financial framework

overview of cost increases

Methodology
123. The methodology for the calculation of cost increases in 2006-07 follows the approach of previous biennia, which was approved by the Finance Committee, Council and Conference. As noted under the section on Risk Assessment, staff cost increases in particular remain difficult to predict despite the sophisticated information systems used to analyse current costs and quantify trends. Cost increase calculations will be further refined and updated for the full PWB.

124. As in previous biennia, the cost increase estimates in the SPWB are developed based on actual cost adjustments that have occurred in the first year of the current biennium and cost projections over the planning horizon. The resulting financial adjustments are sub-divided into biennialization and inflation.

125. Biennialization incorporates the full biennial effect of cost increases that have occurred or will materialise during the current biennium, but which will be incurred for the full 24 months in 2006-07. As such, biennialization objectively reflects the financial impact of events that will have already taken place before the implementation of the 2006-07 budget. The financial implications are essentially a matter of fact and arithmetic, not conjecture or long-range planning.

126. Inflation represents the cost impact in 2006-07 of those adjustments that are expected to take effect at various points in the next biennium. The planning assumptions are summarised below. To assure prudent fiscal management and transparency, independent verifiable forecasts from the Economist Intelligence Unit and published data of authoritative bodies such as the International Civil Service Commission (ICSC) are used.

Analysis of cost increases
127. This section provides an overview of the cost increases needed to maintain purchasing power, which are estimated at US$ 45.7 million for the 2006-07 biennium at ZRG. This corresponds to a biennial cost increase rate of 5.4% of the Programme of Work (equivalent to a 3.6% annual increase), or 6.1% of the total net budget (equivalent to 4% per year).²⁷

128. In line with previous SPWB documents, at this stage the cost increase projections assume the same input mix for 2006-07 as the current approved PWB 2004-05 (i.e. 67% staff costs and 33% non-staff costs). The estimated cost increases for 2006-07 could change in the full PWB as a result of the application of cost increases to the proposed input mix in the biennium. For example changes between the current budget and the PWB 2006-07 in the proportion of staff in the total programme of work, or even modifications in the distribution of posts across locations, would alter the cost increase calculations.

Table 3: Summary of Cost Increases (US$ 000)

	PWB 2004-05 Programme Base	Biennalization	Inflation	Total Cost Increases for 2006-07	2006-07 ZRG Budget after Cost Increases
Personnel Services: Salaries, Pension Fund Contributions and Allowances	539.7	17.6	18.1	35.7	575.4
After Service Medical	10.1	2.3	0.0	2.3	12.4
Other After Service Benefits	16.5	1.8	0.0	1.8	18.3
Total Personnel Services	566.2	21.7	18.1	39.9	606.1
Total Goods and Services	274.8	0.0	5.8	5.8	280.7
Programme of Work	841.0	21.7	24.0	45.7	886.7
Less income	(91.9)	-	-	-	(91.9)
Net Budget	749.1				794.8

129. Explanations are provided below for the most significant cost increases and the underlying assumptions by main cost heading.

Personnel services
130. Personnel Services comprises all staff costs, including salaries, pension fund contributions, dependency allowances, social security and other staff related entitlements and after service benefits for both the professional and general service staff categories.²⁸ The increases in personnel services costs are exclusively those deriving from the UN common system, as reviewed by the ICSC and approved by the UN General Assembly.

131. Personnel Services are estimated to increase by 7% compared to the previous biennium and account for US$ 39.9 million out of the overall US$ 45.7 million cost increases for 2006-07 (87%). The significant cost adjustments are, in turn, primarily the effect of events that are occurring in the current biennium.

132. Biennialization accounts for US$ 21.7 million of the total cost increase, due mainly to under-budgeting of unit staff cost rates in the current biennium²⁹ arising from:

the increase in Staff-Related Liabilities of some US$ 5.2 million due to a change in methodology in the actuarial valuation as at 31 December 2003 (US$ 4.2 million of this amount was unforeseen and unbudgeted in 2004-05);
the increase in the Organization’s share of the premiums for the Basic Medical Insurance Plan that was budgeted at 12% per year against an actual increase of around 20% in 2004 and a similar increase expected in 2005;
increases in Education Grant and Entitlement travel; and,
the impact of a lower US dollar against local currencies in decentralised offices.

133. With regards to inflation, a total cost increase of US$ 18.1 million is foreseen based on estimates for the various cost components, including:

for headquarters general service staff remuneration, the Economist Intelligence Unit (EIU) Average Nominal Wages Index in Italy for 2006 (2.4%) and 2007 (2.3%);
for headquarters professional salaries, the consumer price index (CPI) in Italy for 2006 (1.9%) and 2007 (1.8% adjusted upwards to 2% in view of the place-to-place survey foreseen for late 2005); and
an average of factors such as inflation indexes, exchange rate forecasts and recent past patterns of increases, as applied to staff costs in other locations.

134. For pensionable remuneration, a somewhat lower increase than for the Average Nominal Wages Index for the USA for 2006 and 2007 is applied, at 3% and 2% respectively. This adjustment takes account of a 4.42% across-the-board increase in September 2004 in the scale of pensionable remuneration for the professional and higher categories.

135. The Basic Medical Insurance Plan witnessed a sharp cost escalation in 2004³⁰ and the same is forecast for 2005. However, a slowing down is assumed in the next biennium with an 11% increase for each year, as the contract for the medical plan will come to an end in 2006 and, through the tendering process, cost containment measures are expected.

136. Funding for after service staff benefits, including After-service Medical Coverage (ASMC) is assumed to remain at the same level set by the actuarial valuation of 31 December 2003.

Goods and services
137. This cost heading includes Other Human Resources, Travel, General Operating Expenses, Furniture, Equipment and Vehicles.

138. Other Human Resources, which consist of non-staff human resources in the form of temporary assistance, consultants and contracts, are estimated to increase by 2.4% overall in the biennium due to inflation. The calculation is based on the weighted average of the estimated nominal wage increase for Italy applied to headquarters-based expenditures and the consumer price index for goods and services, and lower estimated increases for decentralised expenditure.

139. Travel costs have been increased by 0.9% for the biennium in view of the low level of increases in air tariffs and DSA, assuming that cost containment measures mentioned under Efficiency Savings are implemented. The 1% inflationary increase in General Operating Expenses is based on the CPI for Italy applied to headquarters-based expenditures and lower inflation rates for the remaining part of expenditure. Under Furniture, Equipment and Vehicles, it has been assumed that most of the expenditure will be incurred under international tendering provisions for which US rates of inflation are considered appropriate.

Amortization of accrued liability for After-service Medical Coverage
140. The governing bodies approved the Organization’s treatment of the ASMC liability in respect of the past service of staff members in 1998. This involved an annual accrual in the accounts from 1 January 1998 over an amortization period of 30 years. In addition, the current service costs of staff members are being accounted for and funded from the regular budget.

141. The Conference at its 2003 session approved an additional assessment to begin funding the amortization of the ASMC. Document FC 109/17 proposes several options for funding the ASMC, which are not part of the Organization’s current or proposed Programme of Work.

Lapse factor
142. The methodology approved by the Council at its 107th session in November 1994 for a reduction of staff costs for staff turnover (the lapse factor), has been followed. As in the PWB 2004-05, an across-the-board budgetary reduction of 2.52 percent and 1.63 percent continues to be applied to professional and general service staff costs respectively in arriving at the programme budget estimates for 2006-07. The percentages will be revised in the full PWB 2006-07 to take account of standard retirement lead times and staff turnover rates.

financial analysis of the general and related funds

143. The General and related funds comprise three distinct elements which together characterise the overall financial health of the Organization:

the most significant caption is the General Fund, which reflects the accumulated historical result of all receipts from assessments on Members, miscellaneous and other income, offset by cumulative expenditures to execute the Programme of Work;
the Working Capital Fund (WCF), which is authorised at a level of US$ 25 million, its primary purpose being to advance monies to the General Fund to finance expenditures pending receipt of assessed contributions to the budget. The WCF can also be used to finance emergency activities not contemplated in the budget;
the Special Reserve Account (SRA), which is authorised at a level of 5% of the effective working budget (currently US$ 37.5 million). Its primary purpose is to protect the Programme of Work against the effects of unbudgeted extra costs arising from adverse currency fluctuations and unbudgeted inflationary trends. The SRA can also advance monies on a reimbursement basis to the WCF.

144. The breakdown of the General and related funds as at 31 December 2003 (i.e. from the latest available audited accounts), is summarised as follows:

Table 4: General and Related Funds Equity Position as at 31 December 2003

	US$ Millions
General Fund Balance/(Accumulated Deficit)	(90.1)
Working Capital Fund	25.2
Special Reserve Account	23.0
Total Reserves and Fund Balances/(Deficit) at 31 December 2003	(41.9)

145. The significant accumulated deficit under the General Fund at 31 December 2003 can be largely explained by:

the treatment of arrears in assessed contributions from Members; and
the recognition of After-service Medical Coverage (ASMC) costs in the accounts of the Organization.

146. Outstanding payments of assessed contributions are not recognised in the accounts. However, the accumulated deficit of US$ 90.1 million as at 31 December 2003³¹ is covered by outstanding arrears in assessed contributions from Members, amounting to US$ 97.7 million on the same date.

147. The Organization’s accounting policy with respect to ASMC is similar to that of the international accounting standards and the policy of some other UN organizations. At the same time, it is more prudent than the policy presently adopted by the United Nations itself and several other agencies. For example, the United Nations recognises ASMC liabilities only to the extent of the payments actually incurred every biennium on retiring or separated staff. However, this is currently under review with the assistance of a recognised firm of actuaries, to see how the matter can be brought in line with best practice.

148. In the case of FAO, since 1998 the governing bodies have approved the following approach:

the current service costs, as determined in the actuarial valuation, are planned in the Regular Budget and charged in the accounts; and
the unrecorded liabilities for past service determined by the actuarial valuation are being amortised over 30 years for ASMC.

149. The accumulated deficit at 31 December 2003 includes charges for ASMC amortisation amounting to US$ 49.5 million which are not funded and have augmented the accumulated deficit by a corresponding amount. However, at 31 December 2003 ASMC liabilities not yet recorded amount to US$ 202.9 million.

150. While the above clarifications provide a justification for the accumulated deficit balance on the General Fund at 31 December 2003, the difficulty is real. The accumulated deficit will grow in 2004-05 and will continue to rise unless further action is taken. For example, the unrecorded ASMC liabilities will continue to be amortised in current and future biennia, in accordance with the above-mentioned decisions of the governing bodies.

151. The Conference approved additional funding in 2004-05 of US$ 14.1 million for ASMC in 2003 and the Finance Committee and Council were subsequently informed in 2004, that according to the latest actuarial report, the current funding would need to increase significantly to cover the ASMC liabilities. Options for dealing with the funding of the ASMC liabilities are submitted to the governing bodies in a separate document.³²

152. The governing bodies are also being informed³³ that delays in the receipt of assessed contributions will exacerbate the cash position of the General Fund, requiring monies to be advanced to the General Fund from the WCF and SRA on a more frequent and continuing basis. There will be a requirement for external borrowing during 2005, unless significant contributions from Members are received earlier than was the case in 2004.

153. The Organization must, therefore, seek solutions to reverse the trend of an increasing accumulated deficit under the General Fund, or at least to stabilise it, and to improve the cash flow situation. A possible partial solution, on which guidance is sought from the governing bodies, concerns the treatment of Miscellaneous Income in arriving at the assessment of the contributions to the biennial budget.

154. In accordance with Financial Regulation 7.4, Miscellaneous Income shall be estimated for each financial period. The estimates are provided in every Programme of Work and Budget, and the amounts put forward during the past three biennia are tabulated below:

Table 5: Miscellaneous Income (US$ 000)

Description	2000-01	2002-03	2004-05
Rental of Conference and Office facilities	196	100	100
Investment Earnings	4,000	4,500	4,500
Less discounts payable	(1,200)	(600)	(600)
Lapse of accrued liabilities	3,700	2,500	5,000
Contributions from New/Associate Members	100	100	100
Sundry	100	95	95
TOTAL ESTIMATED MISCELLANEOUS INCOME	6,896	6,695	9,195

155. In accordance with Financial Regulation 5.2(a), in the assessment of contributions of Members and Associate Members for each financial period, adjustments shall be made in respect of estimated Miscellaneous Income of the financial period in respect of which the assessment of contributions is being made. Thus, in arriving at the assessments on Members, the resolution on the budgetary Appropriation makes a deduction for the estimated Miscellaneous Income in the Programme of Work and Budget.

156. It is befitting to recall the rationale for this treatment of Miscellaneous Income. Under Financial Regulation 7.4, if the actual Miscellaneous Income ... exceeds or is less than the estimate, such excesses or such shortfall shall form part of the surplus or deficit of that financial period. Moreover, under Financial Regulation 6.1(b), any cash surplus in the General Fund at the close of any financial period shall be allocated among Member Nations. Therefore, the practice of estimating Miscellaneous Income is aimed at projecting the likely surplus in the General Fund at the end of a biennium. Assuming full implementation of the Programme of Work, the deduction of Miscellaneous Income from assessments serves to obviate the need to raise assessments for the portion that would anyway have to be distributed to Members after the implementation cycle.

157. In fact, the governing bodies have already recognised the risk in this approach should the level of forecast Miscellaneous Income not eventuate, with the consequent adverse effect on the delivery of the Programme of Work. For this reason “the Council asked the Director-General to prepare conservative estimates of Miscellaneous Income for the purpose of determining the level of payment of contributions from Member Nations”.³⁴

158. The reality now is that the Organization has a large and growing accumulated deficit in the General Fund. Therefore the basis for reducing the assessed contributions to a figure that is lower than the net Appropriations, on the assumption that the Organization will have a cash surplus, is no longer valid. In the light of such circumstances, the governing bodies may consider it prudent fiscal management to fully fund the net Appropriations.

159. Options that could be considered by the governing bodies to fully fund the net Appropriation from 2006-07 might be to:

temporarily suspend the application of Financial Regulation 5.2(a), which requires adjustments to be made to the assessments in respect of estimated Miscellaneous Income, until such time as the General Fund nears a surplus; or
further to the guidance previously provided by Council, request the Secretariat to supply only a nominal estimate for Miscellaneous Income until such time as the Organization returns to a stronger financial and cash flow position.

²⁷ The overall real reduction in resources at ZNG is derived by applying the 6.1% biennial cost increase to the reduced programme of work base required to remain at a total net budget level of US$ 749.1 million. This produces a real reduction in resources of approximately US$ 43 million.

²⁸ FC 108/11(b) on Cost Analysis of Staff Remuneration and Benefits contains a detailed description of the various benefits and allowances granted to internationally and locally recruited staff.

²⁹ FC 109/3 paragraphs 12-13

³⁰ The increase is directly related to the benefits paid from the plan each year together with projections for medical inflation for the next year and the fact that in 2003 claims were substantially higher than in 2002.

³¹ This includes the effect of the balance of one-time expenditures authorised by the Conference against the major contributor’s arrears payments (US$ 41.4 million).

³² FC 109/17

³³ FC 109/4

³⁴ CL 91/REP paragraph 278