Establishing Reserve Policies

There are many disconnects in the normal process of "building" a reserve study (RS) in today's world.  Most of these disconnects occur because associations don't control the RS process themselves, they depend instead on their outside reserve professional to make decisions for the association. Most associations place complete reliance on the outside reserve professional, and that is where diisconnects arise, simply because the reserve professionals thoughts have not always been aligned with the association's thoughts.

There is still considerable disagreement within the industry as to what the Reserve Study report really represents; is it an independent study by the outside professional, or is it a report that belongs to the association, in which the outside reserve professional assisted the association in the preparation of the report?  A similar situation occurs in the accounting  process for an association.  The association is responsible for the accounting process, but engages an independent CPA firm to look over the internal reports and make suggested modifications to arrive at the final financial reports.  The financial reports are the property of the association, and they are ultimately responsible for the accuracy of those reports, even though the report may be the work product of the outside CPA.   There is no confusion as to responsibilities in the accounting situation, but there is still confusion in the RS situation.  The confusion is further exacerbated by the fact that reserve professionals typically do not include a "report," on their letterhead, that explains what they did and what conclusions they arrived at.

An example of the disconnects that typically occur in the RS process are:

  • The reserve professional, rather than the association, decides which components should be included in the study and which should not
  • The reserve professional, rather than the association, decides what useful and remaining lives are for the components (which often do not match up with what maintenance staff recommends)
  • The reserve professional, rather than the association, decides what investment and inflation rates to use (which may not agree with what your investment advisor is actually getting)
  • The reserve professional, rather than the association, selects funding goals
  • The reserve professional, rather than the association, may assume all costs based on using outside contractors, when association staff may be able to perform replacement activities at a lower cost

If the report is truly an independent study by the outside reserve professional, then that person should be making all those decisions and making them as recommendations to the association.  This type of an independent study places a much higher level of to the reserve preparer in terms of professional liability.  More importantly, it often means that the association has had little input on preparation of their long-term capital budget, and "disconnects" are more likely to occur.

Even if the association is more involved in the process, and the outside reserve preparer is viewed as assisting the association in a more collaberative process, disconnects can still occur.  The most effective way for the associaiton to eliminate disconnects is to establish reserve policies - The Association should take control of the reserve study process by establishing reserve policies that address the following matters:

Identification of Association maintenance responsibilities

    1. Governing documents
    2. State statutes (if applicable)
    3. Common industry practices
    4. Agreements with members or third parties

      Budgeting policies

      1. Reserve budget
      2. Operating budget
      3. Budget to actual comparisons
        a)      Frequency of reports
        b)      Who must review
        c)      Policy on variance analysis
        d)     Policies on follow up procedures

      Description of reserve maintenance plan

        1. Policies identifying reserve components
        2. Policies of replacement cycles
        3. Purchasing policies
        4. Policies on use of maintenance staff versus outside contractors
        5. Description of effect of operating maintenance activities on replacement activities

        Description of operating maintenance plan

        Funding policies

          1. Percent funded goals
          2. Policies on inclusion or exclusion of investment income
          3. Policies on inclusion or exclusion of income taxes
          4. Effect of selection of tax form to file – tax status

          Investment policies

            1. Policies on segregation of reserve and operating funds
            2. Policies on capital reserves versus non capital reserves
            3. Policies on approved investment vehicles
            4. Policies on selecting investment broker or banker

            Cash handling procedures

              1. Who may authorize expenditures
              2. Who may sign checks / authorize transactions
              3. Bank reconciliation procedures
              4. Review and approval of bank reconciliations

              Facilities Advisors provides its clients with model reserve policies to help start the process.  Please contact us if you would like a copy of our reserve policies.