Statement of Risk
This chapter addresses some of the risks facing the Territory, particularly in regard to Economic Risk, Commonwealth Government Funding, Stage 4 Water Restrictions, Investments and Borrowings, Superannuation Liabilities, and Insurable Risk.
Economic Risk
The Territory economy is well placed to deal with future economic shocks because of the strength of the economy in recent years.  Changes in Commonwealth Government outlays are the most significant risk to the ACT’s economy.  The potential for significant savings measures arising from the upcoming Federal Budget magnifies this risk in the short term.  The economic forecasts in this Budget have been made on the assumption that the Commonwealth Government will deliver a budget surplus in 2008‑09 of 1.5 per cent of Gross Domestic Product (GDP) including their announced savings and spending measures.  
Although interest rates are expected to remain relatively stable over the forecast period, the impacts of contractionary monetary policy will take time to flow through the economy, meaning the effects may be felt for some time to come, even if monetary policy settings were eased during the forecast year.  The risk is that the contractionary stance of monetary policy impacts on the national economy to a greater and faster extent than anticipated by the Reserve Bank of Australia (RBA).  Such a situation would generate weaker levels of ACT economic activity than currently forecast.  
Furthermore, if volatility in stock markets begins to impact on personal wealth, particularly via lower superannuation returns, there is a risk that economic activity in the ACT may be lower than forecast as individuals lower their consumption and investment.
Risk to Tax Revenue
Economic risk extends to the Territory tax revenue.  Payroll tax, stamp duty, rates and land tax are exposed to risk associated with employment levels and wages in the ACT, which are driven largely by expenditure in the public sector.  A significant change in Commonwealth Government public sector expenditure, particularly in the form of ACT based staffing levels, would affect the property market in the ACT with a flow‑on effect on property related taxation revenue.  This would also have a flow‑on effect on private sector economic activity, and therefore affect payroll tax revenue.
Commonwealth Funding
Adverse economic conditions could result in a moderating of Goods and Services Tax (GST) revenues, particularly as the GST is not imposed on a range of staple items, but instead on discretionary expenditure.  Any deterioration in the national economy may place at risk the expected growth in additional funding to the States and Territories.
States’ and Territories’ shares of GST revenue grants are derived from Australian Bureau of Statistics population estimates.  Any decline in population share for the forward years could also adversely impact on GST funding to the ACT.
A number of significant Specific Purpose Payments (SPPs) will be due for negotiation in 2008 and 2009, such as the Commonwealth-State Housing Agreement; Natural Resource Management Agreement; and Australian Health Care Agreements.  However, following the change of Commonwealth Government and the subsequent adoption of a Council of Australian Government (COAG) led reform agenda, including agreement to a far reaching reform of Commonwealth-State financial relations, these negotiations will now recommence within the new SPP framework.
The adoption of the new framework, which includes ongoing funding agreements and an overarching Intergovernmental Agreement, should provide States and Territories greater long‑term funding certainty and reduce the risk of Commonwealth backsliding and re‑imposition of conditions on SPP’s.
However, in the shorter term, while at a whole of government level no jurisdiction will be financially worse off, the Territory will need to be vigilant that this undertaking is fully met.  A large part of the more difficult and detailed work has yet to be done.
The ACT will also need to be diligent as the framework, by itself, does not overcome vertical fiscal imbalance or obviate a requirement for the comprehensive application of the horizontal fiscal equalisation principle, which ensures that the national wealth is distributed in a fair and equitable manner.
The ACT will also need to seek a fair share of the new National Partnership Payments incorporated as part of the new framework (new money), recognising that while most may be targeted at need, good outcomes and current investments should also be rewarded.
Stage 4 Water Restrictions
Stage 4 Water Restrictions, which effectively stop all outdoor water use, will be needed if the ACT’s water storage levels fall below a determined minimum level, currently set at around 30 per cent of capacity.  Due to improved dam levels, current forecasts from ACTEW suggest these measures will not become necessary until at least September 2008, and may be avoided entirely for the duration of 2008 provided current Stage 3 restrictions remain effective or the ACT receives further sufficient rainfall. 
Besides the impact on the community from a decrease in economic activity, Stage 4 Water Restrictions would also have a significant impact on the Budget and the opportunity to engage in a number of outdoor activities.  Lower water consumption volumes would reduce ACTEW’s revenue and hence dividend as well as the revenue received by the Government from the Water Abstraction Charge.  
Stage 4 Water Restrictions would also damage a number of Government assets such as sporting fields which would reduce revenue to Government from user charges and incur future expenditure to repair any damage once Stage 4 restrictions were lifted.  However, the Government has made a significant commitment to mitigating these risks, namely through initiatives announced in the current Budget and the 2007‑08 Supplementary Appropriation.  These include drought proofing measures for sports facilities, parks and open spaces, and water demand management schemes, targeted at schools and the wider community.  
The Government announced in October 2007 a suite of initiatives in response to ACTEW’s water security recommendations for the ACT region.  These measures include the enlargement of the Cotter Dam, water transfers from the Murrumbidgee to Googong Dam and the design of a demonstration water purification plant.  The suite of initiatives will help to develop the capacity of the ACT to endure extended dry periods.  However, it will be some years before these initiatives are fully implemented.
Government Investments and Borrowings
Governance, Advisory and Consultancy Arrangements
•	An external Investment Advisory Board is established to provide advice to Treasury on financial investment and borrowing related issues.
•	An independent investment consultant is contracted by Treasury to provide a range of investment advisory services, including portfolio optimisation and strategic asset allocation, fund management and portfolio monitoring.
•	Treasury also uses the services of external risk management advisers to provide assistance with the development of appropriate financial risk management policies and practices, identification of financial exposures, reporting and benchmarking, and performance management in respect of the Territory’s borrowing liabilities.
The established governance, advisory and consultancy arrangements provide the Territory with the ability to implement best practice management of the Territory’s financial assets and liabilities.
Market Risk – Investment Assets and Financial Liabilities
Market risk associated with the management of the Territory’s investment assets and liabilities, including the Territory Banking Account (TBA) investments and the Superannuation Provision Account (SPA), is the risk that the value of an investment will decrease, or the value of a liability increase, due to moves in market forces.  Market risk includes:
•	interest rate risk, which is the risk that the relative value of a security, mainly debt securities, will decrease, or that the value of liabilities will increase, due to an interest rate increase;  
•	currency risk, which is the risk of incurring losses in relation to the value of international assets or liabilities as a result of movements in international exchange rates; and  
•	equity price risk, which is the risk that the valuation of stock market equity securities will decrease.
Interest Rate Risk – Territory Banking Account and Superannuation Provision Account Investments
The Territory’s financial investments include some diversification across the domestic money and capital markets, including cash, short‑term debt instruments (maturity less than twelve months) and fixed interest bonds (maturity greater than twelve months), each of which has its own unique risk/return characteristics.  The diversification between these markets provides some trade‑off between returns and interest rate risk.  Changes in the fair market valuations of investments and interest income, resulting from changes in interest rates, will have a direct impact on the Territory’s net operating balance and balance sheet.
In regard to the TBA and SPA cash investment portfolios, the impact of a 1 per cent variation in the estimated interest rate returns assumed in the Budget estimates for interest revenue is shown in Table B.1.  
Table B.1
Impact of an interest rate change on interest revenue
+/- 1%	2008-09	2009-10	2010-11	2011-12	
	$’000	$’000	$’000	$’000	
TBA 	+/‑ 8,400	+/‑ 8,600	+/‑ 9,000	+/‑ 10,000	
SPA	+/- 2,754	+/‑234	+/‑ 258	+/‑ 282	

In the case of fixed interest investments for both the TBA and SPA, the majority of securities held will have fixed interest payments (coupons) for the life of the security.  Changes in interest rates will therefore not cause material changes to expected interest earnings.  However, interest rate changes will impact on the valuation of debt securities and on the total return achieved.  Although many of these debt securities will be held until maturity, changes in interest rates will impact the total return achieved through the reinvestment of coupon payments over the life of the bond at rates different to what is assumed under a yield to maturity measure.  The market valuation of these securities for accounting and trading purposes will also change over time due to changes in interest rates.  An increase in interest rates will generally lead to a decrease in the valuation of debt securities and vice versa.  The degree of change in the valuation will depend on, amongst other things, the term to maturity and the coupon rate.  
Interest Rate Risk – Territory Borrowings
Total Territory borrowings are accounted for at amortised cost and are typically held to maturity, or repaid on an amortising basis. 
Approximately 50 per cent of Territory borrowings are held on a fixed rate basis, 50 per cent on a floating rate basis.  Presently, the floating rate borrowings are exposed to interest rate movements.  An increase or decrease in market interest rates applicable to the Territory’s floating rate borrowings, above or below the interest rates used in the development of the budget estimates, will have a direct impact on the interest costs of these borrowings.
The impact of a 1 per cent variation in the assumptions used to calculate the interest costs on floating rate borrowings is shown in Table B.2.
Table B.2
Impact of interest rate change on borrowing costs
+/- 1%	2008-09	2009-10	2010-11	2011-12	
	$’000	$’000	$’000	$’000	
Total Borrowings 	+/‑ 1,337	+/‑ 3,927	+/‑ 4,430	+/‑ 4,430	
Currency Risk – Territory Banking Account and Superannuation Provision Account Investments and Territory Borrowings
In relation to Territory borrowings, the Territory does not have any financial borrowings in non‑Australian denominated currency and therefore is not exposed to any currency risk.  The Territory also does not have any significant exposure to currency risk in relation to the purchase of international goods and services.  Likewise, the TBA investment portfolio does not have any foreign currency exposure.
Approximately $841 million (40 per cent) of SPA investments are denominated in foreign currency through the purchase and holding of international equity and fixed interest securities.  Currently, 55 per cent ($460 million) of these investments are fully hedged back to Australian dollars using currency derivatives.  The use of currency hedging mitigates the impact on international asset valuations in Australian dollar terms from the changes in exchange rates.
Without currency hedging, an appreciation of the Australian dollar against foreign currency asset holdings would have an adverse impact on the valuation of the investments in Australian dollar terms.  In relation to unhedged foreign investments, holding a diversified basket of currency investments may also serve to reduce overall currency risk.  
The estimated impact on international asset valuations from a 1 per cent variation in the Australian dollar against all international currency holdings, assuming all other parameters being constant, is shown in Table B.3.
Table B.3
Impact from the movement of the Australian dollar on valuations*
+/- 1%*	2008-09	2009-10	2010-11	2011-12	
	$’000	$’000	$’000	$’000	
SPA	+/‑ 3,813	+/‑ 5,862	+/‑ 6,447	+/‑ 7,050	
* A negative outcome represents an appreciation of the Australian dollar relative to other currencies.
Equity Risk – Territory Banking Account and Superannuation Provision Account Investments
The TBA investment portfolio does not invest in publicly listed equity securities and is not exposed to equity risk.
The SPA will have approximately $1.4 billion invested in domestic and international equity securities during 2008‑09.  Equity markets are inherently volatile and not suitable for short‑term investments.  However, equity investments have proven to be an excellent long‑term investment, if managed prudently.  Over the long term, equity markets can also be a good source of inflation protection, through maintaining and growing asset valuations in real terms.
The equity risk is part of a total investment portfolio strategy for the SPA and a significant level of portfolio exposure to this risk is acceptable and required.  Unintended equity risk can be mitigated through diversification of the number of equity securities held, including maximum allowable exposure to any one security, through broad sector and industry allocations, and broad country allocations.
Table B.4 outlines the impact on the SPA equity portfolio valuation from a 1 per cent variation in equity security valuations.
Table B.4
Impact of a change in equity valuations
+/- 1%	2008-09	2009-10	2010-11	2011-12	
	$’000	$’000	$’000	$’000	
SPA	+/‑ 13,748	+/‑ 17,585	+/‑ 19,341	+/‑ 21,151	
Credit Risk – Territory Banking Account and Superannuation Provision Account Investments
Credit risk, or default risk, is the risk of loss due to a counter-party defaulting on a contract, or more generally the risk of loss due to some ‘credit event’.
The level of credit risk exposure to the Territory’s investment portfolios with allocations to debt securities is managed through limiting allowable investment securities to an investment grade credit rating.  Each individual security held must hold an acceptable short or long-term credit risk rating by either Standard and Poor’s or Moody’s.  The applicable credit ratings are outlined in the investment management guidelines issued under the Financial Management Act 1996 (FMA) and the Territory Superannuation Provision Protection Act 2000.

Defined Benefit Employer Superannuation Liabilities
The level of employer liability associated with defined benefit superannuation schemes is actuarially determined.  This process requires setting a range of demographic and financial assumptions that are fully reviewed every three years (triennial review) and are applied annually to actual staffing membership and salary levels.  Because of the influence these variables have over time, the ultimate cost of a defined benefit plan (final benefits to employees) is uncertain.  This uncertainty is likely to persist over a long period of time.  
Accounting for defined benefit plans is complex because actuarial assumptions are required to measure the obligation, and the expense, and there is a possibility of actuarial gains and losses (these arise when actuarial assumptions are changed or different from actual outcomes).  The obligations are measured on a discounted basis because they may be settled many years after the employees render the related service.
The ACT Government currently has approximately 32,400 members in either the defined benefit Commonwealth Superannuation Scheme (CSS) or the defined benefit Public Superannuation Scheme (PSS).  Of these members, approximately 14,680 are current contributors, 10,200 have preserved their benefits, and 7,500 are current pensioners.  Due to the large number of members in these schemes, small variations to the financial or demographic assumptions can lead to large impacts on individual liability valuations and therefore the total liability estimate for the Territory.  
Sensitivity to Discount Rate
The discount rate is meant to reflect both the estimated average timing of benefit payments and the time value of money.  AASB119 ‘Employee Benefits’ International Financial requires the defined benefit employer superannuation liabilities to be valued, at 30 June each year, using a discount rate equivalent to an Commonwealth Government long-term bond rate (in practice, the annualised ten year Government bond rate).  The discount rate adopted for the annual actuarial reviews has a substantial impact on liability valuations.  Small changes in the discount rate adopted for each review can lead to significant variations in the liability valuations and annual superannuation expenses.  
A 1 per cent variation in the discount rate results in an estimated change to the current liability of approximately $590 million (actuarial gain or loss), resulting in the approximate annual variation estimates of superannuation related expenses (accruing liability) outlined in Table B.5.
Table B.5
Impact of liability valuations on superannuation expense from variation in discount rate
+/- 1%	2008-09	2009-10	2010-11	2011-12	
	$’000	$’000	$’000	$’000	
SPA	+/‑ 49,000	+/‑ 47,000	+/‑ 45,000	+/‑ 43,000	
Sensitivity to Demographic Assumptions
Demographic assumptions incorporated in the reviews by the Actuary are used to provide a better estimate of the current and future liability valuations for the Territory.  The assumptions incorporated include variables such as salary increases from promotions, invalidity, mortality, retirement, resignation, preservation, pension election by PSS members, member contribution levels for the PSS, and spouse assumptions.  Over time these assumptions will change based on actual membership experience and will impact upon future liability valuations.  
Contingent Liabilities
Contingent liabilities are liabilities resulting from uncertain timing or amount.  They arise from past events, which are not recognised because their outflow of economic benefit is not probable or the liability cannot be measured reliably.
Under the FMA, it is the responsibility of the Government to disclose its contingent liabilities as they relate to the presentation of the financial report in accordance with the Australian Equivalents to International Financial Reporting Standards (AASB 137).  This is done by way of a note in the Financial Statements.
Claims lodged against the Territory include property damage, contract disputes, economic loss, personal injury and tax related claims.  Further details of the Territory’s contingent liabilities are provided each year in the Australian Capital Territory Consolidated Annual Financial Statements available at: www.treasury.act.gov.au. 
Insurable Risk
The ACT Insurance Authority (ACTIA) is a statutory authority under the Insurance Authority Act 2005.  The Authority commenced operation on 1 April 2001.
ACTIA manages a fund, which was established to finance the cost of insurable risk for ACT Government agencies, excluding workers’ compensation risks.  The objectives of ACTIA are to:
•	be the insurer of Territory risks;
•	take out insurance of Territory risks with other entities;
•	satisfy or settle claims in relation to Territory risks;
•	with the Treasurer’s approval, to take action for realising, enforcing, assigning or extinguishing rights against third parties arising out of or in relation to its business, including, for example: 
–	taking possession of, dealing with or disposing of, property; or
–	carrying on a third party’s business as a going concern;
•	develop and promote good practices for the management of Territory risks;
•	give advice to the Treasurer about insurance and the management of Territory risks; and
•	administer, under agreement with the Chief Minister’s Department, the Default Insurance Fund.
ACTIA is financed through risk-based levies that reflect the asset holdings and liability risks faced by each agency.  In theory, the levies are set to generate sufficient funds to ensure that ACTIA’s internal funds and its overlying insurances will be able to meet all claims incurred during the current year, even if those claims are not paid until a later year.
Each agency meets the cost of claims below the level of an agreed deductible or excess.  ACTIA purchases insurance to protect the Territory against large claims or losses, or a series of such events, which would threaten the viability of ACTIA’s internal funds.  Because of worldwide insurance events and the bushfires in January 2003, this protection is becoming increasingly difficult and expensive to purchase.  As a result, ACTIA’s self‑insured retentions are being reviewed to ensure an appropriate balance between risk transferred and risk retained.
The Enterprise Wide Risk Management Framework for the ACT Government was launched in early 2004.  This framework and policy gives agencies the direction and tools to identify risk and implement risk management practices across all aspects of their operations and business.  Agencies are continuing to develop and implement their own risk management plans and policies based on the guidelines.
In relation to risks associated with dealings with external organisations, the Government has revised its guidelines under the FMA.  In the case of procurements, the main change is to shift the onus of establishing the insurance risk and level from individual tenderers to the procuring agency.  Centralised procurement provides the opportunity to manage this in a more consistent and cost effective manner.