Water regulator Ofwat has published a “lessons learned report” on its internal budget planning and forecasting process which failed to anticipate the need to seek a significant increase in its 2013-14 budget and budget forecast for 2014-15.

Ofwat said its  Audit Committee, main Board and Executive Team have devoted “significant attention” to learning lessons from the need, mid-way through the financial year, to increase Ofwat’s 2013-14 budget and budget forecast for 2014-15.

The report says Ofwat’s original 2013-14 budget was developed by the Executive Team on the basis of including costs where there was a high degree of probability that they would arise, in the expectation of an amount of additional flexibility to meet risk-based contingencies associated with unspent licence fees accumulated in previous years.

Ofwat’s expectation was that the flexibility would be sufficient to deal with any uncertain costs not covered within the original budget. In the event however, the scale of the increase required – £5.6 million (from £21.5 million to £27.1 million) – exceeded the level of permitted flexibility. The increased budget was needed to address an under-estimate of the organisation’s budget to meet the full delivery costs of the 2014 price review alongside other commitments.

Ofwat subsequently committed last July to review, through both its Audit Committee and Board, how the full resource requirements were not forecast earlier in the budgeting and planning cycle and identify lessons to improve future forecasting and budgeting. The report sets out the findings of the organisation’s review.

The report says that the most significant and immediate cost pressures for 2013-14 related to delivering the 2014 price review, stating:

“In part, the under-estimate reflected a long-term challenge of finalising very significant policy change through the new price setting methodology with a robust delivery plan, approach and costings. Finalising Ofwat’s approach to delivering the price review involved very significant changes in how customers’ prices are set and so involved extensive stakeholder consultation in the first half of 2013. The timing of this process did not align with the budgetary cycle, meaning that the total costs of delivering the new methodology were not fully understood at the time the 2013-14 budget had to be set.”

The shortfall for 2013-14 was bridged through a combination of a special licence fee of £3.2 million, and drawing down an additional £2.4 million - the value of the permitted flexibility associated with accumulated unspent licence fees from previous years. For 2014-15, a licence modification has now been agreed with the sector which has the effect of increasing the licence fee cap using the provisions of section 13 of the Water Industry Act 1991.

Ofwat said that publication of the report reflects “the commitment of the organisation to learn lessons from the issues which emerged, and to be transparent in sharing both the lessons learned and the actions taken as a result of the events set out in this report.”

However, the scope of the report is limited to the corporate budget setting process for 2013-14. The wider lessons to be learned from the price review, including its process, programme and outcomes, will only be considered once the 2014 price review has concluded.

Multiple causes included skills shortages, financial culture, control and accountability

The lessons learned exercise concluded that:

• while the usual business planning and forecasting processes had been followed, they had not worked effectively in forecasting the implementation costs of the 2014 price review; and
• there were multiple causes of the issues, which centred on programme management, information, skills shortages, and financial culture, control and accountability.

Ofwat said that a detailed action plan has been developed to address the root causes which the review had identified, with significant progress already made on implementing its recommendations.

In February 2013, Ofwat’s Board approved a £21.5 million budget for 2013-14 which included £5.6 million for external consultancy and legal support. However, the report says that “while the normal processes had been followed, they clearly failed to work effectively.”

From February 2013 an internal debate then centred around the desirability of using a Delivery Partner to support the implementation phase of the price review by providing advice, analysis and assurance. The report says that by April 2013 it was clear that there were "serious budget pressures" and by May the full Board had discussed a proposal that a Delivery Partner should be used. A tendering process for a Delivery Partner began in June 2013, with bids received in July 2013.

This culminated in August with the appointment of consultancy PwC as Delivery Partner following negotiations with Delivery Partner bidders and parallel negotiations with the Treasury.

Ofwat now needs “ a strong, capable and empowered finance function”

Among the measures required to improve future forecasting and budgeting, the Report says:

“The organisation will need better programme and project management approaches for all significant pieces of work …….Risk management techniques and practices will need to be applied more consistently and the alignment between budgeting and programme management improved. Finally, the organisation will need a strong, capable and empowered finance function to provide horizontal challenge and scrutiny across projects.”

The report is also highly critical of what is described as Ofwat’s focus on policy at the expense of effective implementation planning, saying that “this reflects wider cultural issues, including staff training, effective leadership and capacity, particularly the absence of sufficient, experienced programme management capacity below the Executive Team.”

Skills shortages a key issue

On skills shortages, the report says that shortages of the necessary skills and capacity, both within the price review and wider organisation, contributed to the planning and forecasting difficulties. In particular, although the price review project had a clearly defined ‘Programme Director’ role, at the time this was filled by an interim working on a part-time basis, which focused predominantly on delivering the methodology against a continuously difficult timetable.

Compounded by wider skills gaps which already existed within Ofwat, this led to a lack of sufficient capacity both to deliver the complexity of the methodology and plan the next 18-24 months of the programme. The report states:

“While the existence of the organisation’s skills gap was acknowledged, the reality is that the problem was never adequately resolved.”

“Consequently, a number of specialist interim contractors filled these gaps, which led to a mix of internal and external resources which we would not have chosen for this key project.”

 On financial management, the report flags up insufficient clarity and lack of accountability for each budget line, compounded by poor links between the Finance Team and key programmes. This meant that forecasting, monitoring and budget discussions did not take place in a sufficiently timely manner to identify and address the key risks.

To address the problems, the report has set out recommendations and action plan which “build on rapid operational changes in Ofwat’s financial and risk management.”

“Slick processes” to be in place for recruitment

On the skills issues, which played a key part in the failures, the report says:

“To address problems with recruitment of suitably skilled staff, we will implement separate actions within Ofwat’s People Plan to develop a co-ordinated and robust approach to resourcing in ‘professional services’ style, including improving our approach to staff and non-core recruitment, ensuring that we have slick processes that enable us to respond quickly and recruit effectively.”

Click here to read the report in full