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HomeMy WebLinkAbout12 - Revision of Council Policy F-2CITY OF NEWPORT BEACH CITY COUNCIL STAFF REPORT Agenda Item No. 12 November 12, 2008 TO: HONORABLE MAYOR AND MEMBERS OF THE CITY COUNCIL FROM: Administrative Services Department Dennis C. Danner, Administrative Services Director (949) 644 -3123 or ddanner(a-city.newport- beach.ca.us Dan Matusiewicz, Finance Officer (949) 644 -3126 or dmatusiewicz(a)-city.newport- beach.ca.us SUBJECT: Revision of Council Policy F -2 - Reserves /Designations of Fund Balance ISSUE: Should the City Council approve staff recommended changes to Council Policy F -2, Reserves /Designations of Fund Balance, that have been reviewed and approved by the City Council Finance Committee? RECOMMENDATION: Approve recommended changes to Council Policy F -2 - Reserves /Designations of Fund Balance. DISCUSSION: The City Council Finance Committee previously requested a review of the City's Internal Service Funding policies, primarily with a view toward establishing and maintaining optimal target balances in the City Council's Reserve /Designation Policy Statement (F -2). To that end, there have been numerous analytical reports, presentations, and discussions during Finance Committee meetings, as well as working sessions with staff and Council Member Henn. As a result of the analysis and discussions, staff has now incorporated several policy refinements which we believe will further strengthen the City's financial position and credit worthiness. The proposed policy before you today represents the net sum of all policy discussions and revisions including the final recommendations made at the September 30, 2008 Finance Committee meeting. Council Policy F -2 November 12, 2008 Page 2 Although the primary focus of the analysis was geared towards Internal Service Funds, F -2 addresses reserves and designations in other funds as well, so a few changes outside the Internal Service Funds section have also been incorporated. Attached is the proposed new F -2 Policy incorporating both staff and Finance Committee recommendations. Since revisions were too extensive to permit the use of the usual strike - out/underline format to identify changes, a summary and brief discussion of the changes is set forth below. The current policy is still available on the City's website. Alternatively, we will provide paper copies as requested. I. Internal Service Funds Internal Service Funds are contained in Section F of the Policy. It begins on page 11 and continues to page 16. The major changes are summarized below. A. E ui ment Maintenance Fund Annual Contributions: Vehicle maintenance rates under the current and proposed policy are charged to departments by vehicle type. Rates are set to simply cover the annual operating costs associated with personnel, parts and equipment used in maintaining the City fleet. The proposed policy remains unchanged. Target Reserve Balance: Since there is virtually no deferred cash flow associated with vehicle maintenance, the target reserve balance is zero in both the current and proposed policy. B. Equipment Replacement Fund Annual Contributions: This is also budgeted as a rate charged to departments by vehicle type. Under the current policy, the annual contribution is essentially based on the estimated equipment replacement value, with some flexibility to adapt to changes in equipment needs, longer than anticipated equipment life /use, expected regulatory changes and other variables. The proposed policy differs only in that it is more specific with regard to replacement value. Target Reserve Balance: In practice, there is no target reserve balance in the current policy. It sets rates at a level to accumulate 100% of the depleted value of each vehicle on an historical cost basis. The proposed policy establishes a target balance reserve at 50% of accumulated depreciation calculated on a replacement value basis. By way of comparison, a recent calculation equated this value to approximately 75% of accumulated depreciation on a historical cost basis. Council Policy F -2 November 12, 2008 Page 3 Discussion: The secondary purpose of this particular Internal Service Fund is to act as a reserve for vehicle replacement. Its primary purpose is to level out annual cash requirements for budgeting purposes. Over the long run, the annual contributions are set to accumulate the proper amount to replace each vehicle. However, the portion of the fleet that is due for replacement varies significantly from year to year. Therefore, the fund balance moves up and down each year, much like a shock absorber. This is what it is intended to do. C. Insurance Reserve Fund Annual Contributions: Under the current policy, both the Workers' Compensation and General Liability contribution rates generally represent a flat charge to departments based on previous experience factors. Over the years, the rates have been increased during the budget process based on a combination of actuarial recommendations and cash balances relative to estimated liabilities. In the proposed policy, annual contribution rates are targeted to achieve a 75% confidence level (CL) that accumulated resources will be sufficient to pay future cash flows associated with the current and past operating period claims. Target Reserve Balance: Under the current policy, the targeted reserve balances achieve less than a 25% CL that accumulated resources are sufficient to pay future claims. As indicated above, the City would target to accumulate sufficient resources to achieve a 75% CL under the proposed policy. Discussion: Based on an August 2008 survey of 10 cities included in the April 3, 2008 "Risk Financing Analysis" report, Newport Beach's current funding level is substantially below the average of the cities surveyed. Excluding Newport Beach and the high and low respondents, the average target funding level approximates 79 %. A "Best Practices" approach may make it difficult to defend our current funding level practice to potential creditors and rating agencies. D. Compensated Absences Fund Annual Contributions: Under the current and proposed policy, annual contributions are estimated to cover the average annual cash flow plus a margin intended to cover possible variations in annual cash flows. Target Reserve Balance: Under the current policy, target reserve balances were not identified. Under the proposed policy, the minimum balance is targeted at the average annual cash flow plus the maximum annual deviation from the average during a three year term. The maximum balance in this reserve is 50% of the outstanding liability balance. Council Policy F -2 November 12, 2008 Page 4 Discussion: For budgeting purposes, it is important for the target balance of this fund to be set as a range, rather than a specific number, in order to minimize the frequency of departmental rate changes. II. Collective Impact on Total Funding Set Aside for this Purpose The proposed changes in the Internal Service Fund structure impact both the required balance and the ongoing contribution practices. The table below shows the current status of various segments of the funds from both perspectives. Following that is a recommended implementation strategy. Fiscal Impact of Recommended Policy Change 2007 -08 Balance Reserve Reserve Balance Per Balance Balance Policy Rule Surplus (Shortfall) 2008 -09 Contributions PER Internal Policy Rule Premiums Annual Per Budget Contribution Shortfall Worker's Compensation 9,628,474 12,773,000 (3,144,526) 4,550,000 3,199,422 (1,350,578) General Liability 3,540,021 6,313,525 (2,773,504) 4,309,000 3,328,698 (980,302) Total Insurance Reserve 13,168,495 19,086,525 (5,918,030) 8,859,000 6,528,120 (2,330,880) Compensated Absences Equipment Fund TOTAL 2,149,896 2,095,305 (54,591) 2,095,305 2,265,457 170,152 11,826,599 10,395,809 1,430,790 3,896,969 3,896,969 - 27,144,990 31,577,639 (4,541,831) 14,851,274 12,690,546 (2,160,728) One -time Reserve Balance Adjustment Annual Contribution Shortfall III. Implementation Strategy A. Current Fund Balance Surplus /Shortage 1) One possible source for the shortage identified in the table above would be to transfer the bulk of the existing $5 million PIERS reserve to substantially Council Policy F -2 November 12, 2008 Page 5 reach the 75% CL target funding goal for workers' compensation and general liability. However, since CalPERS has experienced substantial losses in the equities market in 2008, another alternative is to fully fund the target shortfall from current operating surpluses. 2) Since there are significant heavy equipment changes being considered related to compressed natural gas vehicles, staff recommends leaving the surplus equipment reserve balance in place for the time being until the heavy equipment replacements are further defined. B. Ongoing Contribution Rates There are a number of budget variables currently unfolding associated with current economic instability, but we will begin the 2009 -10 budget preparation cycle with a view toward adjusting the workers' compensation and general liability contribution rates to generate funds at the levels indicated in the table. IV. Changes in Other Sections of F -2 Other than format and descriptive modifications, other policy changes include: • Modifications to the CIP Reserve to incorporate references to the Facilities Financing Plan. • Termination of the former Senior Citizen Site reserve which was replaced by a cooperative agreement with the Friends of the Oasis signed May 10, 2005. • Addition of a Cable Franchise reserve to memorialize the restricted purpose of funds received in connection with the latest Cable Franchise agreement. • No changes to the Water Reserves at this time due to significant modifications being developed by the Utilities Department. Anticipated incorporation of these changes into a subsequent revision of F -2 is expected within the next year. • Formal documentation of the City's commitment to funding the Annual Required Contribution for the City's Pension & OPEB obligations. ENVIRONMENTAL REVIEW: The City Council's approval of this agenda item does not require environmental review. Council Policy F -2 November 12, 2008 Page 6 PUBLIC NOTICE: The agenda item has been noticed according to the Brown Act (72 hours in advance of the meeting at which the City Council considers the item). FUNDING AVAILABILITY: Current operating surpluses could fund the proposed policy changes or Council could choose to reallocate funds from existing Council designated reserves. ALTERNATIVES: The City Council could choose not to adopt the policy recommendations and no further action would be required or the City Council could provide alternative policy changes for further consideration. Prepared by: an Matusiewicz Finance Officer Attachments: Proposed Policy F -2 Submitted by: Dennis C. Danner Administrative Services Director RESERVES/ DESIGNATIONS OF FUND BALANCE PURPOSE F -2 (Proposed) To establish City Council policy for the administration of financial reserves and fund balances. DISCUSSION A. Background. Prudent financial management dictates that some portion of the funds available to the City be reserved for future use. Future uses are categorized as either strategic savings programs for pre - planned projects or funds set aside for unforeseen financial emergencies. These are Discretionary Reserves. In addition, some funds are maintained in reserve for non - discretionary purposes. "Non- Discretionary' means that some external entity is requiring that the funds be set aside for a specific purpose, and the City has little or no discretion to use the funds in any other way. Examples are funds still on hand but already contractually encumbered; or funding provided specifically for a certain project. (For clarification, the City also has a number of Special Revenue Funds. These Funds are similar to reserves in that they act as a repository for money that can only be used for specific purposes.) B. Structure and Funding of Reserves. This Policy establishes Reserve Accounts or designated Fund Balance levels for moneys being held in reserve. In addition, the sources and eventual uses of Reserve Funds are set forth. It is the policy of the City Council that reserves are to be funded at the levels specified herein as part of the annual budget process. If operational or other considerations require the City Council to temporarily override this policy during any fiscal year, the City Manager will recommend to the City Council a plan to restore any Reserves falling below required minimum levels. Reserve levels will be restored as soon as practical. Each of the City's fiscal reserves is established and maintained for one of four purposes listed in general order of importance below. If the reserve requirements of this policy are unmet in any fiscal year, the City Manager will recommend funding prioritization to the City Council as part of the Budget. 1 F -2 (Proposed) C. Use of Reserves. The City Council decides whether to appropriate funds from Reserve Accounts. Even though a project or other expenditure qualifies as a proper use of Reserves, the Council may decide that it is more beneficial to use current year operating funds or bond proceeds instead, thereby retaining the Reserve Funds for future use. Reserve Funds will not be spent for any function other than the specific purpose of the Reserve Account from which they are drawn without specific direction in the annual budget resolution; or by a separate City Council resolution approving that specific action. Information regarding Annual Budget Adoption and Administration is contained in City Council Policy F -3. D. Categories of Reserves. 1. Accounting Reserves (Non Discretionary). Generally accepted governmental accounting practices require identification of generic reserve funds for certain purposes. These accounts represent the unspendable portions of fund balance, such as inventories and long -term receivables, as well as funds that are legally restricted by some external source, such as debt service reserves and encumbrances. Reserving funds for a contract awarded in one year but not completed until a succeeding year is one example of an accounting reserve for encumbrance. 2. Contingency Reserves. Contingency Reserves represent funds for unexpected financial emergencies. One example requiring the use of this Reserve is the adverse impact of natural disasters such as earthquake or flooding on revenue availability, as well as increased demand for City services. Other examples are unexpected loss or reduction of a key revenue source; special projects, programs, or price changes mandated by another government entity; and emergency capital projects needed to deal with unforeseen structural failure. 3. Designated Reserves (Strategic Savings). These Reserves are designated for known or anticipated events. Such events require large, non - recurring financial outlay, such as the replacement of systems and equipment or major capital improvements. 4. Stabilization Reserves. Stabilization Reserves enhance the orderly management of the Operating Budget by stabilizing revenues and expenditures, which fluctuate beyond the ability of City staff to control or predict. Some examples are changing prices for utilities and fuel, market 2 F -2 (Proposed) value adjustment for investment earnings, and volatility in certain special program funding. In the General Fund, these Reserves will normally be established for specific purposes when significant fluctuations to the normal trend in a particular revenue or expenditure are projected. FUNCTION AND ADMINISTRATION OF RESERVE ACCOUNTS Reserves are identified below by fund, category and specific function. The specific numbers of accounts where these Reserves are physically located change from time to time as the overall account structure is updated and modified. However, the Fund Balance Statement, which is available for ready reference in the City's Annual Budget document, identifies balances, past -year activity, and projected current year activity for each of these Reserves. A. General Fund. 1. Accounting. Reserves. a. Reserve for Inventories. The value of inventories purchased by the City but not yet issued to the operating Departments is reflected in this account. b. Reserve for Debt Service. Funds are placed in this Reserve at the time debt is issued. The provisions governing the Reserve are established in the Bond Indenture, and the Reserve itself is controlled by the Trustee. C. Reserve for Long Term Receivables. This Reserve is used to identify and segregate that portion of the City's financial assets which are not due to be received for an extended period, so are not available for appropriation during the budget year. d. Reserve for Encumbrances. This Reserve accommodates spending for contracts or other items, which are legally committed but not yet expended by fiscal year end. e. Reserve for Prepaid Assets. This reserve represents resources that have been paid to another entity in advance of the accounting period in which the resource is deducted from fund balance. A common example is an insurance premium, which is typically 3 F -2 (Proposed) payable in advance of the coverage period. Although prepaid assets have yet to be deducted from fund balance, they are no longer available for appropriation. 2. Contingency Reserve. This Reserve has a target balance of not less than twelve percent (12 %) of annual General Fund expenditures. Funds in this reserve cannot be used without the specific authorization of City Council. 3. Designated Reserves. a. Capital Improvement. In conjunction with the City's master Facilities Replacement Plan, a sinking fund has been established to amortize the cost of critical City facilities such as, but not limited to, City Hall and Police Department buildings, Fire Stations, and Library Branches. The master Facilities Replacement Plan establishes a level charge to the General Fund that will perpetually replenish the cash flows necessary to finance the construction of critical City facilities. This plan will be updated annually as part of the budget process, or as conditions change. b. Senior Citizen Site. This Reserve was established and funded by former Council Policy B -5, which specified that ten percent (10 %) of revenue collected from rental of facilities at the Oasis Center be set aside for equipment replacement and /or refurbishment at the Center. This policy was replaced by a Cooperative Agreement with the Friends of OASIS on May 10, 2005 (Contract # C- 3772). This agreement constituted a significant change from the formal City Council policy. No new funds are being added to this reserve at this time. Funds in the reserve are available for appropriation by the City Council. C. Off Street Parkine. Newport Beach Municipal Code 12.44.025 establishes this Reserve and governs its administration. Fifty percent (50 %) of parking meter revenue collected in designated areas is set aside for acquisition, development, and improvement of off street parking facilities within those areas. m F -2 (Proposed) d. Paramedic Program (Hoag). This Reserve was established by the City in conjunction with debt issuance agreements with Hoag Hospital. In addition to the original amount(s) deposited to this reserve, effective July 1, 2000, any excess revenues generated by this program, after accounting for General City Overhead of fifteen percent (15 %), shall be deposited to this reserve account for future paramedic related purposes. Funds in this reserve account may be used for any paramedic related purpose as directed by the City Council. e. Recreational Instruction Reserve. City Council Policy B -2 establishes reserves for the refurbishment of certain recreational facilities and equipment used in connection with fee -based recreation classes. The Policy requires twenty percent (20 %) of gross annual revenues derived from specified recreational classes be set aside. f. In Lieu Parking Reserve. This Reserve is established by NBMC 12.44.125. The City requires commercial businesses to provide adequate off- street parking. In some cases where this is not possible, businesses are afforded the opportunity to pay an annual fee and use parking spaces in a municipal lot, providing such a lot is located within specified proximity to the business. In establishing this practice, it was the City Council's intention to accumulate the proceeds of these fees for use in providing additional parking. This Reserve is the repository for these fees. g. Park In Lieu Reserve. This Reserve was established by NBMC 19.52. The City requires dedication of land or payment of fees for park or recreational purposes in conjunction with residential development. When fees are paid, the funds are placed in this Reserve. Specific guidance regarding use of the funds is contained in 19.52.030 and 19.52.070. h. Neighborhood Enhancement Reserve A. This Reserve was established by NBMC 12.44.027, which directs that Revenues from parking meters in Zone 9 shall be apportioned to this Reserve. Funds in the Reserve will then be used for the purpose of enhancing and supplementing services to the West Newport area. 61 F -2 (Proposed) Both the nature of the supplemental services and the definition of the area served are set forth in the Code Section above. i. Neighborhood Enhancement Reserve B. This Reserve is almost the same as Reserve A above. The difference is that this Reserve pertains to the Balboa Peninsula, and it specifies that fifty percent (50 %) of the parking meter revenue will be apportioned to the Reserve. Specific details are contained in the Code Section. j. Oceanfront Encroachment Reserve. In the early 1990's, it was discovered by survey that improvements to several ocean front parcels were encroaching onto the public beach. The encroachment was relatively minor. The negotiated solution was for the property owners to pay a permit fee each year to the City. Revenue thus generated may only be used for ocean front restoration projects and incidental costs of improvements and maintenance to enhance public access and use of ocean beaches as approved by the City Council. This Reserve is the repository for those funds. City Council Policy L -12 contains additional background and details about the encroachment issue. k. Affordable Housing. A principal provision of the Newport Beach Housing Element requires developers to provide housing units for lower income households, the number of which is to be negotiated for each development project. In lieu of constructing affordable housing, developers have paid into this reserve which is used at the City Council's discretion to provide alternate methods for the delivery of affordable housing for lower income households. 1. Cable Franchise. Pursuant to the provisions of the Newport Beach Municipal Code, Title 5, Business Licenses & Regulations, Chapter 5.44, in return for the use of the City's streets and public ways for the purpose of installing, operating, maintaining, or reconstructing a cable system to provide cable service, fees are collected by the City from cable providers. Those fees are to be used by the City for support of Public, Education, and Government access programming. M. Other Designated Reserves. The Administrative Services Director may add additional designated reserves as required. This will I. F -2 (Proposed) normally be done in response to new programs or policies established by the City Council or another government entity providing funds to the City. Examples are the Oil Spill Recovery Reserve and the Public Library Fund Reserve. 4. Stabilization Reserves. a. Appropriations Reserves. This is a temporary repository for funds not yet fully appropriated in the annual budget. It is normally used during the budget process to set aside funds for known or strongly anticipated expenses that will need to be addressed by budget amendment during the budget year. Sometimes the dollar amount and /or appropriate account breakdown for such expenses cannot be specifically identified at the time the budget is adopted, even though the funds will be needed. In such cases, the funds will normally be budgeted to the Reserve for Appropriations. b. Change in Fair Market Value of Investments. As dictated by GASB 31, the City is required to record investments at their fair value (market value). This accounting practice is necessary to insure that the City's investment assets are shown at their true value on the balance sheet. However, in a fluctuating interest rate environment, this practice records market value gains or losses which may never be actually realized. In any case, it causes the gains or losses to be recorded well ahead of actual cash flows. Therefore, although actual cash investment earnings may be relatively stable, investment income recorded on the City's books will often be artificially volatile. From a budgeting standpoint, actual cash investment earnings should be considered as available for the annual budgeting process, whereas market value fluctuations should not. Therefore in order to mitigate any such adverse budgetary impact, the City records two Stabilization Reserves related to Market Value fluctuation: Reserve for Prior Year Unrealized Market Value Gains: This is a known value that will be reserved annually during the City's closing process since the early recognition of investment earnings will reduce the investment earnings potential in the new year. (Target Balance = to Prior Year MV Gain) 7 F -2 (Proposed) Reserve for Potential Current Year Market Fluctuation: This is a defensive reserve that may be utilized to avail resources during the next budgeting cycle if interest rates rise sharply relative to the investment portfolio's current stated return. (Target should be 2% of General Fund's position in total Investment portfolio). C. PERS Rate Reserve. This Special Subdivision of the Stabilization Reserve has been established for the specific purpose of helping to smooth out (for internal budgeting purposes) the year -to -year fluctuations in PERS rates. PERS rates have been one of the most volatile and unstable elements on the expense side of the City's annual budget process. The long -term goal is to budget the normal cost of PERS rates, setting aside the extra money in this Reserve when actual rates are below that level. Conversely, when actual rates are above that level, funds from this Reserve can be drawn upon. B. Tide and Submerged Land Fund. Within this Special Revenue Fund, special Designated Reserves have been created. 1. Upper Newport Bay Restoration Reserve. This reserve is the repository for funds mandated by SB573, as well as special fees charged to permit holders as an alternative to meeting certain specified mitigation criteria. In addition to the mitigation fees, 10% of Beacon Bay lease revenue is placed in this Reserve. Funds in the Reserve are designated for Upper Newport Bay restoration projects. 2. Oil and Gas Designated Reserve. This designation was established by the City with the intent to build a reserve that will provide funding to abandon wells and facilities as they go out of service. Annually, $40,000 will be set aside from the oil and gas field production revenues to fund this reserve. C. Permanent Endowment Fund (Robinson Skinner Annuity) for Newport Bay Dredging. Similar to the above Fund, there is a Designated Reserve within this special purpose Fund. In general, the endowment specifies that the principal amount will not be depleted, but that investment earnings may be used for dredging projects in Newport Bay. 8 F -2 (Proposed) D. Water Fund. [Revision pending] (City Council Policy L -20 contains additional information concerning budgeting and rate setting within the Water Fund.) 1. Accounting Reserves. The same four Accounting Reserves identified in the General Fund will also be used in the Water Fund. 2. Contingency Reserve. _Water System Reserve. This Reserve is used for emergency repair to the water system. The target level for this Reserve is thirty -five percent (35 %) of the annual budget for operations. 3. Designated Reserves. Future Water Infrastructure Reserve. This Reserve is used for large designated projects that are part of the water distribution system. System replacement/ upgrade and most improvement/ major maintenance projects are funded within that amount. However, certain large -scale projects are projected on a ten -year horizon, which is updated and refined each year. The purpose of this Reserve is to set aside partial funding for those projects in advance. Included as part of the City Manager's annual budget proposal will be a plan to fund this Reserve at a level of not more than one hundred percent (100 %) of the projected cost of planned projects by the year in which contract award is anticipated. Projected future costs notwithstanding, a minimum of ten percent (10 %) of the annual budget for operations will be set aside to this reserve each year. The City Council must approve the ultimate fund transfer from this Reserve to a designated Water Enterprise Fund Capital Project Account as part of the Budget process. No new funds will be added to Designated Reserves unless Contingency and Stabilization Reserves are fully funded. 4. Stabilization Reserve. Water Rate Stabilization Reserve. This Reserve is used for water rate or fee stabilization to offset large expenditures changes such as water 0 F -2 (Proposed) purchase, energy or treatment costs. The intent of the Reserve is to provide funds to offset cost increases that are projected to be short - lived, thereby partially eliminating the volatility in annual rate adjustments. It is not intended to offset ongoing, long -term pricing structure changes. The target level of this reserve is twenty -five percent (25 %) of the annual budget for operations. Funds will be set aside only if target Contingency Reserve level is met. The City Council must approve use of these funds, based on City Manager recommendation. See also City Council Policy Lr20. Change in Fair Market Value of Investments. This Reserve will be used in the Water Fund in the same manner it is used in the General Fund. E. Wastewater Fund. [Revision pending] 1. Accounting Reserves. The same four Accounting Reserves identified in the General Fund will also be used in the Wastewater Fund. 2. Contingency Reserve. Wastewater System Reserve. This Reserve is used for emergency repair to the Wastewater system. The target level for this Reserve is seventy percent (70 %) of the annual budget for operations. 3. Designated Reserve. Future Wastewater Infrastructure Reserve. This Reserve is used for large designated projects that are part of the City's Wastewater system. Funds are reserved for large -scale future projects, which cannot be accommodated within the annual budget of the year in which they are planned. In the years prior to estimated contract award, the City Manager's budget proposal will include a plan to set money aside in this Reserve sufficient to accumulate not more than one hundred percent (100 %) of the projected cost of such projects. Projected future costs notwithstanding, a minimum of ten percent (10 %) of the annual budget for operations will be set aside to this reserve each year. The City Council must approve the ultimate fund transfer from this Reserve to a designated Wastewater Enterprise Fund Capital Project Account as part of the Budget process. 10 F -2 (Proposed) 4. Stabilization Reserve. Wastewater Rate Stabilization Reserve. This Reserve is used for wastewater rate or fee stabilization to offset large expenditure changes such as energy or operational costs. The intent of the Reserve is to provide funds to offset cost increases that are projected to be short - lived, thereby partially eliminating the volatility in annual rate adjustments. It is not intended to offset ongoing, long -term pricing structure changes. The target level of this reserve is twenty -five percent (25 %) of the annual budget for operations. Funds will be set aside only if target Contingency Reserve level is met. The City Council must approve use of these funds, based on City Manager recommendation. Change in Fair Market Value of Investments. This Reserve will be used in the Wastewater Fund in the same manner it is used in the General Fund. F. Internal Service Funds. 1. Background. Internal Service Funds are used to centrally manage and account for specific program activity in a centralized cost center. Their revenue generally comes from internal charges to departmental operating budgets rather than direct appropriations. They have several functions. - -They work well in normalizing departmental budgeting for programs that have life - cycles greater than one year, thereby facilitating level budgeting for expenditures that will, by their nature, be erratic from year to year. This also facilitates easier identification of long term trends. - -They act as a strategic savings plan for long -term assets and liabilities. —From an analytical standpoint, they enable appropriate distribution of city -wide costs to individual departments, thereby more readily establishing true costs of various operations. 11 F -2 (Proposed) Since departmental charges to the internal service fund duplicate the ultimate expenditure from the internal service fund, they are eliminated when consolidating entity -wide totals. The measurement criteria, cash flow patterns, funding horizon and acceptable funding levels are unique to each program being funded. Policy regarding target balance and /or contribution policy, gain /loss amortization assumption, source data, and governance for each of the City's Internal Service Funds is set forth as follows: 2. Equipment Maintenance Fund and Equipment Revlacement Fund. The Equipment Maintenance and Replacement Fund receives operating money from the Departments to provide equipment maintenance and to fund the regular replacement of major pieces of equipment (mostly rolling stock) at their economic obsolescence. a. Equipment Maintenance Fund. The Equipment Maintenance Fund acts solely as a cost allocation center (vs. a pre - funding center) and is funded on a pay -as- you -go basis by departmental maintenance charges by vehicle type and usage requirement. Because of this limited function, the target year -end balance is zero. Contribution rates (Departmental charges) are set to include the direct costs associated with maintaining the City Fleet, including fleet maintenance employee salary and benefits, operating expenses and maintenance related capital outlay. Administrative overhead and maintenance facility improvements and replacement costs are to be provided outside of this cost unit. Because of the limited purpose of this fund, a gain / loss assumption is not needed. Source data is ongoing city fleet inventory and maintenance cost information. 12 F -2 (Proposed) Governance is achieved through annual management adjustment of contribution rates on the basis of maintenance cost by vehicle and distribution of costs based on fleet use by department. b. Equipment Replacement Fund. Operating Departments are charged annual amounts sufficient to accumulate funds for the replacement of rolling stock in accordance with Council Policy F -9, City Vehicle/ Equipment Replacement Guidelines. The City Manager approves annual rate adjustments as part of the budget preparation process. These adjustments are based on pricing, future replacement schedules, and other variables. The age and needs of the equipment fleet vary from year to year. Therefore the year -end fund balance will fluctuate in direct correlation to accumulated depreciation. In general, it will increase in the years preceding the scheduled replacement of relatively large percentage of the fleet, on a dollar value basis. However, rising vehicle costs, dissimilar future needs, replacing vehicles faster than their expected life or maintaining vehicles longer than their expected life all contribute to variation from the projected schedule. In light of the above, the target funding level is not established in terms of a flat dollar figure or even a percentage of the overall value of the fleet. It is established at 50% of the current accumulated deprecation value of the fleet, calculated on a replacement value basis. This will be reconciled annually as part of the year -end close out process by Administrative Services. If departmental replacement charges for each vehicle prove to be excessive or insufficient with regard to this target funding level, new rates established during the next budget cycle will be adjusted with a view toward bringing the balance back to the target level over a three year period. 3. Insurance Reserve Funds. The Insurance Reserve funds account for the activities of general liability and claims workers' compensation. 13 F -2 (Proposed) a. Background. The City employs an actuary to estimate the liabilities associated with the general liability and workers compensation activities. The costs typically associated with these programs include: claims administration, legal defense, insurance premiums, self insured retention and the establishment of appropriate loss reserves including "incurred- but -not reported" (IBNR) claims. In a prescribed measurement methodology, the Actuary estimates the liabilities in conformity with Generally Accepted Accounting Principles (GAAP). The Actuary refers to this measurement level in his report as the "Expected Level ". However, because actuarial estimates are subject to significant uncertainties, actuaries typically recommend that a target funding level be set at an amount in excess of expected liability as a margin to cover contingencies. A typical target funding level would be set to obtain a specified confidence level (the percent chance that resources set -aside will be sufficient to cover existing claims). Full funding of the Actuary's "Target Funding Level" establishes an 75% confidence there will be sufficient resources (including projected interest) to pay the full amount of existing claims without future contributions. Funding at the "Expected Level' produces a confidence level of only 50 % -65 %. b. Policy & Practice. The City should target funding of its risk management obligations at not less than the Expected Level, described above; and not more than an amount sufficient to establish an 75% Confidence Level. Actuarial losses should be recovered over a rolling 3 year basis while actuarial gains should be amortized over a rolling 5 year basis. As part of the operating budget, each department will be charged a rate equal to its proportionate share of the total "revenue" required to fund the Insurance Reserve Fund at this level. W! F -2 (Proposed) To lessen the impact of short -term annual rate change fluctuation, City management may implement one -time fund transfers (rather than department rate increases) when funding shortfalls appear to be due to unusually sharp and non - recurring factors. Excess reserves in other areas may be transferred to the internal service fund in these instances but such transfers should not exceed the funding necessary to reach an 75% confidence level interval. The City Council will be informed of any such transfer action. 4. Compensated Absences Fund. a. Background. The primary purpose of flex leave, vacation leave, and sick leave is to provide compensated time off as appropriate and approved. However, under certain circumstances, typically at separation from service, some employees have the option of receiving cash -out payments for some accumulated leave balances. The Compensated Absences Fund is utilized primarily as a budget smoothing technique for any such leave bank liquidations. The primary purpose of the Compensated Absences Fund is to maintain a balance sufficient to facilitate this smoothing. b. Policy and Practice. The contribution rate will be set to cover estimated annual cash flows based on a three year trailing average plus a margin to provide sufficient resources to fund high cash flow years, as further described below. The minimum cash reserve should not fall below that three year average, plus the maximum annual variance. The maximum cash reserve should not exceed 50% of the long term liability. The target cash reserve shall be the median difference between the minimum and maximum figures. Each department will make contributions to the Compensated Absences Fund through its operating budget as a specified percentage of salary. The Administrative Service Director will review and recommend adjustments to the percentage of salary 15 F -2 (Proposed) required during the annual budget development process. This percentage will be set so as to maintain the reserve within the parameters established above. In addition, if the cash reserve falls below the target floor, the Administrative Services Director may implement a one time cash infusion. This action is appropriate when the decline in cash balance is precipitated by an off -trend non - recurring event. If the size of the infusion is greater than $500,000, the City Council will be advised. G. Post Retirement Funding Policies. 1. Pension Funding. a. California Public Employees Retirement System CaIPERS). The City's principal Defined Benefit Pension program is provided through contract with CaIPERS. The City's contributions to the plan include a fixed employer paid member contribution and an actuarially determined employer contribution that fluctuates each year based on an annual actuarial plan valuation. This variable rate employer contribution includes the normal cost of providing the contracted benefits plus or minus an amortization of plan changes and net actuarial gains and losses since the last valuation period. It is the City's policy to make contributions to the plan equaling at least 100% of the actuarially required contribution (annual pension cost). Because the City pays the entire actuarially required contribution each year, by definition, its net pension obligation at the end of each year is $0. Any unfunded actuarial liability (UAL) is amortized and paid in accordance the actuary's funding recommendations. b. Laborer's International Union of North America ( LIUNA). The City provides funds to support a supplemental pension plan for some employee associations through contract with LIUNA. This is funded at a fixed percentage of total compensation on a pay - as- you -go basis. The City is not contractually required to guarantee the level of the ultimate LIUNA benefit to retirees, nor does it do 16 F -2 (Proposed) so. Therefore the City's liability for this program is full funded each year. 2. Other Post Employment Benefits (OPEB Funding). a. Background. The City's OPEB funding obligations consists of two retiree medical plans. New Plan. Effective January 2006, the City and its employee associations agreed to major changes to the Post Employment Healthcare Plan. New employees and all current employees participate in a program that requires certain defined employee and employer contributions while the employee is in active service. However, once the contributions have been made to the employee's account, the City has no further funding obligation to the plan. Old Plan. Eligible employees who retired prior to the "New Plan` and certain active employees were eligible to continue to receive post- retirement medical benefits (a defined benefit plan). The cost was divided among the City, current employees, and retirees. In the past, this program was largely funded on a pay -as- you -go basis, so there was a significant unfunded liability. Recognizing this problem, the City began contributing to this obligation in 2001. In 2008, these assets were placed in a pre - funding trust. The City's intention is to amortize the remaining unfunded liability within 20 years. b. Policy & Practice. New Plan. Consistent with agreements between the City and Employee Associations, the new defined contribution plan will be 100% funded, on an ongoing basis, as part of the annual budget process. Funds to cover this expenditure will be contained within the salary section of each department's annual operating budget. Old Plan. The City's policy is to pre fund the explicit (cash subsidy) portion of the Actuarial Accrued Liability (AAL) of the remnants of the old plan over a 20 -year amortization period, or 17 F -2 (Proposed) less. This amount will be based on the Annual Required Contribution (ARC) determined by a biennial actuarial review; subject to review and analysis by the City. The annual target reserve balance will be established and maintained through this process. City policy is to not separately fund any actuarially defined liability for "implied subsidy" because the City will not incur an additional cash flow with this premise, outside of active employee salary and benefits. However, the City plans to meet all other contributions connected with this retiree benefit as defined by GASB 45. Costs of administering this program will be contained within the Human Resources Department's annual operating budget. Adopted - January 24,1994 Amended - April 10, 1995 Amended - April 27,1998 Amended - March 14, 2000 Amended - May 8, 2001 Amended - April 23, 2002 Amended - April 13, 2004 Amended - November 12, 2008 (Proposed) UZI