Reserve Disclosures... The Good, The Bad & The Missing

BY ROBERT W. BROWNING, PCAM, RS

Sure it’s only summer, but it is never too early to start thinking about reserve studies and California reserve disclosure requirements. With only one small change in the law relating to reserves and reserve studies for 2010 (we’ll get into that below,) this is a good time to take a breath, catch up, and ensure we have a proper understanding of what California reserve disclosure requirements’ include, and what may be missing from your annual budget and disclosure packet.

The implementation of the California Assessment and Reserve Funding Disclosure Summary approximately five years ago created a new two page disclosure. It is commonly referred to as the “Laird” form for Assemblyman John Laird who carried the legislation on behalf of the California Association of Realtors.

The good news is the Laird form has provided a level of consistency for conveying information from the association to its members about the association’s reserve funding status. The bad news is, some folks think the Laird form is all that is needed to provide reserve funding information from the association to its members.

Now to the missing! The Laird form’s addition to the annual budget packet did not remove the obligation to disseminate disclosures that were in the Davis-Stirling Act prior to the Laird form’s existence. To add to the confusion, there is an overlap between the Laird form’s contents and those pre-existing disclosures in Section 1365. Unfortunately there is not enough overlap in the two statutory disclosure areas in the Davis-Stirling Act to allow the association to only provide the Laird form in the annual budget packet.

The “Laird” form has seven statements disclosing many items including, but not limited to, the current regular assessment, a statement of any actual or proposed special assessments, a sufficient reserve balance expression and finally a display of fully funded balance data over the next five years. The intention of this article is not to explain the Laird form in detail, but to talk about the disclosures that have been in the Davis-Stirling Act for many years and how they must augment the Laird form, not supplant it.

As mentioned above, there was one change to the Laird form beginning in 2010. There is now a requirement to include the reserve study’s projected assumed long-term, before tax, interest rate earned on reserves and the assumed long-term inflation rate. This new statement is at the bottom of the Laird form.

The Laird form presents many items that are important to understanding the financial health of an association’s reserves. But there are many items that need to be disclosed regarding the association’s reserves and reserve study and they are not on the Laird form. If the Laird form is the only disclosure being provided to the members in the overall budget packet, the packet is missing several key requirements of the Davis-Stirling Act, specifically Civil Code Section 1365.

Section 1365 for many years prior to the implementation of the Laird form required the following items be disclosed:

The current estimated replacement cost, estimated remaining life, and estimated useful life of each major component. This is the main item missing from many associations annual budget packets. Make sure your reserve analyst is providing this in a format for inclusion in the annual packet.
As of the end of the fiscal year for which the study is prepared: (i) The current estimate of the amount of cash reserves necessary to repair, replace, restore, or maintain the major components. (ii) The current amount of accumulated cash reserves actually set aside to repair, replace, restore, or maintain the major components. The percentage that the amount determined for purposes of clause (ii) equals the amount determined for purposes of clause (i). This is one of those overlapping areas with the Laird form as the calculation above is really a percent funded calculation similar to the tables in the Laird form. Be careful here as this disclosure must be in boldface type per Section 1365.
The current deficiency in reserve funding, expressed on a per unit basis, must be disclosed. See Civil Code 1365 for the formula. Although the Laird form overlaps this disclosure in a general sense, the Laird form does not mandate the amount be broken down by unit.
A statement regarding the board of director’s decision to defer the repair or replacement of major components along with the justification for the deferral.
A statement detailing if a special assessment will be needed, pursuant to the funding plan adopted by the board of directors. This is also an overlap area with the Laird form because the Laird form has a table for displaying adopted and needed special assessments.
If the association has any outstanding loans, for any purpose, with an original term greater than one year, a statement must be included in the budget packet. This is a newer disclosure, yet it is not on the Laird form so if the association has a loan as described above, there must be a statement identifying: payee, interest rate, amount outstanding, annual payment, and loan retirement date.
The mechanism or mechanisms by which the board of directors will fund reserves to repair or replace the major components including assessments, borrowing, use of other assets, deferral, etc. Oftentimes the reserve study will (should) have this statement, but it may not make it to the member disclosures.
A general statement addressing the procedures used for the calculation and establishment of the reserves to defray the future repair, replacement or additions to those major components that the association is obligated to maintain. Again as above, this is a standard reserve study statement the board of directors will see, yet in many cases this does not make it into the member disclosures.
The reserve funding plan adopted by the board of directors including a statement that the full reserve study is available upon request to any association member. This is the full 30 year, reserve funding plan as presented by the reserve analyst and adopted by the board of directors in an open meeting of the board of directors. This is usually a one-page report and is easy to insert in the budget packet. The Laird form discloses (overlaps) the first 6 years of data from this funding plan, however the full plan must be included in the annual budget packet.

The California Legislature did an interesting thing in 2009. They codified the term “Annual Update of Reserve Study,” in the new Disclosure Documents Index. See Section 1363.005 This index, which displays all of the disclosures in the annual budget packet, is not mandatory for associations to use. An association is only required to use this index at the request of a member, for the member.

The Davis-Stirling Act does not have a requirement for a yearly update to the reserve study, despite the language in the new index. However, the Laird form can only be executed properly AFTER the update of the reserve study is completed as the information for the Laird form flows directly from the reserve study. Oftentimes a client will call the reserve analyst asking for a cost to update the Laird form not realizing that this form is dependent on a current reserve study. The reserve study update can be an update without a site visit if the association is not yet due for a three-year site visit study.

Be sure to seek the advice of legal counsel if there is any question as to what should be included in the yearly budget packet. There are many reasons why an association may need to revise or augment the reserve or budget disclosures based on special circumstances. In addition, if the association has received funds from a compensatory damage award or settlement related to design or construction defects, there are specialized disclosures needed in the annual budget packet that are best left to legal counsel.

In addition, there are many more disclosures and miscellaneous items that are in the yearly budget packet mailing. This article has only focused on those items related to reserves, that might be missing if only the Laird form is disseminated. There are a myriad of disclosures related to insurance, rules, operating budget, collections, etc. The new Disclosure Documents Index alone has 14 entries.

Budget season is right around the corner. Be sure the disclosures you receive from your reserve study professional include all of the items in Section 1365 AND the Laird form, Section 1365.2.5. If the only disclosure document you receive with the reserve study is the Laird form, the disclosure packet may be missing important information.

Annual Budget Packet Reserves and Reserve Study Disclosure Checklist

California Assessment and Reserve Funding Disclosure Summary (Laird form)
Major component summary including current replacement cost, useful life and remaining life (bold type)
Percent funded as of the end of the year for which the study was prepared (bold type)
Current deficiency in reserve funding, expressed per unit (bold type)
A statement explaining if there are deferrals of major component work along with the justification
Special assessment declaration
Loan disclosure if applicable
The mechanism by which reserves will be funded
Statement detailing procedures used for calculation and establishment of reserves
Reserve Funding Plan Summary with a statement that the full reserve study is available to any member

Robert W. Browning, PCAM, RS is the owner of the Browning Reserve Group. He has served on the Board of Trustees of CAI and is a past President of CAI’s Foundation for Community Association Research.

This article may be reproduced with permission of the Browning Reserve Group. Does your association need an article for their newsletter? Maybe we can help. Give us a call at (877) 708-0600 Toll Free. This article appeared in ‘the communicator’, a publication of Community Associations Institute Bay Area/Central California Chapter Volume 3 – Issue 3 – Summer 2010.