% of its portfolio in overseas equities for growth purposes. However over the past year the portfolio consisted solely of fixed income and cash assets in order to limit short-term volatility of returns while the funds are being redeemed to meet the costs of claims arising from the Canterbury earthquakes. As a result, the NDF is very low risk.

The EQC also holds $2.6 billion in receivables that relate to reinsurance recoveries arising from the Canterbury earthquakes.

EQC recognises an outstanding claims liability, based on expected future claim payments. Prior to the Canterbury earthquakes, EQC recognised a few minor claims liabilities, however post earthquakes the level of expected claims significantly exceeds assets. These claims are expected to be largely resolved by the end of the 2015/16 financial year.

Figure 4.72 - EQC outstanding claims liability profile
Figure 4.72 - EQC outstanding claims liability profile   .
Source:  The Treasury

Performance

Traditionally, EQC's fund objective was to outperform New Zealand Government Bonds plus 1% per annum. However due to the impact of the Canterbury earthquakes, this benchmark is no longer relevant as the remaining assets are needed to meet insurance claims.

Figure 4.73 - EQC returns index
Figure 4.73 - EQC returns index  .
Source:  The Treasury

Opportunities and challenges

The fund acts as a buffer for the Crown to assist in meeting the liabilities from a natural disaster, and assists in offsetting or reducing the need for post-disaster borrowing. Recent seismic events have had a significant impact on the NDF. Due to it being insufficient to meet the full cost of insurance claims it will be fully depleted, requiring a call on the Crown guarantee. Once the remaining claims have been resolved, the main challenge for the Crown is how to prepare for future events and what role the NDF should play in funding any future obligations.

While the NDF acts as a buffer against shocks, it is not the sole method of providing for disaster relief. Currently while it deals with the existing claims liability, EQC is providing for any future significant events through reinsurance. The costs and benefits of risk transfer mechanisms need to be carefully assessed.

In the wake of the Canterbury earthquakes, the challenge will be in determining what level of mix between post-disaster debt funding, prefunding through the NDF, and reinsurance is most appropriate and cost effective for the Crown in the long-term.

From a policy perspective, to manage any potential liability there is a need for stronger clarity over the roles and responsibilities of EQC and private insurers, both implicit and explicit, and the structure and extent of cover provided by EQC. A number of these issues are being addressed by the EQC legislative review which is currently underway.

Notes

  • [37]Note that the total EQC asset portfolio value differs from the value of the EQC asset portfolio to the Crown due to the elimination of New Zealand Government Bonds on consolidation.

Government Superannuation Fund

Government Superannuation Fund
Government Superannuation Fund   .

Profile

The Government Superannuation Fund (GSF) is a defined benefit scheme established in 1948 to provide a way for public sector employees to save for their retirement. The fund currently has around 64,000 members consisting of 11,000 contributors, 47,000 annuitants, and 6,000 deferred pensions. The GSF was largely closed to new members in 1992 in recognition of the risks a defined benefit scheme posed to the Crown's finances.

Figure 4.74 - GSF asset portfolio
Figure 4.74 - GSF asset portfolio   .
Source:  The Treasury

The GSF is managed and administered by the Government Superannuation Fund Authority, an autonomous Crown entity that manages member interests with the Crown underwriting the total GSF liability.

At 30 June 2013 the GSF managed $3.3 billion in assets, primarily in growth assets (around 82%). Prior to 2001 the GSF invested solely in low risk fixed-interest securities, where equities now make up around 64% of the GSFs total portfolio. This is primarily due to a need for higher returns to partially reduce the level of the unfunded liability. The GSF asset portfolio is therefore relatively risky.

Figure 4.75 - Undiscounted defined benefit obligation
Figure 4.75 - Undiscounted defined benefit obligation   .
Source:  The Treasury

The GSF liability had a present value of $15.3 billion at the end of June 2013. This is a reflection of the expected future cash outflows to meet the obligations, which are expected to be over $0.9 billion per annum for the next 20 years.

Performance

The GSF investment objective is to maximise return without undue risk. Return and risk is measured relative to New Zealand Government Bonds and a Reference Portfolio. The Reference Portfolio is a notional portfolio invested passively in global equities and bonds that is expected to return 2.5% per annum more than Government bonds over rolling ten year periods.

Figure 4.76 - GSF returns index
Figure 4.76 - GSF returns index  .
Source:  The Treasury

Over the past five years the GSF performed in line with the Reference Portfolio but significantly behind Government bonds owing to the strong out-performance of fixed income assets relative to growth assets post-GFC.

Opportunities and challenges

GSF assets are not sufficient to meet future liabilities primarily because successive governments have not made employer contributions to the fund. In spite of the portfolio's asset mix being focused primarily on growth, this unfunded shortfall is unlikely to improve in the future due to the implications of meeting the costs of annual entitlements.

The implication of having a significantly large unfunded liability and a high level of annuitants within the GSF scheme is that the Crown needs to make a top-up of around $0.7 to $0.8 billion every year to meet the shortfall. However, the level of top-up depends on the performance of the fund. Excellent performance would reduce the required top-up but, as more of the remaining contributing members approach retirement, this will become increasingly difficult to achieve. The Crown therefore bears significant risk as a result of GSF performance.

Reserve Bank of New Zealand

Reserve Bank of New Zealand
Reserve Bank of New Zealand    .

Profile[38]

The Reserve Bank of New Zealand (RBNZ), the central bank, has three main objectives: maintaining price stability; maintaining a sound and efficient financial system; and meeting currency needs.

Assets, transformation trade, liabilities and equity
Assets, transformation trade, liabilities and equity.

To achieve these objectives, the RBNZ has a wide range of functions that includes providing liquidity to New Zealand's banking system, managing the country's foreign reserves, issuing official currency, setting and maintaining monetary conditions, regulating and supervising large parts of the financial sector and overseeing/operating efficient payment systems. One of the main tools the RBNZ employs to meet its objectives is its financial market operations. These operations have a direct impact on the RBNZ's balance sheet.

The majority of the RBNZ's assets are made up of foreign currency assets. These enable the RBNZ to influence the exchange rate when its value moves away from long-term norms, or intervene during a disruptive currency episode.[39]

Other assets on the RBNZ's balance sheet include New Zealand Government Bonds and highly rated NZD fixed income securities. The size of these holdings can change quickly because they primarily serve as instruments for the RBNZ's open market operations.

Most of the RBNZ's liabilities are NZD deposits from banks and the Crown, and the currency in circulation. The RBNZ accepts deposits from commercial banks in its capacity as a bank for New Zealand's commercial banks. When trading banks need currency, they can exchange deposits at the RBNZ for delivery of banknotes and coins. Commercial banks can also borrow from the RBNZ to cover liquidity shortfalls.

Performance

The links between the RBNZ's balance sheet and its objectives are complicated. Accordingly, performance analysis must consider the connection between balance sheet instruments, target levels for instrument settings, and the final impact on objectives - namely achieving price stability and a sound and efficient financial market.

System cash management

The RBNZ undertakes market operations to maintain a relatively stable level of cash in the financial system. Crown tax and spending flows have a significant effect on the availability of funds to the banking sector and when the Crown spends large amount of cash (for example repaying a large debt maturity), the RBNZ offsets large changes in cash by altering liquidity in the banking system.

Figure 4.77 - Influences on settlement cash
Figure 4.77  - Influences on settlement cash   .
Source:  RBNZ
Managing inflation

Over the past two years the RBNZ has been successful in maintaining inflation within the 1%-3% band, with the exclusion of one quarter in 2011/12 and the latter part of 2012/13.

Figure 4.78 - Core inflation measures
Figure 4.78 - Core inflation measures  .
Source:  RBNZ
Maintaining short-term interest rates

An intermediate goal for the RBNZ is to ensure that short term interest rates are consistent with the Official Cash Rate (OCR). The measure of success for this is that wholesale interest rates are maintained at levels close to the OCR. Over the last year, the interbank market traded slightly under the OCR.

Figure 4.79 - Deposit rate spread to OCR
Figure 4.79  - Deposit rate spread to OCR  .
Source:  The Treasury
Exchange rate stability

The RBNZ also has a role in managing exchange rate stability, and achieves this by purchasing or selling NZD in the market. The RBNZ has maintained its ability to intervene in the exchange rate in the event of a financial crisis. Foreign intervention capacity stands at $9.5 billion with an unhedged position of $2.5 billion.[40]

Figure 4.80 - Foreign reserves intervention capacity
Figure 4.80 - Foreign reserves intervention capacity  .
Source:  RBNZ
Figure 4.81 - Trade Weighted Index vs. net NZD purchased or sold
Figure 4.81 -  Trade Weighted Index vs. net NZD purchased or sold   .
Source:  RBNZ
Maintaining banking system confidence

The RBNZ successfully supported confidence in the banking system during the global financial crisis. Part of this success is due to the RBNZ's domestic market operations which provided liquidity to New Zealand's trading banks during the crisis. OIS-bank bill spreads act as an indicator of banking system stress. This improved markedly following periods of RBNZ intervention (the green bars in Figure 4.82 represent periods where the RBNZ injected liquidity).

4.82 - RBNZ settlement cash intervention
4.82 - RBNZ settlement cash intervention   .
Source:  The Treasury

Opportunities and challenges

RBNZ needs to retain sufficient capital to reflect the risks of its activities. As the New Zealand economy grows the RBNZ's level of capital will need to reflect any higher demands on its operational capabilities.

The way the RBNZ supervises and interacts with the financial system has implications for financial sector stability. As international events have shown, this can have implications for sovereign balance sheets so requires prudent management.

Being a small, indebted, open economy with a relatively narrow export base, New Zealand is susceptible to changing perceptions of its risks. There are limitations to the level of influence the RBNZ can have in the event of a major currency shock. Additionally, the level of reserves held across the Crown need to complement other measures that improve the economy's resilience to potential adverse events.

Notes

  • [38]Note that RBNZ assets and liabilities to other Crown agencies are eliminated on consolidation.
  • [39]See http://www.rbnz.govt.nz/markets_and_payment_operations/foreign_reserves/intervention/
  • [40]Intervention capacity is defined by RBNZ as foreign assets net of foreign liabilities that mature within 12 months.

New Zealand Debt Management Office[41]

New Zealand Debt Management Office
Figure   .

Profile[42]

NZDMO is responsible for managing the Crown's borrowing requirements and debt portfolio, overall net cash flows and a portion of its financial assets within an appropriate risk framework.

Figure 4.83 - Debt portfolio composition
Figure 4.83 - Debt portfolio composition  .
Source:  The Treasury

The Crown debt portfolio is almost entirely composed of NZD denominated debt.[43] NZDMO regularly issues short term (less than one year to maturity) Treasury bills, longer term nominal (fixed rate) Government bonds and long-term inflation-indexed bonds. There has been a move towards longer term debt instruments over the past five years. This, among other things, reduces funding risk, helps attract new investors, and provides better risk and return characteristics.

Figure 4.84 - Bond maturity profile
Figure   .
Source:  The Treasury

In the near term, debt is forecast to increase modestly before falling back towards the Government's stated target of net core Crown debt being no higher than 20% of GDP by 2020.

NZDMO holds assets to manage Crown liquidity, and does so via a combination of cash, liquid assets and by maintaining access to a diversified pool of funding markets.

Performance

NZDMO's goal is to minimise the Crown's cost of debt, within an appropriate risk framework.

The cost of debt is dependent on the economy and the general interest rate environment that the Crown is operating in. This is highlighted by the close relationship between the Crown's cost of borrowing and market interest rates (the five year swap rate in Figure 4.85).

Figure 4.85 - Average cost of debt
Figure 4.85 - Average cost of debt  .
Source:  The Treasury

Opportunities and challenges

In recent times, the challenge for NZDMO has been to manage the Crown's increased borrowing requirement in a cost-effective manner. This has been made easier by the Crown's low absolute sovereign debt levels and successive governments' commitment to prudent fiscal management.

The increase in borrowing has also required a significant increase in size of the New Zealand Government Bond market. NZDMO has managed this by maintaining a transparent, even-handed and predictable approach to debt management which in turn has given confidence to investors and intermediaries to invest in Government bonds. NZDMO has also extended the length and range of products available in the market to attract a wider investor base. This is best reflected by NZDMO's reintroduction of the inflation-indexed bond market.

Looking forward, a key area of opportunity is in structuring the debt portfolio so that its risk characteristics interact in the best possible way with the wider Crown balance sheet. The aim of this work is to minimise variability in Crown net worth by improving the interrelationship between debt servicing costs and the fiscal position ie, making debt servicing cost more pro-cyclical. The reintroduction of inflation-indexed bonds was in part driven by this goal.

Notes

  • [41]NZDMO is an operating unit of the Treasury and has no separate legal identity.
  • [42]Note that NZDMO assets and liabilities to other Crown agencies are eliminated on consolidation.
  • [43]The Crown debt portfolio is free from currency risk to reduce susceptibility from currency shocks.

Commercial Portfolio

Purpose

The Crown's Commercial portfolio includes a range of businesses with commercial objectives.[44] The entities are expected to be as profitable and efficient as comparable businesses that are not owned by the Crown. The portfolio consists of:

  • Listed Companies: Companies listed on the NZX with the Crown owning a majority holding. These include Air New Zealand, Mighty River Power (MRP) and Meridian Energy. Meridian was an SOE as at 30 June 2013, but listed in October 2013.
  • Commercial Priority Entities: Entities that operate, for the main part, as commercial enterprises in competitive environments. This includes all SOEs, as well as Television New Zealand, Public Trust, the corporatised airports and Fairway Resolution.

Like all Crown investments, Commercial assets require an underlying rationale for ownership, discussed more fully in Box 4.1.

As an example of Crown ownership changing, the Government Share Offer Programme saw a sale of shares in Air New Zealand and sales of up to 49% of two electricity generator-retailers.[45] This has allowed the Crown to recycle capital from one part of the balance sheet to fund other important social infrastructure.

For more information on the Commercial portfolio, see the 2013 Annual Portfolio Report (APR).[46]

Box 4.1 - Commercial asset ownership

Commercial asset ownership requires an underlying policy rationale. The reasons why any government may wish to own commercial assets can change over time and therefore the rationale for ownership should be continually monitored.

The ownership of the Crown's commercial assets mainly reflects a range of historical factors. Previously only the Crown had the financial, organisational, and technical capabilities to establish and operate large scale industries. In particular, these reasons were most acute for national network industries such as electricity, telecommunication, post, and railway. Other reasons for commercial asset ownership include:

  • Regulation does not sufficiently moderate the behaviour of a monopoly.
  • State ownership is needed to satisfy international treaties.
  • The market does not have sufficient scale or coordination to achieve investment or service levels needed for the national interest.
  • A business is systemically important and Crown ownership is the most cost-effective means to ensure continuity of goods and services.

With all assets, ownership needs to be as efficient as possible. With purely commercial assets this means maximising shareholder returns.

Over time ownership reasons for commercial assets have lessened, while the economic costs from Crown ownership have become more apparent. Governments may not manage commercial assets and entities as effectively and efficiently as private sector owners. This can be because of:

  • a lack of private sector disciplines and incentives to get better value and minimise costs because boards, managers and shareholding Ministers do not have a direct financial ownership interest
  • a lack of specialist knowledge and expertise
  • governments potentially weighting social responsibility more heavily than financial performance objectives
  • a status quo bias (in terms of buying/selling assets and greater/less investment)
  • governments typically not having an exit strategy with regard to devaluing assets that erode Crown wealth
  • public sector monitoring having less impact than market monitoring
  • difficulty in making speedy decisions.

Some of these barriers to performance are being addressed through the Government Share Offer Programme.

Notes

  • [44]Commercial companies incur liabilities as part of their operations, which are reflected in the Crown balance sheet. However, this section of the Investment Statement considers the performance of commercial entities as an organisation - ie, the net effect of their assets, liabilities and performance.
  • [45]Refer to pages 36-41 of HYEFU 2013 for further discussion on the Government Share Offer Programme.
  • [46]http://www.treasury.govt.nz/commercial/publications/annual-portfolio-report/2013/

Current holdings

At 30 June 2013, the carrying value of equity in the Crown's commercial portfolio, inclusive of minority interests but excluding inter-entity balances (eg, tax liabilities), was $19.4 billion. Excluding minority interests and including inter-entity balances, this net asset value reduces to $14.3 billion. These were held within 21 commercial priority entities, and major stakes in two listed companies (refer to Table 4.1).

Table 4.1 - The Crown's commercial portfolio
  State-owned Enterprises Crown Companies Crown Entities
NZX Listed Entities  

Air NZ (73%)*

MRP (52%)

 
Commercial Priority

Airways

Animal Control Products

AsureQuality

Genesis Energy

KiwiRail Holdings

Kordia

Landcorp

Learning Media

Meridian Energy*

MetService

NZ Post (incl.  Kiwibank)

Quotable Value

Solid Energy

Transpower

TVNZ

FairWay Resolution

Christchurch Airport (25%)

Dunedin Airport (50%)

Hawke's Bay Airport (50%)

Invercargill Airport (2.8%)

Public Trust

* Note that these are the ownership percentages as at 30 June 2013. As at the HYEFU 2013, the Crown's shareholding in Air New Zealand had moved to 53% and Meridian to 51%.

Commercial priority portfolio

Of the commercial priority portfolio, 92% of the assets and liabilities were concentrated within the largest five entities (NZ Post including Kiwibank, Transpower, Genesis, Landcorp and KiwiRail).

Figure 4.86 - Commercial priority portfolio assets
Figure 4.86 - Commercial priority portfolio assets  .
Source:  The Treasury
Figure 4.87 - Commercial priority portfolio liabilities
Figure 4.87 - Commercial priority portfolio liabilities  .
Source:  The Treasury

Listed companies

As at 30 June 2013, the Crown held majority stakes in two listed companies. As the Crown owns more than 50% of the listed entities and therefore retains control, it continues to report 100% of the assets and liabilities of these companies on its balance sheet. To reflect the ownership of the minority interests, a separate line on the balance sheet deducts the net assets attributable to those shares owned outside the Crown.

Market capitalisation can be thought of as a proxy for a company's net worth (or commercial value). However it is important to note that the share prices from which market capitalisation is calculated reflect the market value of a minority stake in the companies. The value of the Crown's shareholding includes a control premium and to this extent, the market capitalisation understates the commercial value of the Crown's stake.

Performance

The Treasury's 2013 APR contains the individual company summaries which outline the specific company performance. The following section provides a high level summary of that document.

Commercial priority companies

To create value for the Crown, commercial priority companies must, over time, make a return that covers the Crown's cost of borrowing plus a margin reflective of their business risk. Total Shareholder Return (TSR) is the key metric used and is the combination of dividends paid to the Crown (less any equity injections) and the change in commercial value over the financial year. Overall TSR has been moderate for the past five years (see Table 4.2).

Table 4.2 - Commercial priority portfolio, five year performance
  2009 2010 2011 2012 2013
Total Shareholder Return 2.0% 19.3% 4.5% (8.2% 3.0%
Dividend yield 1.6% 4.2% 4.3% 2.5% 6.5%

Source: The Treasury

Commercial value is a forward looking measure, generally based on the net present value of future free cash flows. Commercial value can deviate significantly from the book value of equity, particularly for service firms with low assets relative to their labour inputs (eg, MetService) and where the earning power of the assets has changed since they were acquired or revalued (eg, KiwiRail).

Figure 4.88 - Commercial priority portfolio returns (excluding KiwiRail)
Figure 4.88 - Commercial priority portfolio returns (excluding KiwiRail)  .
Source:  The Treasury

Listed companies

Given the recent listing of both MRP and Meridian, it is not yet possible to assess this portfolio in terms of market return. However, points to note include:

  • Air New Zealand’s share price outperformed the NZX50 Gross Index in the 2012/13 financial year.
  • Over MRP’s brief period of listing prior to the end of the financial year it underperformed the NZX50 Gross Index.

Opportunities and challenges

The APR highlights key opportunities and challenges for the portfolio, including:

  • More effective use of scarce capital. In aggregate, the companies have invested large sums in capital expenditure over the last five years. While the portfolio is now seeing a reduction in the level of capital investment, KiwiRail and Transpower continue to invest heavily.
  • Financial performance needs to improve. In spite of significant investment across the portfolio in recent years, this has yet to lead to a sustained improvement in performance.
  • Debt ratios need to remain within reasonable levels. While some of the recent investment has appropriately been funded from third party debt, there are limits around the extent to which higher gearing is desirable.
  • There is an opportunity to consider how the Crown fulfils its ownership and monitoring responsibilities. Ministers have shown an increased willingness to consider alternatives to the current institutional arrangements to improve outcomes.
  • Better performance may be achieved by utilising greater private sector expertise and disciplines.
  • The Government Share Offer Programme leads to a more complex set of relationships between the Crown, MOM companies and private shareholders.

Part 3: Balance Sheet Management

This section examines some of the principles of good balance sheet management and assesses the public sector management system against those principles to identify areas for potential improvement. Government Objectives and Delivery examines what it means to be a good owner of assets, and what is needed to make better investment decisions. Financial Risk Management outlines the issues the Crown faces with regard to risk, including how to improve on current risk management frameworks. Fiscal Sustainability and Liability Management examines the importance of effective whole of Crown liability management to resilience and the importance of rebuilding buffers to underpinning living standards.

Chapter 5: Government Objectives and Delivery

...The highest priority government objectives need to be delivered as efficiently and effectively as possible and quality asset management is required to get the most from new and existing investment.  This allows more or better services to be provided at lower cost to taxpayers...

  • Chapter summary
  • Government objectives
  • Delivery mechanisms
  • Investing well
  • Owning well
  • Future developments

Chapter summary

Governments have many objectives and limited resources with which to deliver on them. Delivering on these objectives effectively and efficiently allows for more or better public goods and services to be delivered with a given amount of funding, or alternatively, to deliver current levels of service at less cost to taxpayers.

There are alternative options available to deliver on government objectives, with new options emerging over time such as cloud computing technologies. These delivery mechanisms have differing costs, benefits and risks that need to be robustly evaluated. Crown ownership should not be seen as the default option. Alternative methods of delivery can have benefits over ownership for attaining optimal value for money.

To ensure value for money, the highest value investment options should be implemented. Governments need to continually assess whether existing assets still align with objectives, and if not, consider freeing up capital resources for other uses. Better information and a more systematic decision making approach to investment would support this.

Asset management is critical to ensuring that maximum benefit is generated from Crown assets on an on-going basis. There is evidence of a gap between current and desired levels of asset management practice within capital intensive Crown entities and departments. This suggests there is scope for improvement.

While steps have been taken in recent years to improve capital allocation and investment decisions, an initial assessment suggests there is a case for greater coordination in improving asset performance and decision making. However, it is important that coordination does not reduce agency accountability.

Government objectives

This chapter focuses on mechanisms for delivering on government objectives. Various factors have shaped governments' policies and their approach to service provision. From a public policy perspective, governments should prioritise those objectives where private sector provision is unlikely to be adequate.

Individuals and communities have increasingly high expectations for the quality, range and quantity of goods and services they receive. These are provided by both the public and private sectors. Like individuals, the government has many objectives and limited resources with which to deliver on them.

Delivery mechanisms

Governments must continually strive for more effective and efficient methods of delivering on objectives. This allows more and better publicly funded goods and services to be produced and delivered, or alternatively to maintain existing levels of service for lower taxes.

Governments have entered into a wide range of arrangements to achieve their objectives. Objectives can be met by regulating private provision, purchasing services, funding or subsidising private providers or directly using public resources. Each of these has a differing set of relative costs and benefits.

Direct provision may require the acquisition of capital assets. This can be achieved through purchase, renting or leasing, or via a public private partnership (PPP) - see Box 5.1 for further detail.

Ownership can provide greater certainty of supply and control. For example, specialised hospital facilities are unlikely to be available for lease when needed. As such, ownership of these facilities may be more desirable. However, ownership is not without risk, as assets can become surplus to need over time. For example, in many provincial towns, the Crown owns social houses and school buildings that are no longer required due to the impacts of demographic change. Ownership also reduces opportunities for savings from utilising contestability between suppliers.

Ownership requires ongoing discipline to ensure its benefits continue to accrue to citizens. This is not consistently present in the public sector. Therefore, ownership should not be seen as the default option for attaining value for money from government assets. Alternative delivery methods can have benefits over ownership. But to assess this requires comprehensive evaluation of the relative costs, benefits and risks.

For the Crown, the Better Business Case methodology, including cost benefit analysis, is the primary tool for assessing the best option for delivering a government objective. However, the Crown needs a further framework for determining the best value portfolio of investments across competing government objectives.

Box 5.1 - New Zealand's approach to PPPs

What are PPPs?

A PPP is a long-term contract between a private sector provider and the Crown for services and typically involves constructing or enhancing a specialised asset. PPPs bring together a range of services under a single contract for the design, construction, finance, maintenance and operation of an asset.

In a PPP, the Crown is buying outcomes, not inputs, and only pays for services when they are available and delivered to pre-agreed performance levels. This allows the private sector provider to make decisions about the appropriate mix of inputs to best meet the outcomes sought by the Crown.

PPPs are common abroad but some have different drivers. The Australian PPP model includes a focus on reducing the whole of life cost of infrastructure investments, while in Canada PPPs are used to incentivise the delivery of a project on time and on budget.

PPPs in New Zealand

In New Zealand, the aim of PPPs is to improve the service outcomes from public sector investment for the same or less cost than traditional procurement or government provision. Projects that make good PPPs:

  • have significant opportunities to improve service outcomes and reduce whole of life asset management costs
  • have real opportunities for performance risk transfer
  • are part of a larger portfolio that can benefit from lessons learned from the private sector, and
  • require significant scale in order for benefits to outweigh additional transaction costs.

The New Zealand model seeks to hold the PPP contractor to account for the effectiveness of the asset or services being provided, rather than simply measuring whether or not they have been supplied. If suppliers do not deliver the required outcomes, their payments are reduced accordingly and their profit is at risk.

Under the New Zealand PPP model, the Crown retains legal ownership of the land and buildings used to deliver the services at all times. Examples of PPP projects that are in place are Hobsonville Point primary and secondary schools, and Wiri prison. PPP projects that are being progressed are Transmission Gully, Auckland East prison, and four new schools.

Investing well

Investment and disposal decisions (see Box 5.2) need to be considered within a comprehensive framework that systematically analyses alternative choices so that highest value options are chosen. This means assessing not only the costs and benefits of the method of delivering an objective, but also which objectives to prioritise.

Box 5.2 - Divestment in the public sector

Good balance sheet management relies on the ability to sell assets that are no longer needed to allow for capital reinvestment. The ability to reprioritise assets and recycle capital is key to balance sheet flexibility and avoiding unnecessary and costly asset holdings.

However, before Crown assets can be sold there can be a number of legal and policy requirements to be fulfilled. For example, the creation of the MOM companies required legislation. But even smaller scale and ordinary asset sales can require a number of legislative and policy requirements to be met. For example, Cabinet has decision rights over any departmental asset based divestment proposal that exceeds $25 million or is high risk. Moreover, the disposal of any Crown-owned land is subject to a range of statutory and government policy requirements. The particular requirements will depend on the legislation under which the land is held, but can include the Public Works Act and Treaty of Waitangi obligations.

In general, disposing of Crown property is a lengthy, complicated, and costly exercise because of these legal and policy obligations. This can discourage active balance sheet management of assets surplus to requirements. For this reason the government has established the Crown Land Centre of Expertise within Land Information New Zealand (LINZ), which has specialist knowledge to assist with these processes.

The decision making framework needs to take account of the following factors:

  • The overall expected economic costs and benefits of the investment proposal (see Box 5.3 for a discussion of this in the context of financial and commercial assets). This process can be challenging in a public sector context as there are also non-financial considerations to be incorporated such as those outlined in the Living Standards Framework. For example, it is hard to quantify the value of an investment in a courthouse to social infrastructure.
  • The project’s fit with existing assets and services within the wider state sector. This is especially the case where assets are part of a highly integrated system (eg, roads, schools, health system or the delivery of defence capability).
  • The risks and likelihood of an investment meeting its objectives, taking into account agency past performance, asset management maturity and delivery capability.
  • What resources are already being applied to meet that objective and/or whether other resources could be reallocated for better use.
  • The profile of future investments including costs, benefits and spending pressures that may emerge.

Investment outcomes also need to be carefully assessed against forecast benefits and costs. Systematic ex-post review helps support continued improvement in the investment decision making framework by providing an important feedback loop to the process.

Box 5.3 - Financial and commercial assets, risk and return and cost benefit analysis

When making an assessment as to whether to invest in financial and commercial assets both risk and return must be accounted for. Thus, making the case for investment on the basis that government borrowing rates are lower than the expected returns available on financial or commercial asset is not sufficient.

Financial and commercial assets have a higher expected return than government borrowing because of their greater risk. Their higher expected return compensates an investor for the chance that these assets may decrease in value. Because of this, a decision to invest must take account of risk tolerance - that is, how much additional return is required for the increased risk.

In a government context this is difficult, as individuals' risk tolerances vary. Also, and always, governments should only intervene where they are either more efficient than the private sector in doing so, or the private sector will not or cannot provide the intervention.

For these reasons, the Crown should only invest in assets for which there is an underlying reason for ownership. For example, in the case of the NZSF, this is to part fund the increasing future costs of superannuation benefits.

Assessment

Based on the initial assessment in this Statement, the public sector management system has some of the features required for effective capital decision making. However, even where individual agencies are making rational decisions from their perspective, they may not be ideal from a whole of government perspective.

Each year through the budget process a new capital allowance is made. New investment alternatives compete for this capital. They are assessed with a whole of Crown lens and decisions to invest are made by Cabinet. The budget process is supported by departmental four-year plans which provide a longer term view of agency needs and plans.

However, these capital allocation decisions are not always supported by rigorous cost benefit analysis. Typically funding is conditional upon further analysis in the form of a business case. In addition, decision making is not systematically supported by analysis of agency capability, what it currently owns, or the utilisation and condition of these assets. Improved information about Crown assets would give a better understanding of needs and enable judgements on whether capital is meeting current objectives or could be put to more productive uses.

Both the quality of cost-benefit analysis and planning could also be improved. With cost-benefit analysis there is some evidence that its practical application often overstates benefits and understates costs of projects.[47] In addition, planning horizons are currently too short. Planning over a longer term would further support decision making, especially for capital intensive but less frequent projects. Systematic review of project outcomes against expectations would also improve incentives on agencies to analyse investments accurately.

Investments made using the funding that agencies hold specifically for the replacement of existing capital, or from their own asset reprioritisations, or from specific revenue streams, are not subject to a systematic whole of Crown prioritisation process.[48] This contrasts with the oversight applied to new spending decisions through the budget process.

There is no formal process to ensure capital investment funded this way aligns well with overall government priorities. While this may already be occurring to some degree, a more systematic approach would better ensure that it does.

This also makes it more difficult for the government to manage its overall fiscal strategy. Ideally investment timing should take into account prevailing economic conditions.

Capital spending funded in this way is the majority of total investment made each year. In recent years the Crown has allocated around $1 billion of new capital at each budget, this compares with annual capital expenditure of around $7 billion of capital reinvestment.

Notes

  • [47]See http://www.infrastructure.govt.nz/publications/betterbusinesscases/guidance for a discussion of bias in cost benefit analysis.
  • [48]Cabinet retains some decision rights with respect to major capital projects. See http://www.dpmc.govt.nz/cabinet/circulars/co10/2

Owning well 

The process of good asset management does not stop at the investment decision. The State Sector Act now explicitly requires departmental chief executives to exercise good asset stewardship.

Owning well is critical to ensuring that maximum benefit is generated from Crown assets at lowest cost. To be successful there needs to be continual assessment of whether the rationale for past investment decisions remains valid. Such a review process would highlight where capital is no longer needed or where new more efficient delivery methods are available. To do this an owner of physical assets should have well formed asset management plans and practices.

Agencies should regularly assess asset performance including asset condition and use, operating cost implications, timing of maintenance and refurbishment, and long-term disposal and investment plans. These are the hallmarks of a mature asset owner (see Box 5.4).

Box 5.4 - Asset management maturity in the public sector

In 2011/12 the Treasury commissioned an independent assessment of the level of asset management maturity within capital intensive departments and Crown entities. The findings showed that:

  • Most agencies were able to demonstrate an intermediate level of asset management maturity, and there were some advanced practices in a number of agencies.
  • Some agencies were close to demonstrating an appropriate level of asset management maturity, but most had more work to do to build people, process and information capability to the level appropriate to their business context and government expectations.
  • The size of some capability gaps (between current and target levels of maturity) suggested that life-cycle decisions may not be as well informed by plans, information and analysis as they should be given the scale and complexity of assets under management.

In the current fiscal environment and with government imperatives for better public services, agencies face more pressure to maintain or strengthen asset management and service delivery capability. Yet without ongoing investment in such capability, agencies (and the Crown) will carry more risk to service failure or poorer quality decisions than would otherwise be the case.

While progress has been made since 2011/12, most agencies still struggle to articulate the strategic linkages between the services they provide and the assets they need to use, and capture that thinking and analysis in their planning documents and in subsequent asset-related performance reporting.

Good asset management practices ensure that assets continue to remain fit for purpose and align with objectives, and that costs of ownership are minimised and asset values are maximised. This will be necessary in the future given demographic changes, which will require considerable adaptation of the balance sheet as the demand for services change. Good asset management is important to all Crown assets regardless of their type, use and ownership arrangements.[49]

Capital asset management

The processes outlined in the chapter are called Capital Asset Management, and are summarised in Figure 5.1.

Figure 5.1 - Capital Asset Management (CAM) regime
Figure 5.1 - Capital Asset Management (CAM) regime   .
Source:  The Treasury

Notes

  • [49]A new international asset management standard has recently been issued by the International Organisation for Standardisation (ISO55000) that reinforces the need for good asset management practices.

Future developments

This chapter has discussed the mechanisms to achieve effective capital investment and management. In recent years steps have been taken to improve capital allocation and investment decisions, but improvements could still be made. Accordingly, there may be a case for greater coordination in improving asset performance and decision making to better ensure government objectives are met as efficiently and effectively as possible.

Better information to support analysis and decision making

Better analysis and decision making requires better information. The Crown needs to develop a way to systematically capture better information about the state of its assets and their effectiveness at meeting government objectives. Longer term capital planning would also support decision making and accountability for achieving outcomes cost effectively. Systematic ex-post review of investment outcomes against expectations would help support continued improvement in the investment decision making framework.

Better analysis of options

There is a need for better analysis of investment alternatives and for interventions to meet government objectives as efficiently and effectively as possible. While cost benefit analysis is a useful tool, it is not always performed well and has limitations. Analysis needs to continue to improve.

Prioritising investments from a whole of government perspective

Notwithstanding the existing controls that help ensure that investment is well founded, capital resources may not be as well allocated as they could be relative to the priorities of the government as a whole. Coordination across government could be improved, but needs to be mindful of maintaining agency accountability. This could take the form of adjusting settings such as decision rights, clarifying guidance, issuing directions, or stronger monitoring to sharpen incentives and improve practice.

Sharper incentives

Asset management is the responsibility of agencies, as are many investment decisions. Capital ownership and decision making should be improved such as through agencies implementing more robust business case methodologies and through a higher rate of capital recycling on the Crown balance sheet. These issues could be addressed by sharpening the incentives on the various agents of the Crown.

Recent legislative changes and the Better Public Services policy initiatives are helping. However, they will still need to be supported with more effective administration and coordinated decision making to ensure that Crown capital is employed to the highest and best use over time in response to changing circumstances.

Areas of focus

  • Ensure settings bring about more rigorous capital investment decision making and support asset management practice to improve alignment between investment and governments’ long-term priorities.
  • Strengthen the means for recycling capital into priority areas to meet changing demands and priorities without incurring unnecessary costs.

Chapter 6: Financial Risk Management

...The Crown bears significant risk from a wide variety of sources.  Crown risk management is needed to support delivery of government funded services, and economic and social outcomes...

  • Chapter summary
  • Why manage risk?
  • Managing risk
  • Implications of the Canterbury earthquakes
  • Future developments

Chapter summary

Risk affects governments' ability to cost-effectively deliver on their objectives. This chapter focuses on the financial implications to the Crown of a wide variety of risks, including many non-financial risks.

Effective financial risk management is important because it can raise the living standards of New Zealanders by increasing New Zealand's resilience to shocks. This maximises the benefits and minimises the costs of publicly funded goods and services and improves economic and social outcomes.

Given the breadth of governments' objectives, Crown risk management needs to be aware of risks well beyond those that directly relate to its own asset and liability holdings. These risks can be some of the largest that the Crown will ever face - such as an international economic or financial crisis, a global pandemic or a natural disaster at home. These require astute management.

To manage this diverse range of risks effectively, a comprehensive and cost-effective framework needs to be in place which systematically and continually assesses risk.

The Crown's risk management framework generally involves holding agencies responsible for the risks that they individually face, subject to some central guidance and coordination for risks with broader national implications. This is because agencies are generally best placed to understand their own risks. These processes have worked well under a wide range of circumstances, although there is scope to strengthen the framework further through the development of a more complete understanding of the risk exposure of the Crown as a whole. This issue will gain in importance as the balance sheet grows and becomes more heavily weighted towards financial assets, which expose the Crown to new forms of risk.

A focus in the years ahead will be to better understand aggregate Crown risk to enable more effective and integrated risk management practices. An assessment is necessary on whether efficiencies can be captured while ensuring that total risk exposure remains within the risk appetite of governments.

Why manage risk?

Governments have a number of objectives that aim to improve living standards which are generally advanced through delivery of public goods and services. Risk comprises anything that might affect this delivery - either by impacting on costs or benefits. Risks affect governments' ability to deliver value for money. However, risk may be tolerated if expected benefits are assessed to outweigh expected costs.

Because of its size and unique role in the economy and society, the Crown has a role to play far beyond managing the direct risks to its own assets and liabilities. The Crown bears risk on behalf of all New Zealanders. Where the Crown is better placed than individuals to do this there are benefits. However bearing risk also incurs costs, because resources used to manage risk cannot be used to meet other objectives.

Sources of risk 

Risk can arise from everyday occurrences or from one-off shocks. These can have operating or capital implications, but all affect the balance sheet. Sources of risk include economic, environmental, natural disaster, biosecurity, societal, technological and operational events. See Figure 6.1 for a broad indication of consequences and likelihood of risks to New Zealand.

A shock is an event with an uncertain likelihood and timing that tends to have a greater effect on the Crown. Shocks can come from many sources with different likelihoods, sizes and impacts, and durations. Shocks to economic activity have particularly large effects on the Crown. New Zealand is a small open economy with relatively high external debt, mainly in the private sector, thus it is susceptible to economic shocks from overseas. This susceptibility makes risk management and resilience even more important for the Crown.

The Crown bears a number of contingent liabilities and implicit risks. Contingent liabilities are contractual obligations that arise after the occurrence of some uncertain event.[50] Implicit risks are non-contractual obligations that the Crown may choose to meet following a shock for policy reasons.

Figure 6.1 - Relative likelihood and consequences of various risks
Figure 6.1 - Relative likelihood and consequences of various risks   .
Source:  http://www.dpmc.govt.nz/sites/all/files/publications/national-security-system.pdf

Notes

  • [50]Contingent risks are documented in the FSGNZ.

Managing risk

General elements of good risk management

A good risk management framework will operate within clear lines of agency accountability and responsibility with overall central coordination. These should be based on who has the necessary skills, knowledge and expertise to manage risks as efficiently and effectively as possible. Risk tolerance needs to be clearly specified at an aggregate level, as this will impact how agencies manage risk. See Figure 6.2 for an overview of the risk management cycle.

Mitigating risk

Mitigating risk involves taking actions to reduce the potential impacts of risks before they are realised. This can include taking regulatory measures, buying insurance, public information and communication exercises, cost sharing or risk pooling arrangements and hedging actions.

Risk management also involves building resilience. Resilience refers to the ability to withstand the effects of an event or shock.

Risk management is rarely free of cost. Accordingly, its desirability will depend on the overall costs and benefits to the Crown and wider economy. These need to be continually assessed to ensure efficiency and effectiveness.

Figure 6.2 - Comprehensive risk management
Figure 6.2 - Comprehensive risk management   .
Source:  The Treasury

The Crown's current framework for balance sheet risk management

The basic elements of a comprehensive approach to systematic risk management are present in the Crown's current framework for risk management.

Agency risk

Each individual entity is responsible for identifying and managing any risks they are exposed to on the basis that they have the best information and incentives to do so. This generally involves managing individual operational, insurance, financial, asset management, and reputational risks.

However, risk management may be subject to overarching guidance. For example, Treasury Instructions stipulate that departments must undertake a systematic financial risk management process covering:

  • identification of the risks faced, or likely to be faced
  • quantification of the type and size of the risk (including consideration of possible losses and probability of loss)
  • determination of a risk appetite (ie, the amount of risk the department is prepared to accept), and
  • how the risks are to be managed or controlled, including whether to purchase insurance cover.[51]

Taking this into account, there are strong expectations that each agency considers and manages risks that are relevant to their responsibilities.

Macro and national security risks

In the case of macro and national security risks that affect New Zealand (such as financial and economic risks, biosecurity and natural disaster risks), risk is managed more centrally. The Officials' Domestic and External Security Committee, led by the Department of the Prime Minister and Cabinet, provide an overarching risk management framework for risk of national significance that spans the responsibilities of several agencies. This involves assessing overall national preparedness, providing guidance and policy advice, planning, and co-ordinating risk management roles across agencies.

In some instances, purpose-designed agencies have been established to manage these risks, such as the EQC. The Treasury has responsibility for providing advice around the overall fiscal and economic implications of nationally important events.

Implicit risks and contingent liabilities

The Crown plays a key role in managing risks on behalf of others. Events in other countries through the GFC have shown the material effect implicit risks can have on governments' finances. In New Zealand this led to the Retail Deposit Guarantee Scheme, which transferred risk from the private to the public sector.

This highlights why efficient and effective management of these off-balance sheet risks and issues is critical. Where the Crown is best placed to address these risks on behalf of others this can be a valuable function. However, there can be unintended consequences particularly where the Crown takes on costs that would be more appropriately carried by the private sector.

Implicit risks and contingent liabilities need to be well understood to allow for careful management to ensure there are no unintended negative fiscal consequences and that economic and social outcomes are protected.[52] These types of risks, including the effects of natural disasters and perceptions about implicit support of the banking sector, represent some of the largest risks the Crown faces.

Resilience

Ultimately the Crown and taxpayers bear any residual risk of an event through potential loss of service provision, increased costs, or both.

New Zealand's approach to resilience has been to run a strong and disciplined fiscal position with low net core Crown debt levels. This allows the cost of an event to be absorbed without unduly affecting the continuation of core public services or the wider economy. For example, many of the costs of the Canterbury rebuild were funded through an increase in debt issuance. This allowed the response to the earthquake to be swift, without putting undue pressure on Crown finances or current taxpayers. This approach is discussed in more depth in the next chapter regarding fiscal buffers.

Assessment

The devolved model for Crown risk management, with some centralisation of nationally significant risks, generally has worked well. The way that risk management responsibilities are assigned has created generally appropriate management accountabilities.

That does not mean there is not scope to seek opportunities to find efficiency gains in risk management practices. This may involve, for example, finding ways for agencies to take advantage of offsetting risks or diversification benefits available elsewhere in the Crown's overall balance sheet.

In addition, taxpayers through the Crown may bear some of the residual impacts of risk that agencies are responsible for managing. There may be room to improve the alignment of incentives for managing risk in agencies and the wider Crown.

As the Crown balance sheet grows and its composition changes the magnitude of risks the Crown faces will increase and their sources will likely change. Therefore, managing risk will become more important over time. In particular, the projected growth of financial assets the Crown owns will likely lead to increased operating and balance sheet volatility. This will require astute management and a greater understanding of the implications of interventions.

These issues will require a greater understanding of the total risk implications of agency interventions, and on and off-balance sheet risks. Accordingly, there could be further improvements to the existing Crown risk management framework to capture some of these benefits while maintaining the benefits of the status quo.

Notes

  • [51]http://www.treasury.govt.nz/publications/guidance/instructions
  • [52]The EQC scheme is an example of this approach. In the event of a disaster, it can be difficult for governments to withstand the pressure to meet the costs of uninsured homeowners. Knowing this, homeowners may choose to underinsure. The EQC scheme is a way of limiting this moral hazard by levying homeowners in return for financial support following an earthquake.

Implications of the Canterbury earthquakes

The Canterbury earthquake sequence beginning 2010 highlighted the importance of Crown risk management. In addition to the loss of life and property damage, earthquakes in densely populated areas can have significant impacts on government service delivery and Crown finances.

Canterbury rebuild costs:

Total estimated cost:
$40.0 billion

Crown contribution to cost:
$14.9 billion

At least 80% of the costs to the Crown from the Canterbury earthquakes, net of insurance proceeds, have arisen from the need to meet, or contribute to, the costs of replacing or repairing physical assets. Not all of these assets are owned by the Crown. For instance, costs have arisen from:

  • the Earthquake Commission’s insurance of privately owned residential property
  • the Crown’s contribution to the restoration of essential local government underground infrastructure such as fresh water supply, wastewater and stormwater services (see Box 6.1), and
  • the Crown’s decision to support AMI insurance – a private company – after property claims arising from earthquakes caused it financial distress.

Box 6.1 - The cost of restoring local government infrastructure

Under current policy settings the Crown may contribute 60% of eligible costs incurred in the restoration of essential local government infrastructure, being fresh water supply, wastewater, stormwater and flood protection management systems (horizontal infrastructure).  The relevant local authorities are responsible for maintaining sufficient financial capacity to meet remaining horizontal infrastructure restoration costs.

Before the Canterbury earthquakes, the estimated replacement cost of the Christchurch City Council's (CCC) entire network of horizontal infrastructure was approximately $2.6 billion.  Post earthquake, restoration costs are still uncertain but are likely to be at least $2.0 billion even though, as the below table illustrates, there were significant proportions of the CCC's network which did not sustain damage.

CCC Network
Network Type of Asset   Total Damaged % of Total Damaged
All networks Reticulation Km 4785 754 16
Pump Stations No. 309 254 82
Reservoirs No. 113 113 100

If this is representative of other local authorities, it may mean that they are not maintaining sufficient financial capacity for their share of restoration costs, investing sufficiently in resilience or adequately transferring the risks on to other parties.  This has implications for ratepayers' exposure to the costs of future disasters and ultimately Councils' financial sustainability.

Future developments

Ultimately the Crown faces the consequences of the quality of risk management and needs to have confidence in agency risk policies. While the overall focus on risk management across government as a whole appears to be adequate, there are opportunities to improve on current arrangements through more coordination in Crown risk management.

Improved coordinated, aggregated risk information

Because most risk management decision making is the primary responsibility of individual entities, there has been no systematic coordinated collection of specific agency risk information. This could have significant implications for cost effective and appropriate risk management from a whole of Crown perspective.

The current risk management framework could be improved through increased sharing of agency risk information. This would assist in determining overall Crown risk exposure and allow for identification of potential action.

An enhanced understanding of risk could support government objectives by increasing resilience. It could also support policy development and lead to a better understanding of the possible impacts of, and risk management techniques for, high-impact-low-probability events such as earthquakes. For example, understanding Crown risk is helpful when looking at how to best structure the core Crown debt portfolio.

Better policy decision making to manage implicit risks

Events in other countries through the global financial crisis and the experience with AMI Insurance and cost sharing arrangements post Canterbury earthquakes highlight the importance of appropriate policy settings in supporting efficient and effective risk management. In particular, the ability of the Crown to manage the implications of large scale events is critical.

Further policy development to support risk management and ensure that appropriate incentives are in place and that costs are borne appropriately is needed.

Better risk pooling

The current model for individual agency risk management means agencies manage risk without consideration of others. Risk pooling would allow diversification benefits to be captured and could potentially reduce costs.

This can be achieved by transferring risk to a central hub, which could then be managed on a consolidated basis. This is a model utilised by many private sector organisations and some other governments. Risk transfer would occur on a commercial arm's length basis and it would remain the responsibility of agencies to make their risk management decisions, thus maintaining accountability.

Risks most fit for pooling are those that can be contracted easily, have similar characteristics, and are easily understood. Arrangements may only apply to agencies where risk management is not core business.[53] This approach currently occurs to an extent within the Crown, as some government agencies voluntarily transact foreign exchange risk with the NZDMO.

Better risk appetite guidance

Agencies' individual risk affects the Crown, so risk appetite guidance is needed. While expectations are set with respect to certain risks and agencies, the approach could be more holistic and comprehensive.

With the growth in financial assets forecast in the future, the contribution to total risk from the financial component of the balance sheet will continue to grow. In the future, the Crown will need to consider the level of risk it is willing to bear with respect to this activity.

Areas of focus

  • Build a fuller understanding of aggregate Crown financial risk.
  • Investigate whether efficiencies can be achieved within the current financial risk management framework.
  • Continue to develop policy to manage the Crown’s contingent and implicit liabilities to help ensure economic stability, fiscal resilience and social outcomes are maintained.

Notes

  • [53]This suggests specialised financial management entities such as the RBNZ or the CFIs would be excluded from arrangements for the pooling of financial risk.

Chapter 7: Fiscal Sustainability and Liability Management

...The ability of the Crown to remain solvent over time within predicable tax and spending parameters is integral to all of the dimensions that underpin living standards.  This requires careful management of both debt and non-debt liabilities...

  • Chapter summary
  • Understanding balance sheet sustainability
  • Balance sheet buffers
  • Debt composition
  • Managing non-debt liabilities
  • Future developments

Chapter summary

Over the economic cycle, operating revenue should be sufficient to at least cover operating expenses, meaning that in the long term, borrowing is mainly used to fund asset acquisition. Sustainability requires fiscal buffers to be sufficient to manage both the effects of economic cycles and shocks. The composition of the fiscal buffer can reflect some combination of borrowing capacity and reserve assets.

The current Government has a long-term fiscal objective of reducing net core Crown debt to no higher than 20% of GDP by 2020, which reflects a prudent level of debt. This debt target is lower than in many other OECD countries because New Zealand faces vulnerability because of its relatively high levels of private offshore debt and its narrow commodity export base.

The Crown also has many non-debt liabilities that require careful management. Saving now to meet these obligations reduces the resources available for spending today, but will reduce future fiscal pressures. This approach has the potential benefit of better aligning the costs of an obligation to those who benefit from them.

A key focus should be to rebuild the fiscal buffer following the effects of the global financial crisis and Canterbury earthquakes. Reducing net core Crown debt to a prudent level should be a priority and would go some way to rebuilding the fiscal buffers. Following that, there is scope to continue to increase resiliency of the Crown balance sheet by further reducing debt, financing other non-debt liabilities, building reserves, or a combination of these approaches. If managed well, this process can support macroeconomic stability and growth objectives.

Understanding balance sheet sustainability

Crown solvency - a minimum requirement

A sovereign is solvent if it can meet its obligations or liabilities when they fall due. This requires it to be able to raise finance when needed, refinance debts as they mature, and meet any associated finance costs.

There are a number of important factors that impact on solvency that are not captured by the balance sheet. These include future tax revenues, discretionary social expenses and the possible triggering of implicit or contingent liabilities. These issues were outlined in Box 2.1.

Sustainability - the heart of fiscal strategy

Fiscal sustainability is a stricter form of solvency. It requires that a sovereign be able to meet its obligations as they fall due without significantly changing existing tax and spending policies.

Sustainable fiscal policy provides confidence that allows for better planning across the economy. This improves labour productivity, investment and innovation leading to better economic performance. A stronger economy in turn helps to support fiscal sustainability.

The importance of sustainable fiscal policies has been demonstrated following the global financial crisis, where countries with fiscal positions that have not been perceived as sustainable have faced significant fiscal adjustments to avoid further destabilising interest rate increases. This has frustrated efforts to improve economic growth.

To maintain fiscal sustainability, it is important that governments keep debt at prudent levels. Achieving this over the long run requires governments running a balanced budget or operating surpluses on average over the economic cycle.[54] This means that over the long run the primary use of debt is to finance capital expenditure.[55] These requirements are a key feature of the fiscal responsibility provisions in the PFA.

Benefits of debt

Debt creates a financial obligation that needs to be serviced through future revenues, but its sustainable use provides many benefits. Along with financing capital expenditure that would otherwise be delayed if funded through current revenues, debt can be used to finance short term fiscal deficits. This helps support stability in tax policies and government services.

Crown debt also supports capital markets in New Zealand by enhancing their liquidity and depth, providing a useful benchmark for the pricing of credit, and giving investors access to instruments that better meet their needs.

For these reasons debt should not necessarily be seen as something to be avoided, as long as it is used prudently.

Notes

  • [54]See http://www.treasury.govt.nz/publications/research-policy/wp/2013/13-20 for more discussion.
  • [55]Another benefit of this approach to fiscal policy is that it helps spread the financing costs of long-lived assets over the generations that benefit from them. It does this by transferring financing payment obligations to current and subsequent generations.

Balance sheet buffers

What is a fiscal buffer?

The Crown needs mechanisms to cope with unexpected expenses and falls in revenue. Fiscal buffers play a key role in the event of a shock such as the global financial crisis. The extra financing capacity provided by fiscal buffers can be used to bridge the shortfall between taxes and spending and allows the Crown to absorb the impact of the shock.

A particular case in point is the response to the Canterbury earthquakes, where the Crown is assisting with the replacement of key assets to restore valued public services and reduce further disruptions to economic activity. To date the Canterbury earthquakes have directly cost the Crown around $15 billion. This has been able to occur without undue effects on sustainability because of the Crown's strong balance sheet position prior to the earthquakes.

Considerations for a prudent fiscal buffer 

A strong balance sheet provides a fiscal buffer by allowing governments to either sell assets or increase debt in order to raise finance.

There are few international benchmarks to help guide governments on what constitutes sufficient balance sheet strength. Therefore, attaining and maintaining prudent debt has been a focus of successive governments.

A focus on debt constrains balance sheet size. If debt is to be kept at a prudent level any significant future capital expansion would need to be funded by reprioritising existing assets, or from operating surpluses mainly generated from tax revenues.[56]

Determining a prudent level of debt

Section 26G(1) of the PFA requires that government pursue policy objectives that include moving to prudent debt levels and maintaining them over a reasonable period of time. The focus in New Zealand is net core Crown debt. It is defined as gross sovereign-issued debt less core Crown financial assets that are liquid. It excludes advances, and NZSF financial assets as these are held for public policy purposes (see Box 7.1 for a fuller discussion of reserve assets).[57]

Box 7.1 - Determining levels of reserve assets

Current practice

The Treasury holds reserves consisting of liquid assets available on demand to help finance general government activities. Sufficient assets are held to fund core government needs in case funding markets are closed for short time periods. In addition, around $76 billion in CFI and RBNZ financial assets are held for specific reasons, respectively to mainly match non-debt liabilities or to manage financial market stability. Accordingly, these assets are unavailable for general fiscal purposes.

Why hold reserves?

In rare instances, maintaining a prudent net core Crown debt level may be an insufficient buffer to adequately cope with the financial implications of an extreme shock. This may be because it is difficult for the government to borrow immediately following a shock. Additionally, reserves can be a more cost-effective source of financing than borrowing during a shock. Accordingly, there could be a case for the Crown holding some additional assets, available on demand irrespective of the state of credit markets - a form of permanent self insurance for risk management and resilience purposes - to help cope with fiscal shocks.

Size of reserves

The level of reserves required depends on what scenarios it would be reasonable for the Crown to plan for. This depends on the fiscal, contingent and implicit risks the Crown faces. However, it is unlikely that any country could insure itself through reserves alone against the sort of shocks that were faced during the global financial crisis.

Type of reserves

Different types of reserves carry different benefits and risks that depend on the circumstances. Given managing a domestic crisis is a more likely scenario, carrying reserves in the form of liquid foreign assets is likely to provide the most benefit because the asset value would be less likely to be related to the onset of a New Zealand specific shock.

Alternatives

Extra resilience can also be sought through alternative arrangements, including pre-arranged emergency credit facilities through organisations such as the IMF. These sorts of facilities have their own set of pros and cons.

There are several factors that need to be considered in determining what constitutes a prudent level of net core Crown debt, including:

  • ensuring there is an adequate financial buffer for the fiscal risks posed from shocks
  • maintaining the sovereign credit rating at a level that provides for diverse sources of funds at low cost to the Crown and the economy as a whole[58]
  • ensuring that debt servicing expenses remain at a reasonable proportion of tax revenues
  • spreading the financing cost of assets with long-term benefits over time, and
  • consideration of present and projected economic and demographic impacts on expected fiscal revenues and expenses, asset and financial markets, and the level of external debt.

Many of these factors will depend on circumstances, which change through time. Nonetheless, the current Government's objective to reduce net core Crown debt to no higher than 20% of GDP by 2020 will return debt to prudent levels. This level is low by international standards and reflects New Zealand's relatively high level of foreign indebtedness and a relatively narrow range of commodity exports, which can create vulnerability to international investor sentiment and shocks.

Figure 7.1 compares New Zealand's net international investment position and gross Crown debt against other OECD countries. It shows that one of the key differences between New Zealand and several OECD countries under financial stress is New Zealand's relatively low level of Crown debt.

Short-term cyclical issues 

The speed at which a prudent level of debt is achieved through saving can have macroeconomic stability implications. In particular, an emphasis on debt reduction during an upswing in an economic cycle as New Zealand is currently experiencing could help take the pressure off monetary conditions and allow interest rates and the currency to be lower than they otherwise would be. The timing of Crown investment in fixed assets also has impacts on the economic cycle, particularly if these are large.

A better mix between fiscal and monetary settings could be helpful to wider economic objectives by rebalancing towards a more investment and tradables led economy.

Figure 7.1 - New Zealand's Relative Government Debt and Net International Investment Positions (2012)
Figure 7.2  - New Zealand's Relative Government Debt and Net International Investment Positions (2012)   .
Source:  The Treasury

Notes

  • [56]Reprioritising assets would change the mix of services government provides. Taxation has associated economic costs, but also using tax to fund capital expenditure means it cannot be used for other purposes (ie, there is an opportunity cost).
  • [57]The definition of net core Crown debt is not determined by GAAP.
  • [58]Credit rating agencies have a balanced approach to sovereign credit rating, that includes consideration of economic, institutional, government financial, and event susceptibility factors.

Debt composition

Least cost and risk core Crown debt

The composition of the core Crown debt portfolio impacts on its cost and risk, and the overall quality of balance sheet management. Like asset holdings, debt needs to be managed carefully to minimise its costs and risks.

A diversified portfolio of debt instruments can balance several risks. Floating-rate, short-maturity debt instruments and inflation indexed bonds help stabilise the impact of economic cycles on the fiscal position through their interest rates varying in an offsetting way to the revenue and expenditure changes. For example, during an economic upswing, increases in tax revenue offset higher interest expenses (Box 7.2 highlights these effects). Meanwhile, fixed-rate and long-term debt instruments help offset the impact of interest rate movements on the value of long-term assets on the Crown's balance sheet.

Box 7.2 - Core Crown debt serviceability

Core Crown debt imposes a financing cost in the form of an interest expense. While the traditional method of assessing the Crown's ability to meet its debt obligations is its debt-to-GDP ratio, an alternative approach is to measure debt serviceability. This can be achieved by examining gross interest costs relative to gross debt levels and Crown revenues. For these purposes, revenue includes core Crown tax, interest and dividend revenues, but excludes levies.

Figure - 7.2 - Costs of debt
Figure - 7.1 - Costs of debt   .
Source:  The Treasury

The relative cost of gross sovereign issued debt has improved since 2007, as lower interest rates have seen financing costs decrease from 7.2% of gross debt, to 4.2%. This means that while gross core Crown debt has been increasing, it has come at a lower average cost to the Crown.

Debt servicing costs as a proportion of revenue remained relatively constant at around 4% until 2011, when it started to increase. However, overall the increase in financing costs was proportionately smaller than that of the Crown's debt position.

Other types of debt

Not all debt on the Crown's balance sheet is core Crown debt. Around $30 billion in debt is raised by entities that are controlled by the Crown. This debt is serviced by those entities from their revenues and is legally separate from the Crown. As a result, unless the Crown guarantees payment, this type of debt is more expensive than sovereign-issued debt because of its higher credit risk.

The biggest borrower is Kiwibank with around $15 billion of debt. In normal circumstances, it is government policy for SOEs and MOM companies to borrow at commercial rates from the private sector to preserve competitive neutrality in the industries that they operate in. In contrast, most Crown entity debt (around $5 billion) is borrowed from the Crown at a range of rates depending on the policy circumstances.[59]

There are pros and cons of this approach. It is more expensive, but it has a number of policy and practical benefits - especially for the commercial organisations.

Notes

  • [59]This debt is eliminated on consolidation.

Managing non-debt liabilities

The Crown has many non-debt liabilities requiring careful management. These may arise due to specified contractual arrangements, such as government employee superannuation schemes through the GSF or insurance obligations such as ACC. In addition, the Crown is also exposed to other contingent liabilities, such as Crown guarantees, as well as a range of commitments driven by existing policy settings, the largest of these is New Zealand superannuation.

These future expenses can be funded when they fall due - pay as you go (PAYGO), or they can be matched with assets by saving now based on estimated future needs - save as you go (SAYGO). The discussion below outlines the pros and cons of the respective approaches.

PAYGO

With fiscal pressures arising from an ageing population, a PAYGO approach would require a combination of significantly higher future taxes, lower spending on other objectives, and increased levels of debt. This approach has immediate benefits through lower current taxes or more spending, but it imposes higher costs on future generations that may not receive the benefits.

SAYGO

SAYGO requires higher taxes today or less spending on other objectives, but would see lower future taxes as savings can then be used to meet the future expenses. This is likely to reduce future fiscal pressures and the risk of core Crown debt rising to imprudent levels. It can also lead to economic benefits from increased saving. A SAYGO approach also has the potential benefit of better aligning the costs of an obligation to those who benefit from them, which is considered to be more inter-generationally equitable.

However, there can be risk implications depending on the design of any SAYGO scheme. In addition SAYGO has limitations, it is better suited to circumstances where liabilities are well defined and cannot be avoided by changes to existing policy settings. Overuse of SAYGO may have the unintended effect of unnecessarily locking-in these settings or encourage general fiscal spending because of the better asset position.

Implementing SAYGO

The Crown can save today by investing in assets to match its liabilities using fiscal surpluses or levies, such as in the case of EQC. Alternatively, funds can be used to lower net core Crown debt.

Saving through the use of funds for specific purposes provides greater transparency, and it is likely to be more widely understood. This contrasts with lower levels of core Crown debt which may be less permanent if the reasons for lower debt are not well understood. This could undermine saving for future obligations.

Funding arrangements for non-debt liabilities

The Crown has a range of funding arrangements that depend on the circumstances of the non-debt liability. Non-debt liabilities that are contractual in nature tend to be funded through SAYGO schemes. Future policy obligations tend to be PAYGO, with the exception of New Zealand superannuation. Contingent and unexpected obligations are managed by fiscal buffers.

ACC liabilities are largely fully-funded contractual obligations, however GSF obligations are far less than 100% funded. The NZSF was established to recognise there is a strong policy commitment for New Zealand superannuation.

The NDF has a mandate to hold assets to meet the costs of future natural disasters. The Crown's other contingent liabilities and unexpected expenses are managed by holding core Crown debt at lower levels so there is a fiscal buffer available when needed. Not all contingent and unexpected events are likely to occur at once, which allows the Crown to cover a range of risks with a smaller fiscal buffer.

Future developments

Fiscal sustainability supports economic growth by increasing resilience and predictability of economic conditions. Key to achieving fiscal sustainability is lowering net core Crown debt to prudent levels to rebuild the fiscal buffer.

Once this is achieved there may be a case for further strengthening of the balance sheet by funding other non-debt liabilities or increasing general purpose reserves. These investments would help match future Crown liabilities to smooth taxes in the future.

Choices around how quickly to lower debt and improve the balance sheet more generally should reflect the state of the economy, with greater saving during economic upturns. This would contribute to macroeconomic stability and help with economic growth objectives.

Areas of focus

  • Investigate whether improvements could be made to the Crown’s current arrangements for contingency funds and reserves.
  • Continue the focus on strengthening the Crown’s balance sheet buffers in a timely way to further improve resilience.

Appendix 1 - Government Reporting Entities as at 30 June 2013

Core Crown

Departments

Canterbury Earthquake Recovery Authority
Crown Law Office
Department of Conservation
Department of Corrections
Department of Internal Affairs
Department of the Prime Minister and Cabinet
Education Review Office
Government Communications Security Bureau
Inland Revenue Department
Land Information New Zealand
Ministry for Culture and Heritage
Ministry for Primary Industries
Ministry for the Environment
Ministry of Business, Innovation and Employment
Ministry of Defence
Ministry of Education
Ministry of Foreign Affairs and Trade
Ministry of Health
Ministry of Justice
Ministry of Maori Development
Ministry of Pacific Island Affairs
Ministry of Social Development
Ministry of Transport
Ministry of Women's Affairs
New Zealand Customs Service
New Zealand Defence Force
New Zealand Police
New Zealand Security Intelligence Service
Office of the Clerk of the House of Representatives
Parliamentary Counsel Office
Parliamentary Service
Serious Fraud Office
State Services Commission
Statistics New Zealand
The Treasury

Offices of Parliament

Controller and Auditor-General
The Ombudsmen
Parliamentary Commissioner for the Environment

Others

New Zealand Superannuation Fund
Reserve Bank of New Zealand

State-owned enterprises

Airways Corporation of New Zealand Limited
Animal Control Products Limited
AsureQuality Limited
Electricity Corporation of New Zealand Limited
Genesis Power Limited
Kiwirail Holdings Limited
Kordia Group Limited
Landcorp Farming Limited
Learning Media Limited
Meridian Energy Limited
Meteorological Service of New Zealand Limited
New Zealand Post Limited
New Zealand Railways Corporation
Quotable Value Limited
Solid Energy New Zealand Limited
Transpower New Zealand Limited

Organisations named or described in Schedule 5 of the Public Finance Act 1989

Mighty River Power Limited

Others

Air New Zealand Limited

Crown entities

Accident Compensation Corporation
Arts Council of New Zealand Toi Aotearoa
Broadcasting Commission
Broadcasting Standards Authority
Callaghan Innovation
Careers New Zealand
Children's Commissioner
Civil Aviation Authority of New Zealand
Commerce Commission
Crown Research Institutes (7)
District Health Boards (20)
Drug Free Sport New Zealand
Earthquake Commission
Education New Zealand
Electoral Commission
Electricity Authority
Energy Efficiency and Conservation Authority
Environmental Protection Authority
External Reporting Board
Families Commission
Financial Markets Authority
Government Superannuation Fund Authority
Guardians of New Zealand Superannuation
Health and Disability Commissioner
Health Promotion Agency
Health Quality and Safety Commission
Health Research Council of New Zealand
Housing New Zealand Corporation
Human Rights Commission
Independent Police Conduct Authority
Law Commission
Maritime New Zealand
Museum of New Zealand Te Papa Tongarewa Board
New Zealand Antarctic Institute
New Zealand Artificial Limb Board
New Zealand Blood Service
New Zealand Film Commission
New Zealand Fire Service Commission
New Zealand Historic Places Trust (Pouhere Taonga)
New Zealand Lotteries Commission
New Zealand Productivity Commission
New Zealand Qualifications Authority
New Zealand Symphony Orchestra
New Zealand Teachers Council
New Zealand Tourism Board
New Zealand Trade and Enterprise
New Zealand Transport Agency
New Zealand Venture Investment Fund Limited
New Zealand Walking Access Commission
Office of Film and Literature Classification
Pharmaceutical Management Agency
Privacy Commissioner
Public Trust
Radio New Zealand Limited
Real Estate Agents Authority
Retirement Commissioner
School Boards of Trustees (2,453)
Social Workers Registration Board
Sport and Recreation New Zealand
Standards Council
Takeovers Panel
Te Reo Whakapuaki Irirangi (Maori Broadcasting Funding Agency)
Te Taura Whiri i te Reo Maori (Maori Language Commission)
Television New Zealand Limited
Tertiary Education Commission
Tertiary education institutions (29)
Testing Laboratory Registration Council
Transport Accident Investigation Commission

Organisations named or described in Schedule 4 of the Public Finance Act 1989

Agriculture and Marketing Research and Development Trust
Asia New Zealand Foundation
Crown Asset Management Limited
Crown Fibre Holdings Limited
Dispute Resolution Services Limited
Fish and Game Councils (12)
Health Benefits Limited
Leadership Development Centre Trust
Learning State Limited
Maori Trustee
National Pacific Radio Trust
New Zealand Fish and Game Council
New Zealand Game Bird Habitat Trust Board
New Zealand Government Property Corporation
New Zealand Lottery Grants Board
Ngai Tahu Ancillary Claims Trust
Pacific Co-operation Foundation
Pacific Island Business Development Trust
Research and Education Advanced Network New Zealand Limited
Reserves Boards (21)
Sentencing Council
Southern Response Earthquake Services Limited
Tamaki Redevelopment Company Limited
Te Ariki Trust
The Network for Learning Limited

Glossary of terms

Glossary of terms
Term Definition
ACC Accident Compensation Corporation.
ALOS Average length of stay.
APR Annual Portfolio Report - Produced by the Treasury and describes the performance of the Crown-owned enterprises that have full or partial commercial objectives.
Appropriation A parliamentary authorisation for the Crown or an Office of Parliament to incur expenses or capital expenditure.
Asset A resource controlled as a result of past activities which is expected to deliver future economic benefits.
Balance sheet A statement of assets, liabilities and net worth, also known as the Statement of Financial Position.
Better Business Cases A structured way that stakeholders can work and think together to provide a business case.
Capital expenditure Expenditure which purchases or upgrades an asset.
Carrying value The value at which an asset is recognised after deducting any accumulated depreciation (amortisation) and accumulated impairment losses thereon.
CCC Christchurch City Council.
Contingent liability A cost the Crown will have to face if a particular uncertain and not probable event occurs.  Typically, contingent liabilities consist of guarantees and indemnities, legal disputes and claims, and uncalled capital.
Core Crown The core Crown is represented by departments, Offices of Parliament, the Reserve Bank, and the NZS Fund.
Cost benefit analysis A systematic process for calculating and comparing the benefits and costs of a project(s).
Corrections Department of Corrections.
Crown Includes all Ministers of the Crown and all departments, but does not include an Office of Parliament, a Crown entity, or a state enterprise.
Crown entities The term Crown entity covers a wide range of different organisations that collectively undertake a range of different functions: regulatory, advisory, service delivery, devolved purchase and ownership.  Most Crown entities exist under their own governing legislation.  They form part of the Crown reporting entity, but are not part of the Crown itself.
CFI Crown Financial Institution - Crown entity that has specific responsibilities relating to the management and investment of significant Crown financial assets.  This group includes: ACC, EQC, GSF, and NZSF.
Department A government department is an organization responsible for the administration of a particular area of government.
Depreciation The wearing out, consumption or other loss of value of assets.  Allocated as an expense over the estimated useful life of each asset.
DHB District Health Board. 
DLOC Directed Level of Capability.
DOC Department of Conservation. 
DRTWR Durable return to work rate.
EFTS Equivalent Full Time Student.
EFU Economic and Fiscal Update - The Treasury's latest economic forecasts and the forecast financial statements of the Crown.
EQC Earthquake Commission.
Equity The residual interest in an entity's assets after deducting liabilities.
Fiscal policy The government's policy relating to its spending, revenue and balance sheet.
FSGNZ Financial Statements of the Government of New Zealand.
GAAP Generally Accepted Accounting Practice - Describes the assumptions and rules applied when preparing and presenting financial statements; In New Zealand the Financial Reporting Act 1993 requires most reporting entities in both the private and public sectors to comply with GAAP.
GDP Gross domestic product - A measure of the value of all goods and services produced in New Zealand.
Genesis Genesis Power Limited.
GFC Global financial crisis. 
Government The party or parties that command a majority of the House on confidence and supply matters; also used to mean the Executive.
GSF Government Superannuation Fund.
GST Goods and Services Tax.
HNZC Housing New Zealand Corporation.
HYEFU Half Year Economic and Fiscal Update.
ICT Information and Communication Technology.
Implicit risk Cost the Crown may face in the future which arises from public expectation or moral obligation (rather than a legal obligation).
IRD Inland Revenue Department.
IRRS Income Related Rent Subsidy.
ITPs Institutes of Technology and Polytechnics.
LINZ Land Information New Zealand.
Liability Obligations arising as a result of past transactions which are expected to result in an outflow of benefits in the future.
LTFS Statement of the Long-term Fiscal Position.
M Ha Million Hectares.
Meridian Meridian Energy Limited.
MFAT Ministry of Foreign Affairs and Trade.
MLE Modern Learning Environment.
MRP Mighty River Power Limited.
MoE Ministry of Education.
MoJ Ministry of Justice.
MOM Mixed ownership model.  Also referred to as the Government Share Offer Programme.
MPI Ministry for Primary Industries.
NDF Natural Disaster Fund.
Net core Crown debt Represents gross sovereign issued debt less core Crown financial assets (excluding advances and financial assets held by the NZSF). 
Net International Investment Position A country's public and private international financial assets less liabilities.
Net worth Assets less liabilities (also referred to as Crown balance or equity).
NWAC Net Worth Attributable to the Crown.
NZD New Zealand Dollar.
NZDMO New Zealand Debt Management Office - An operating unit of Treasury.
NZDF New Zealand Defence Force.
NZSF New Zealand Superannuation Fund.
NZTA New Zealand Transport Agency.
OCL  Outstanding Claims Liability. 
OCR Official Cash Rate.
OECD Organisation for Economic Co-operation and Development.
OIS Overnight Index Swap.
Outcomes Impacts on or consequences for the community of the outputs or activities of the Government.
PAYE Pay as you earn.
PAYGO Pay as you go.
PCL Public Conservation Land.
PP&E Property, plant and equipment.
PFA Public Finance Act 1989.
Police New Zealand Police.
PPP Public Private Partnership.
Public Sector Discount Rate The Treasury's estimate of the public sector cost of capital.
RBNZ Reserve Bank of New Zealand.
SAYGO Save as you go.
SME Specialised Military Equipment.
SOE State-owned enterprise.
TEI Tertiary Education Institute.
Transpower Transpower New Zealand Limited.
TSR Total Shareholder Return.
TVNZ Television New Zealand Limited.
TWI NZD Trade Weighted Index.
VKT Vehicle Kilometres Travelled.
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