Are your Reserves Adequate?

By: Robert M. Nordlund, P.E.

How much Reserves are Adequate? Each association requires a different amount of cash in Reserves to perform the anticipated Reserve projects on time without requiring outside assistance (special assessments or loans). In addition to the difference in association types and ages, when one also considers the difference between Reserve plans and reality, measuring Reserves adequacy has the reputation of being a shot in the dark. But an association's risk of having adequate Reserves can be measured. The problem in the past has been using the wrong kind of ruler to make the measurement!

Winston Churchill said "Saving is a very fine thing, especially if your parents have done it for you!" But how much "savings" does it take to provide an adequate level of comfort? A Reserve cash balance that is adequate for one association is not necessarily adequate for another association. But if an association's actual Reserves on hand are compared to its current Reserve requirements, a relative measuring scale called Percent Funded is established. Just as we find clothes which "fit" us based on our own particular measurements, this relative measuring scale allows us to measure how well an association's Reserve fund "fits", and meets, its Reserve needs.

Large associations with many common area amenities in need of replacement have high Reserve requirements. The opposite is true: newly constructed small associations with only a few common area amenities have small Reserve require-ments. You can translate this information into numbers by multiplying the current cost of each component by its fraction of life "used up". The result of this computation for all Reserve compo-nents is summed for an association total, called the Fully Funded Balance. Note that this relative Reserve Fund size measurement is totally independent from any Funding Plan method (Cash Flow, Straight Line, etc.).

Using this relative measurement scale on thousands of our Reserve Study clients, it was clear to see that among associations with relatively little in Reserves, the incidence of inadequate Reserves is very high. We also found the opposite to be true: among associations with a relatively substantial Reserve Fund, inadequate Reserves are rare. By using this relative measuring scale, Reserves adequacy can be measured.

For example: by looking at Table 1 you can note that if an association is 0% - 10% "Funded", there is approximately a 50% chance that the associa-tion will have inadequate cash to perform its anticipated Reserve projects during the year. You can see why we consider a Reserve Fund in the 0% - 30% range "weak", and over 70% as "strong". Note that it is not necessary to have a Reserve balance equivalent to the calculated Fully Funded Balance (100% Funded) to effectively eliminate the risk of inadequate Reserves. Reserves "adequacy" seems to occur at or above the 50% point, where the association's exposure to inadequate Reserves has been effectively minimized.

An ancient Chinese proverb states: "Forecasting is difficult, especially about the future." Every Reserve Plan is destined to be inaccurate, since future events are out of our control and never occur exactly as planned. Table 1 is evidence that associations that have a weak (but positive) Reserve cash balance often find their Reserves inadequate in spite of their good intentions. Designing for a relatively strong Reserve Fund provides a margin for protection when Reserve expenses are higher than expected or earlier than expected.