Risk management is more than just a safety net for when things go wrong—it’s a holistic approach to anticipating and mitigating the wide range of challenges that can disrupt municipal operations or derail a city’s financial health. From maintaining adequate reserves to addressing pension obligations and even navigating litigation risks, proactive planning is essential for budget stability and public trust.
While no single framework can eliminate every hazard, a city that weaves risk management into its budgetary and policy-making processes stands a far better chance of withstanding economic volatility, natural disasters, and unexpected liabilities. Below, we’ll explore how to create robust reserve policies, control operational and financial exposures, and address potential pitfalls in insurance and pension funding.
Why Risk Management Matters
Operational & Financial Risks
Broadly speaking, cities face two principal categories of risk in their budgets. The first is operational, rooted in everyday service delivery and unexpected disruptions (think facility breakdowns, sudden population changes, or emergency services spikes). The second is financial, arising from revenue shortfalls, volatile markets, or misguided assumptions about long-term obligations.
1. Reserve Levels
Well-defined reserve policies are the backbone of municipal risk management. A city’s reserves serve as a buffer against sudden revenue declines, natural disasters, and other shocks.
Contingency Funds
Many cities designate a portion of their general fund as an emergency or contingency reserve. A common practice is to set this at a specific percentage of annual operating expenditures—often in the range of 10–20%.
Define Usage Criteria: Establish clear guidelines for when and how these reserves can be tapped. Examples include:
Natural disasters like floods or earthquakes
Significant revenue shortfalls due to an economic downturn
Emergencies that threaten immediate public health or safety
Smoothing Revenue Volatility
Beyond emergencies, some cities maintain reserves specifically to offset cyclical revenue declines. This could mean setting aside extra funds during economic booms so that core services can continue unimpeded when sales taxes, tourism taxes, or other variable streams dip.
Strategically using stabilization reserves can also reduce the need for drastic mid-year budget adjustments or damaging service cuts.
2. Volatility Protection
A city’s ability to adapt to changing conditions greatly affects its resilience:
Revenue Diversification: Over-reliance on a single source—like sales tax—can amplify the impacts of economic downturns. Encouraging a balanced mix of property taxes, fees, and other revenue streams hedges against steeper declines in any one area.
Expenditure Controls: While cities can’t entirely jettison obligations like wages or core services, they can build flexibility into vendor agreements or staffing structures. For instance, cost-of-living adjustments might be tied to performance metrics, or select positions can be filled with limited-term contracts if the future demand for those roles is uncertain.
Liability & Insurance Considerations
Cities carry myriad liabilities, from potential lawsuits to major pension obligations. Proactively identifying, funding, and managing these exposures keeps them from ballooning into existential threats for the budget.
1. Pension & OPEB Obligations
Long-term benefit obligations for retired employees—often referred to as Other Post-Employment Benefits (OPEB)—pose a significant financial risk if not well-funded. While pensions typically get the spotlight, OPEB costs (like retiree healthcare) can quietly accumulate.
Actuarial Reviews
Routine actuarial analyses ensure that the city’s assumptions on life expectancy, investment returns, and healthcare costs reflect reality. Outdated models can drastically understate the actual liabilities, leading to shortfalls down the line.
Stay current on these valuations, especially if the city’s workforce demographics or market conditions change significantly.
Funding Discipline
Consistently meeting (or exceeding) the annual required contribution (ARC) prevents these liabilities from compounding. Skimping in lean years only pushes bigger burdens into the future, often with interest.
Tip: Explore additional funding strategies, such as establishing dedicated trusts for pension or OPEB obligations, to ensure resources can’t be easily diverted to other uses.
2. Litigation Risks & Self-Insurance
Lawsuits, worker’s compensation claims, and property damage can create sudden, substantial liabilities.
Risk Pooling: Many cities join regional or statewide risk pools to spread the costs of insurance—particularly for specialized areas like public safety. Pooling can reduce premium volatility but may come with membership fees or specific coverage limitations.
Self-Insurance: Larger or well-funded municipalities sometimes opt to “self-insure” certain risks if they believe their reserves are adequate to handle foreseeable claims. This approach demands rigorous claims management practices and close monitoring of legal expenses.
Additional Dimensions of Risk Management
While reserves and liability planning form the core of fiscal risk management, a holistic approach often involves other layers of precaution:
Capital Project Risks: Cost overruns in large infrastructure ventures can ripple across the budget, so it’s wise to do thorough feasibility studies and consider contingency allowances in the CIP (Capital Improvement Plan).
Disaster Preparedness: Beyond setting money aside, work with emergency services to develop continuity plans. Rapid response can reduce the long-term financial fallout of major incidents.
Economic Development & Demographic Shifts: Rapid population growth or contraction can strain infrastructure, while changing economic conditions might reshape tax bases. Ongoing data analysis helps the city pivot more smoothly.
Building a Culture of Preparedness
Risk Assessment & Inventory
Start by systematically cataloging potential threats—from chronic revenue volatility to one-off catastrophic events. This “risk inventory” should be updated at least annually to reflect emerging challenges.
Integration with Budget Cycles
Incorporate risk assessments into each stage of the budget process. Departments seeking new funding should address how their proposals mitigate known risks or could introduce new ones.
Clear Policy Framework
Formally adopt written policies for reserves, insurance coverage, and pension funding. These policies guide decision-making and ensure consistent treatment of liabilities over time.
Routine Monitoring & Adjustments
Schedule quarterly or semi-annual check-ins to review reserve levels, claim activity, and pension fund performance. If shortfalls appear, consider early corrective measures—like modest fee increases or targeted spending reductions—before problems escalate.
Conclusion
Risk management in municipal finance isn’t merely about hedging bets on the unknown. It’s a strategic, forward-looking commitment to safeguarding the services and infrastructure that residents rely on. By diligently maintaining well-defined reserves, keeping a close eye on pension and OPEB obligations, and recognizing the many forms of operational and legal risk, cities can navigate uncertainty with greater confidence.
At its core, effective risk management is about preserving the capacity to serve the public—even when adversity strikes. With a balanced approach that integrates contingency reserves, diversified revenues, and robust insurance or self-insurance mechanisms, municipal leaders can uphold fiscal integrity and ensure their community’s well-being for decades to come.