Public finance is subject to a great deal of uncertainty, such as future recessions, changes in interest rates, forecast inaccuracy, and much more. Uncertainty is a source of risk. The gold standard for analyzing and managing risk is computer simulation. That’s how insurance companies design and price policies, for example. Technological advances have made computer simulation more accessible than ever before and GFOA has been on the cutting edge of applying these advances to public finance.
Conveying Hazards and Natural Catastrophes Through Extracted Simulations
Local governments have a responsibility to prepare for extreme events like natural catastrophes, recessions, and more. Preparation requires planning. The best plans are supported by data. However, most data on extreme event risk is conveyed as single number averages, which masks the uncertainty necessary for valid planning.
Should We Rethink Reserves?
The “Best Practices: Fund Balance Guidelines for the General Fund” is one of GFOA’s most often cited standards. However, GFOA’s consulting work with local governments has revealed that there are many opportunities for reserve optimization beyond the guidance provided in the Best Practices. This paper brings what we have learned together with university research to describe new opportunities for local governments to get the best value from their reserve strategies.
Sample Wildfire Risk Model
This model, developed GFOA estimates the chance of a county depleting its reserve over a ten year period due to wildfire risk. When you make a change to a green assumption cell, 10,000 trials are run for each of ten years for a total of 100,000 calculations using the Excel Data Table. The data, provided by AON, came from a complex simulation built and compiled on large, distributed computer networks on which event generation can take many days to run.
Local governments often join together to pool risk for insurance. Insurance pools save money by aggregating multiple local governments into a larger, more diversified risk pool. Or a government might provide insurance coverage as a central, shared service, which is far cheaper than each department independently contracting with their own insurance providers. This is also a form of risk pooling.
General fund reserves are one of local governments’ primary resources for responding to unexpected financial losses, such as those brought about by natural disasters or man-made extreme events. However, it is neither practical nor desirable for a government to accumulate enough reserves to respond to every possible contingency it might face — that would simply not be affordable for most communities.
This document is our risk-based analysis and stress test of general fund reserve requirements for Salt Lake City, Utah.
This document is our risk-based analysis general fund reserve requirements for the Town of Yountville, California.
Probability Management is a 501(c)(3) nonprofit that is making uncertainty actionable through tools, open standards and training. It has collaborated with GFOA since 2013.
