Adequate Reserves - (Finally!) Defined
Many, if not most Governing Documents require the Board to set aside “adequate Reserves” to care for the common areas. But what exactly are “adequate Reserves”?
I was recently challenged to define the concept of adequate Reserves by a number of attorneys and D&O carriers. The attorneys wanted to know how to give liability exposure counsel to Boards to help them avoid claims of "inadequate Reserves". The D&O carriers wish to understand what is and isn’t responsible behavior, as it affects their loss exposure from claims levied by disgruntled homeowners.
So I enlisted a number of Reserve Study providers from other esteemed Reserve Study firms across the country (among them Mitch Frumkin from Kipcon, John Poehlmann and Ted Salgado from Reserve Advisors, Peter Miller from Miller Dodson Associates, and Bob Browning from Browning Reserve Group) to join me in crafting a long-needed definition. It is not yet endorsed by any governing body, but I’m excited to share our results with you:
"Adequate Replacement Reserves” is defined as a Replacement Reserve Fund and stable and equitable multi-yr Funding Plan that together provide for the timely execution of the association's major repair and replacement expenses as defined by National Reserve Study Standards, without reliance on additional supplemental funding.”
This definition combines two concepts: the size of the Reserve Fund (measured by cash or Percent Funded), and a responsible multi-yr Funding Plan. It takes both for an association to claim they have adequate Reserves. A small Reserve fund which requires crippling high Reserve contributions may pencil out as “cash positive”, but one would not describe their situation as “adequate”. On the other hand, an impressively large Reserve fund in an association that is recklessly making inadequate contributions is also not “adequate”, as such a Reserve fund will soon require supplemental funds in the form of a loan or special assessment. In addition, our expectation is that the component expenses will be all reasonably foreseeable projects that meet the standard National Reserve Study Standards four-part test, not just a few carefully selected components in the next X years, or a short list of required components that barely meets a local statutory requirement.
So “adequacy” is not defined as a particular cash balance, Percent Funded, Funding Methodology, or Funding Goal. Adequacy it also is not defined by the type (or date!) of your most recent Reserve Study update. So I present to you the above definition of “Adequate Reserves”. Now Boards and industry professionals know what that means!