California City City Council
July 8, 2025

City of California City | Budget Book 2026
Name Account ID FY2022 YTD Actual FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget Total Expenditures: $1,224,635 $1,293,281 $1,313,297 $1,133,662 $1,180,800

City of California City | Budget Book 2026
Airport Fund
Summary
The City of California City is projecting $39.4K of revenue in FY2026, which represents a 50.3% decrease over the prior year. Budgeted expenditures are projected to increase by 22.4% or $33K to $180.6K in FY2026. $800K
$600K
$400K
$200K
Actual Revenue Source
Budgeted Revenue Source
Actual Expenditures
Budgeted Expenditures
Over Budget Expenditures
$0
FY2022 FY2023 FY2024 FY2025 FY2026

City of California City | Budget Book 2026
Revenues by Source
Projected 2026 Revenues by Source
Miscellaneous Revenues (22.8%)
Operating Revenue (51.8%)
Intergovernmental (25.4%)
Budgeted and Historical 2026 Revenues by Source
$0.5
$0.4
$0.3
$0.2
Grant Revenues
Miscellaneous Revenues
Intergovernmental
Operating Revenue
$0.1
$0
Name Account ID FY2022 YTD Actual FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget Revenue Source
Intergovernmental
FAA Grant 53-3319 $0 $0 $20,000 $0 $0
CAAP State Grant 53-3345 $10,000 $10,000 $10,000 $10,000 $10,000 Total Intergovernmental: $10,000 $10,000 $30,000 $10,000 $10,000 Millions

City of California City | Budget Book 2026
Name Account ID FY2022 YTD Actual FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget Miscellaneous Revenues
Miscellaneous Revenue 53-3691 $0 $0 $1,249 $9,000 $9,000 Total Miscellaneous Revenues: $0 $0 $1,249 $9,000 $9,000 Operating Revenue
Aviation Fuel 53-3781 $25,005 $10,977 $3,280 $3,300 $0
Jet Fuel 53-3782 $79,388 $54,040 $14,753 $14,800 $0
Tie Down Fees 53-3784 $2,155 $1,980 $440 $500 $300
T-Hangar Rent 53-3785 $25,798 $65,999 $31,113 $22,500 $1,500 Office Rent 53-3787 $2,400 $2,400 $2,400 $2,400 $2,400
Land/Property Lease 53-3791 $68,959 $17,283 $16,644 $16,700 $16,200 Total Operating Revenue: $203,705 $152,679 $68,631 $60,200 $20,400 Grant Revenues
FAA Striping Project 93-3437 $169,387 $0 $0 $0 $0
Total Grant Revenues: $169,387 $0 $0 $0 $0
Total Revenue Source: $383,091 $162,679 $99,880 $79,200 $39,400 Expenditures by Function
Budgeted and Historical Expenditures by Function
$0.8
$0.6
$0.4
Airport Capital Projects
Airport
$0.2
$0
Name Account ID FY2022 YTD Actual FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget Expenditures
Airport
Personnel Services
Regular Salaries 53-5310-110 $32,969 $30,479 $6,571 $0 $0 Millions

City of California City | Budget Book 2026
Name Account ID FY2022 YTD Actual FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget Straight Overtime 53-5310-111 $122 $0 $0 $0 $0
Premium Overtime 53-5310-112 $1,466 $3,183 $0 $0 $0
Cash-In-Lieu 53-5310-128 $6 $0 $0 $0 $0
Medicare 53-5310-132 $544 $572 $348 $0 $0
Cafeteria Plan 53-5310-133 $5,700 $9,375 $2,375 $0 $0
Retirement 53-5310-134 $35,968 -$30,667 -$41,553 $0 $0
Unemployment Ins 53-5310-135 $136 $279 $119 $0 $0
Worker's Comp 53-5310-136 $7,424 $9,501 $7,871 $0 $0
PERS Unfunded Liability 53-5310-137 $23,931 $16,752 $31,385 $0 $0 Uniforms 53-5310-140 $225 $247 $257 $0 $0
Vacation/Sick Buy Back 53-5310-150 $804 $1,260 $6,017 $0 $0 Total Personnel Services: $109,296 $40,981 $13,390 $0 $0 Operations and Maintenance
Subscr/Books/Dues 53-5310-210 $0 $0 $0 $0 $400
Office Supplies 53-5310-241 $16 $0 $100 $200 $0
Postage and Shipping 53-5310-245 $0 $0 $0 $100 $0
Other/Office Equipment 53-5310-250 $0 $0 $64 $0 $0
Fuel Island Testing Maintenane 53-5310-252 $9,190 $9,953 $1,434 $1,500 $1,200 Veh Operation/Maint 53-5310-254 $437 $4 $156 $0 $0
RSI Fuel 53-5310-255 $2,250 $133 $0 $0 $0
Hand Tools 53-5310-257 $0 $0 $5 $0 $0
Bldg Operation/Maint 53-5310-270 $1,760 $9,049 $3,694 $3,000 $0 Electricity 53-5310-281 $10,943 $12,651 $11,549 $19,000 $17,000 Gas 53-5310-282 $859 $3,225 $1,242 $300 $400
Telephone - Cell 53-5310-283 $604 $0 $0 $0 $0
Telephone - Land 53-5310-284 $4,730 $6,236 $8,091 $3,200 $12,000 Communications Maint 53-5310-286 $1,342 $440 $556 $600 $600 Water Service 53-5310-287 $2,760 $2,760 $2,760 $4,000 $3,200 Sewer Services 53-5310-288 $412 $23 $3 $100 $100
Professional Services 53-5310-310 $2,497 $2,693 $544 $60,000 $120,000 Legal Services 53-5310-311 $2,648 $0 $0 $500 $0
Engineering 53-5310-315 $3,510 $4,180 $0 $0 $10,000
Armory/Safety Equip & Supplies 53-5310-451 $200 $475 $264 $0 $0 Liability Insurance - PARSAC 53-5310-510 $27,803 $32,346 $51,710 $46,200 $11,000 Licenses & Permits 53-5310-610 $781 $3,548 $3,181 $3,200 $3,200 Jet Fuel 53-5310-611 $58,618 $41,526 $10,863 $3,700 $0
Aviation Fuel 53-5310-612 $21,188 $38,990 $0 $0 $0
Contracts 53-5310-630 $1,916 $20,704 $8,140 $2,000 $1,500 Transfers Expenses In 53-5310-903 $1,369 $0 $0 $0 $0
Operating Transfers In 53-5310-905 $0 $0 -$93,768 $0 $0 Total Operations and Maintenance: $155,832 $188,937 $10,588 $147,600 $180,600 Capital Outlay

City of California City | Budget Book 2026
Name Account ID FY2022 YTD Actual FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget Depreciation Expense 53-5310-700 $288,941 $280,877 $255,269 $0 $0 LightsandAirportSignageImp 53-5310-735 $0 $0 $1,910 $0 $0 Total Capital Outlay: $288,941 $280,877 $257,179 $0 $0
Total Airport: $554,069 $510,794 $281,157 $147,600 $180,600 Airport Capital Projects
Capital Outlay
Striping Project 93-7020-736 $171,097 $1,763 $0 $0 $0
Total Capital Outlay: $171,097 $1,763 $0 $0 $0
Total Airport Capital Projects: $171,097 $1,763 $0 $0 $0 Total Expenditures: $725,166 $512,558 $281,157 $147,600 $180,600

City of California City | Budget Book 2026
DAR Fund
Summary
The City of California City is projecting $413.31K of revenue in FY2026, which represents a 69.1% decrease over the prior year.

Budgeted expenditures are projected to increase by 3.8% or $11.84K to $319.55K in FY2026. $1.5M
$1.25M
$1M
$750K
$500K
$250K
Actual Revenue Source
Budgeted Revenue Source
Actual Expenditures
Budgeted Expenditures
Over Budget Expenditures
$0
FY2022 FY2023 FY2024 FY2025 FY2026

City of California City | Budget Book 2026
Operating Revenue (0.02%)
Revenues by Source
Projected 2026 Revenues by Source
Intergovernmental (100%)
Budgeted and Historical 2026 Revenues by Source
$1.5
$1.25
$1
$0.75
Operating Revenue
Intergovernmental
$0.5
$0.25
$0
Name Account ID FY2022 YTD Actual FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget Revenue Source
Intergovernmental
Article 4 Funds (LTF) 54-3359 $0 $230 $23,840 $0 $0
Section 5311 Operating 54-3363 $51,237 $67,274 $129,638 $196,500 $81,114 Transit Article 6.5 54-3364 $138,356 $149,529 $100,134 $1,100,000 $275,000 Low Carbon Transit Op.Program 54-3370 $14,771 $0 $0 $39,800 $57,100 Millions

City of California City | Budget Book 2026
Name Account ID FY2022 YTD Actual FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget Total Intergovernmental: $204,364 $217,033 $253,612 $1,336,300 $413,214 Operating Revenue
Fares Income 54-3751 $1,061 $11,157 $9,939 $600 $0
Miscellaneous Revenue 54-3766 $6 $912 $162 $0 $100
Total Operating Revenue: $1,067 $12,069 $10,101 $600 $100 Total Revenue Source: $205,431 $229,102 $263,714 $1,336,900 $413,314

City of California City | Budget Book 2026
Expenditures by Function
Budgeted and Historical Expenditures by Function
$0.35
$0.3
$0.25
$0.2
$0.15 Dial-A-Ride
$0.1
$0.05
$0
Name Account ID FY2022 YTD Actual FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget Expenditures
Dial-A-Ride
Personnel Services
Regular Salaries 54-5410-110 $46,631 $81,691 $112,057 $144,000 $152,700 Premium Overtime 54-5410-112 $16 $1,044 $846 $2,000 $4,500 Temporary/Part Time 54-5410-120 $25,091 $23,800 $16,777 $1,900 $0 Cash-In-Lieu 54-5410-128 $0 $0 $32 $100 $0
Recruiting 54-5410-130 $204 $440 $0 $0 $0
Employment Fees 54-5410-131 $57 $165 $100 $200 $200
Medicare 54-5410-132 $1,412 $1,968 $2,163 $2,200 $2,300 Cafeteria Plan 54-5410-133 $37,895 $55,314 $54,151 $54,000 $54,000 Retirement 54-5410-134 -$131,673 $6,498 $24,289 $11,000 $12,100 Unemployment Ins 54-5410-135 $546 $1,110 $714 $900 $900 Worker's Comp 54-5410-136 $5,045 $5,938 $1,665 $2,500 $850 PERS Unfunded Liability 54-5410-137 $413 $23,744 $92 $500 $200 Uniforms 54-5410-140 $225 $485 $510 $500 $0
Vacation/Sick Buy Back 54-5410-150 $3,278 $507 $0 $200 $0 COVID-19 54-5410-170 $0 $912 $0 $0 $0
Total Personnel Services: -$10,860 $203,616 $213,397 $220,000 $227,750 Operations and Maintenance
Subscr/Books/Dues 54-5410-210 $56 $76 $0 $100 $100
Travel/Lodging/Reg 54-5410-230 $0 $139 $1,422 $4,400 $5,000 Millions

City of California City | Budget Book 2026
Name Account ID FY2022 YTD Actual FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget Office Supplies 54-5410-241 $264 $770 $716 $600 $600
Other/Office Equipment 54-5410-250 $839 $988 $0 $0 $0
Veh Operation/Maint 54-5410-254 $2,131 $4,659 $4,976 $5,000 $5,000 RSI Fuel 54-5410-255 $19,540 $17,031 $20,699 $28,000 $32,000 Bldg Operation/Maint 54-5410-270 $484 $2,340 $910 $1,500 $2,200 Telephone - Cell 54-5410-283 $594 $0 $0 $0 $0
Telephone - Land 54-5410-284 $715 $4,478 $726 $1,600 $1,600 Professional Services 54-5410-310 $0 $0 $4,095 $500 $1,000 Legal Services 54-5410-311 $2 $0 $0 $0 $0
Special Depart Supp 54-5410-450 $0 $98 $0 $0 $0
Armory/Safety Equip & Supplies 54-5410-451 $0 $985 $960 $1,000 $1,000 Liability Insurance 54-5410-510 $5,760 $5,974 $0 $0 $0
Licenses & Permits 54-5410-610 $189 $0 $125 $300 $300
Other Contracts 54-5410-630 $180 $3,936 -$2,816 $900 $1,000 Transfers Expenses In 54-5410-903 $38,272 $36,212 $39,943 $43,815 $42,000 Total Operations and Maintenance: $69,026 $77,686 $71,756 $87,715 $91,800 Capital Outlay
Depreciation Expense 54-5410-700 $36,645 $36,645 $36,645 $0 $0 Total Capital Outlay: $36,645 $36,645 $36,645 $0 $0
Total Dial-A-Ride: $94,811 $317,947 $321,798 $307,715 $319,550 Total Expenditures: $94,811 $317,947 $321,798 $307,715 $319,550

City of California City | Budget Book 2026
Capital Funds
Summary
The City of California City is projecting $99K of revenue in FY2026, which represents a 78.8% decrease over the prior year. Budgeted expenditures are projected to decrease by 94.3% or $361.3K to $21.7K in FY2026. $500K
$400K
$300K
$200K
$100K
Actual Revenue Source
Budgeted Revenue Source
Actual Expenditures
Budgeted Expenditures
$0
FY2023 FY2024 FY2025 FY2026
Revenues by Source
Name Account ID FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget Revenue Source
Miscellaneous Proceeds
EV Charging Station - Aspen Ml 97-3994 $0 $90,659 $99,000 $99,000 CDBG - Balsitis Park 97-3996 $0 $34,972 $369,000 $0
Total Miscellaneous Proceeds: $0 $125,631 $468,000 $99,000 Total Revenue Source: $0 $125,631 $468,000 $99,000
Expenditures by Function
Name Account ID FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget Expenditures
Capital
Capital Outlay
CDBG - Balsitis Park 97-7001-753 $410 $14,507 $355,000 $0 Total Capital Outlay: $410 $14,507 $355,000 $0
Debt Service
EV Charging Station - Aspen Ml 97-7002-800 $49,605 $54,212 $28,000 $21,700

City of California City | Budget Book 2026
Name Account ID FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget Total Debt Service: $49,605 $54,212 $28,000 $21,700
Total Capital: $50,015 $68,720 $383,000 $21,700
Total Expenditures: $50,015 $68,720 $383,000 $21,700

FY25-26 Proposed Budget - Summary Funds
Name FY2026 Proposed Name FY2026 Proposed Fund
Budget Revenues Budget Expenses Gain/(Loss)
General Government
General Fund 10,106,700
General Government
General Fund 11,018,000
GF Transfer to TDS for Services 298,700
GF Transfer to Airport for Services 141,200
Total General Government: 10,106,700 Total General Government: 11,457,900 (1,351,200) Special Revenue Funds Special Revenue Funds
OHV Grants 1,853,150 OHV Grants 1,374,750 478,400
OHV Permit ProgramFund
PS Police Services (Moved to GF)
PS Fire Services (Moved to GF)
Supplemental Law (COPS)
167,300
-
-
183,000
OHV Permit ProgramFund
PS Police Services (Moved to GF)
PS Fire Services (Moved to GF)
Supplemental Law (COPS)
157,800
-
-
183,000
9,500
-
-
-
Public Safety (1/2 Cent Sales)
AB 109 Fund
Prop 64 Cannabis Enforcement
270,000
-
455,000
Public Safety (1/2 Cent Sales)
AB 109 Fund
Prop 64 Cannabis Enforcement
270,000
-
455,000
-
-
-
TDS Golf Course 112,100 TDS Golf Course 410,800 (298,700) Restricted Funding 375,000 Restricted Funding 4,312,186 (3,937,186) AMMDA Fund 35,000 AMMDA Fund 31,250 3,750
SDI Fund - SDI Fund 32,800 (32,800)
Successor Agency Trust Fund - Successor Agency 25,000 (25,000) Housing Corporation Fund
RDA Successor Agency
Street Fund
516,000
-
2,394,200
Housing Corporation Fund
RDA Successor Agency
Street Fund
485,100
-
132,700
30,900
-
2,261,500
Street Capital Projects Fund 4,880,100 Street Capital Projects Fund 4,217,900 662,200 Total Special Revenue Funds: 11,240,850 Total Special Revenue Funds: 12,088,286 (847,436) Enterprise Funds Enterprise Funds
Water Fund 4,390,000 Water Fund 4,288,000 102,000
Sewer Fund 1,169,000 Sewer Fund 1,168,500 500
Airport Fund 39,400 Airport Fund 180,600 (141,200)
Dial-A-Ride Fund
Airport Capital Projects Fund
Water Capital Improvements
413,314
-
3,298,000
Dial-A-Ride Fund
Airport Capital Projects Fund
Water Capital Improvements
320,300
-
2,907,000
93,014
-
391,000
Total Enterprise Funds: 9,309,714 Total Enterprise Funds: 8,864,400 445,314 Capital Funds
General Fund Capital Projects 99,000
Capital Funds
General Fund Capital Projects 21,700 77,300
Total Capital Funds: 99,000 Total Capital Funds: 21,700 77,300 Total AllFunds: 30,756,264 Total AllFunds: 32,432,286 (1,676,022)

FY25-26 Proposed Budget
Name
General Government
- Summary Fund Revenues
FY2022 YTD Actual FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget General Fund 7,866,150 7,654,676 8,642,131 11,117,800 10,106,700 Total General Government: 7,866,150 7,654,676 8,642,131 11,117,800 10,106,700 Special Revenue Funds
OHV Grants 37,787 16,409 1,095,194 1,744,500 1,853,150
OHV Permit Program Fund 165,887 144,973 151,445 178,900 167,300 Measure L 1,226 5,492 1,703 - -
PS Police Services (Moved to GF 25-26) 3,799,671 3,454,485 3,316,452 1,032,900 - PS Fire Services (Moved to GF 25-26) 3,783,411 3,774,861 3,305,036 4,473,100 - Supplemental Law (COPS) 161,285 165,271 194,159 150,000 183,000 Public Safety (1/2 Cent Sales) 220,307 268,971 270,427 270,000 270,000 AB 109 Fund 1,558 1,610 2,724 - -
Prop 64 Cannabis Enforcement - - 272,838 564,844 455,000 TDS Golf Course 174,243 145,426 137,349 137,100 112,100 Restricted Funding 3,440,281 185,279 141,965 3,058,500 375,000 AMMDA Fund 42,298 44,327 31,738 32,300 35,000
SDI Fund (5,130,884) (543,968) 3,037,892 - -
Housing Corporation Fund 714,071 498,949 478,925 508,800 516,000 Successor Agency Trust Fund - - - - -
RDA Successor Agency 1,040,766 1,029,658 889,487 - -
Street Fund 631,764 910,964 1,290,342 4,759,200 2,394,200 Street Capital Projects Fund 132,060 446,674 2,995,601 2,400,100 4,880,100 Total Special Revenue Funds: 9,215,731 10,549,381 17,613,277 19,310,244 11,240,850 Enterprise Funds
Water Fund 4,399,642 4,140,021 3,795,803 4,138,000 4,390,000 Sewer Fund 1,722,624 1,668,426 1,528,233 962,000 1,169,000 Airport Fund 213,705 162,679 99,880 79,200 39,400
Dial-A-Ride Fund 205,431 229,102 263,714 1,336,900 413,314 Airport Capital Projects Fund 169,387 - - - -
Water Capital Improvements 758,792 132,564 1,024,227 600,000 3,298,000 Total Enterprise Funds: 7,469,581 6,332,792 6,711,857 7,116,100 9,309,714 Capital Funds
General Fund Capital Projects - - 125,631 468,000 99,000 Total Capital Funds: - - 125,631 468,000 99,000
Total All Funds: 24,551,462 24,536,849 33,092,896 38,012,144 30,756,264

FY25-26 Proposed Budge
Name
General Government
t - Summary Fund Expe
FY2022 YTD Actual
nses
FY2023 YTD Actual FY2024 YTD Actual FY2025 Adopted Budget FY2026 Proposed Budget Comment General Fund 6,325,411 5,607,029 7,790,260 4,845,850 11,018,000 GF Transfer to TDS for Services 298,700
GF Transfer to Airport for Services 141,200
Total General Government: 6,325,411 5,607,029 7,790,260 4,845,850 11,457,900 Special Revenue Funds
OHV Grants 499,620 600,053 629,036 1,421,550 1,374,750
OHV Permit Program Fund 360,079 160,081 141,580 168,409 157,800 PS Police Services (Moved to GF 25-26) 4,159,880 4,352,587 3,580,180 4,032,610 - PS Fire Services (Moved to GF 25-26) 3,333,115 3,241,399 3,826,873 7,110,805 - Supplemental Law (COPS) 512,850 - 186,159 150,000 183,000 Public Safety (1/2 Cent Sales) 352,361 64,995 263,644 270,000 270,000 AB 109 Fund 106,850 544 8,857 - -
Prop 64 Cannabis Enforcement - - 261,838 555,000 455,000 TDS Golf Course 461,358 449,343 134,118 483,000 410,800 Restricted Funding 43,818 985,279 141,965 6,010,536 4,312,186 AMMDA Fund 30,498 185,264 52,344 31,250 31,250
SDI Fund 19,786 32,971 30,940 32,800 32,800
Successor Agency 22,366 22,940 24,674 32,777 25,000
Housing Corporation Fund 392,371 484,888 422,775 473,165 485,100 RDA Successor Agency 282,955 317,225 292,350 - -
Street Fund 828,532 1,124,888 725,511 483,314 132,700
Street Capital Projects Fund 625,212 685,806 4,285,088 3,393,700 4,217,900 Total Special Revenue Funds: 12,031,651 12,708,263 15,007,932 24,648,916 12,088,286 Enterprise Funds
Water Fund 4,610,278 5,021,215 4,886,441 4,216,632 4,288,000 Sewer Fund 1,224,635 1,293,281 1,313,297 1,133,662 1,168,500 Airport Fund 554,069 510,794 281,157 147,600 180,600
Dial-A-Ride Fund 94,811 317,947 321,798 307,715 320,300 Airport Capital Projects Fund 171,097 1,763 - - -
Water Capital Improvements 18,975 2,706,961 1,175,797 1,000,000 2,907,000 Total Enterprise Funds: 6,673,865 9,851,961 7,978,490 6,805,609 8,864,400 Capital Funds
General Fund Capital Projects - 50,015 68,720 383,000 21,700 Total Capital Funds: - 50,015 68,720 383,000 21,700
Total All Funds: 25,030,927 28,217,268 30,845,402 36,683,375 32,432,286

NB 1

COUNCIL AGENDA ITEM
July 8, 2025
TO: Mayor and City Council
FROM: Christopher Lopez, City Manager
SUBJECT: Discussion and Direction on the Establishment of a Formal Reserves Policy for the City of California City
BACKGROUND/DISCUSSION:

For several years, the City’s uncommitted general fund balance has grown due to lowered expenditures on the general fund side. This excess fund balance has been included on the city’s financial statements as “unassigned fund balance.”
The table below lists the unassigned fund balance for the general fund for the last 10 years:

Fiscal Year Ended General Fund Unassigned Fund
Balance
2015 $ 4,529,453
2016 $ 3,108,555
2017 $ 3,376,890
2018 $ 4,632,343
2019 $ 4,462,752
2020 $ 5,650,100
2021 $ 7,222,310
2022 $ 11,698,275
2023 $ 12,764,938
2024 $ 13,796,765
The numbers reflected in the table below are taken from each of the years’ respective audited financial statements.

With a revenue stabilization policy, or emergency reserves policy in place, this would result in a specifically identifiable line item in the City’s audited financial statements that may commit or

NB 1
restrict the city’s ability to use those specific funds unless approved in a certain manner by the Mayor and City Council. As one example, the screen shot below illustrates this nuance from another agency’s audited financial statements, and the respective detail in the notes of the financial statements:

As shown in the screenshot above, the notes shown later in the document describe and define the specific meaning of the committed fund balance, which is shown on the next page for reference.

NB 1
When comparing to the City of California City, notice the difference:

NB 1
With that said, attached to thisstaff report is a report produced by the Government Finance Officers Association (GFOA) titled “Should We Rethink Reserves? A Multimillion Dollar Question” which may serve as the start of a meaningful policy discussion for the Council. In addition, one approach is also included for background regarding one agency’s practice in identifying its reserve practices.

This staff report is aimed at receiving direction from the Council for a more formal presentation on how the City might establish a formal reserve policy.

RECOMMENDATION:

1. Staff recommendsthat the City Council discuss and provide direction on scheduling a more comprehensive discussion related to an establishment of a formal reserves policy.

ATTACHMENTS:

1. Should We Rethink Reserves

2. A Risk Based Analysis of General Fund Reserve Requirements

SHOULD WE RETHINK
RESERVES?
A Multimillion-DollarQuestion
204 of 266
For more information, visit gfoa.org/rethinking-budgeting

ABOUT THE AUTHORS
▪ Shayne C. Kavanagh, Senior Manager of Research, Government Finance Officers Association (GFOA) ▪ VincentReitano, PhD, AssociateProfessor- School of PublicAffairsand Administration,Western MichiganUniversity ▪ Peter A. Jones, PhD, Associate Professor - Department of Political Science and Public Administration, The University of Alabama atBirmingham

ACKNOWLEDGMENTS
▪ Judith M. Marte, Deputy Superintendent, Operations, Broward County Public Schools ▪ KevinA. Knutson, Assistant County Administrator, Pinellas County - Office ofthe County Administrator ▪ Josh Harwood, Fiscal & Tax Policy Director, METRO
▪ David Allen Hines, Director of Operations, City of Pittston ▪ Ian Tyson, Senior Managing Consultant, PFM Financial Advisors ▪ Katie Sabo, Managing Director, Public Sector Partnership, Aon ▪ Sam Savage, Executive Director, ProbabilityManagement.org ▪ CarolineKousky, Associate Vice Presidentfor Economicsand Policy, Environmental Defense Fund ▪ Christoper Forster, Assistant Town Manager, Townof Bluffton ▪ Timothy Blake, Managing Director, Moody’s Investor Service ▪ Shayne Kavanagh, Senior Research Manager, GFOA
▪ Chris Morrill, Executive Director,GFOA
▪ Mike Mucha, Director, Deputy CEO, RCC Center, GFOA
▪ Katie Ludwig, Director of Resource Development, GFOA
▪ John Fishbein, Senior Program Manager, GFOA
▪ Jake Kowalski, Consultant/Analyst,GFOA
▪ Kyle Wedberg, Senior Manager,GFOA
▪ Chris Williams, Consultant,GFOA

ABOUT GFOA
The Government Finance Officers Association (GFOA)represents over 21,000 public finance officers throughout the UnitedStatesand Canada. GFOA’smission istoadvance excellence in government finance. GFOAviewsitsroleas aresource, educator,facilitator,andadvocateforbothitsmembersandthegovernmentsthey serveandprovides bestpracticeguidance,leadership,professionaldevelopment,resourcesandtools,networkingopportunities,award programs, and advisory services.

ABOUT THE RETHINKING BUDGETING PROJECT
Localgovernmentshavelongreliedon incremental, lineitembudgeting where last year’sbudget becomes next year’sbudget withchangesaroundthemargin. Thoughthisformofbudgetinghasitsadvantagesandcanbeuseful under circumstancesofstability, italsohasimportantdisadvantages. Theprimarydisadvantage isthatit causeslocal governmentsto be slow toadapt to changing conditions. The premise of the “Rethinking Budgeting” initiativeisthat thepublicfinanceprofessionhasanopportunitytoupdatelocalgovernmentbudgetingpracticestotakeadvantage ofnew waysofthinking, new technologies,andtobettermeet thechangingneedsof communities. TheRethinking Budgeting initiative will raise new and interesting ideas like those featured in this paper and will produce guidance forstateandlocalpolicymakersonhow tolocalgovernmentbudgetsystemscanbeadaptedtotoday’sneeds. We hope the ideas presented in this paper will spur conversation about the possibilities for rethinking budgeting. The RethinkingBudgeting initiative is a collaborative effort between the Government Finance Officers Association (GFOA) and International City/County ManagementAssociation (ICMA).

To learn more, visit gfoa.org/rethinking-budgeting.
© 2023 Government Finance Officers Association gfoa.org Page
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SHOULD WE RETHINK RESERVES?
JUMP TO SECTION 1 →
RESERVES VS. FUND BALANCE
“Fund balance” is an accounting term that, generally speaking, describes the difference between assets and liabilities. “Reserves” is a budget and policy term that describes the fungible resources available outside of the budget for use if the resources appropriated inside ofthebudgetareinsufficient. Thereisanoverlapbetween “fundbalance”and“reserves,”but the most important difference is that fund balance covers a broader range of resources. For example,fundbalancecouldincludeprepaidinventoriesorreceivablesfordelinquenttaxes, neither of which is available for current spending.* This paper is focused on the budget and policy role of reserves.

Introduction and How to Use This Paper
The“Best Practices: FundBalanceGuidelinesfortheGeneral Fund”isoneofGFOA’smostoftencited standards.However,GFOA’sconsultingworkwithlocalgovernmentshasrevealedthattherearemany opportunitiesforreserveoptimizationbeyondtheguidanceprovidedin theBest Practices. Thispaper bringswhat wehavelearnedtogetherwithuniversityresearchtodescribenew opportunitiesforlocal governments to get the best value from their reserve strategies.

Tohelpreaders navigatetotheparts ofthispaperthat willbenefitthem most, wehavesummarized each ofthe main sectionsofthispaper. If thesummary ofa section issufficientfor you, weinviteyou to skip the details of thatsection.

Section 1—Why Might We Need to Rethink Reserves?
Wegivefourreasons.First,weliveinanincreasinglyvolatileanduncertainworld.Moreuncertainty givesrisetomorerisk.Reservesareoneofthetoolsusedtomanagerisk,chieflyby“self-insuring” againstcertain risks.Moreriskmeans weneedbetterreservestrategies. Second,thepublichaslower trust in government and experts. This means that governments will face more pressure to justify holdingreservesand willbe lessabletoappealtoclaimsofprofessionalexpertiseasjustification. Third, governmentisbecomingmoreresourceconstrained,whichmeansthatalldollars,includingreserves, must be used with increasing savvy. Fourth, technologymakesit easiertoanalyzereserve strategies andoptimizethestrategy totheconditionsfacedbyeach localgovernment. * The Governmental AccountingStandards Board (GASB) provides guidance on how to classify fund balancestodifferentiatebetween amountsthat are more constrained or less constrained in their potential use. You can read more about these classifications in: “GASB Statement No. 54, Fund balance reporting and governmental fund type definitions,” available at GASB.org. 206 of 266
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JUMP TO SECTION 2 →
JUMP TO SECTION 3 →
SHOULD WE RETHINK RESERVES?
Section 2—How Do We Rethink Reserves?
Westartbychangingourmentalmodel.Amentalmodel isawayofviewingtheworld.Financeofficers can help decision-makers make better decisions by giving them better mental models for public finance.

Thetraditionalmentalmodelforreservesisa“savingsaccount.”Wecontendthatan“insurancepolicy” hasmuchtoofferasanew andcomplementarymentalmodel. Thisconnectsreservesdirectlytotheir role in managing risk and opens up new ways of thinking about reserves.

Section 3—What Actions Can We Take to Rethink Reserves? Theactionsbelow arecriticaltotakingfulladvantageofthepossibilitiesavailablefromthereservesas insurance mental model. The ideas are presented in a rough order of importance.

1. Risk-Based Reserve Analysis. A perennial question in local government finance about reserves is “howmuch isenough?” Thereservesasinsurancemodelwouldsayitdependson what yourrisksare.

We’ll discuss different optionsfor how local governments can take account of their risks.

2. Develop a Comprehensive Reserve Policy. A policy helps the government commit to savvy decisionmaking about reserves by showing why a smart risk-informed reserve strategy is good for the communityanddefiningtheboundariesofacceptableactionsaroundreserves.Mostimportant,a policyshouldaddresstheamountin reservesthatalocalgovernmentwillstrivetomaintain,including a minimum and maximum amount.

3. Optimize the Combination of Commercial Insurance and Self-Insurance. Commercial insurance andself-insuranceeachhaveadvantagesthatcancomplementtheother.Ifwethinkofreservesas self-insurance,itopensupnewwaysofthinkingabouttheapplicationofcommercialinsurancetothe risksthatlocalgovernmentsface.Byusingarisk-basedapproachtoidentifyhowmuchandforwhat severityofeventsreservefundsareneeded,itbecomeseasiertoidentifypricingefficienciesbetween holding funds and purchasing private insurance.

4. Optimize Investment Strategies. Reserves are constituted by cash held back from current spending.

Knowinghowmuchcashisnecessarytokeepliquidtoprovidereasonableassurancesforunplanned, unavoidableexpenditurestellsyouhowmuchcanbeinvestedinlong-term,lessliquidbuthigheryield instruments.

5. Pool Risk. Local governments often participate in external risk pools to save money. Local governmentsmayhaveunrealizedinternalriskpoolingopportunities. Thereservesasinsurancemodel highlights these opportunities.

6. Understand Bond Ratings and Reserves. Bond ratings are often used as a reason to maintain high reserves.However,theinterestrateadvantagewillonlybejustifiedundercertainconditions.Reserves asinsuranceasksustoconsider if higher reservesare“worth” thecosttoobtain ahigherbondrating. 2 207 of 266

SHOULD WE RETHINK RESERVES?
SECTION 1
Why Might We Need to Rethink Reserves?
Reservesaretheliquidfinancialresources*thatlocalgovernmentsdonotincludeintheannualspending plan. Theseresourcesareheldbackfromthebudgetandheldin “reserve”forsomeotherpurpose. The mostimportantpurposeistorespondtosignificant, unplanned, unavoidablecostsor revenuelosses, such as a natural catastrophe or recession. Another common purpose is as a sinking fund or “piggy bank” foralarge,nonrecurring,plannedfutureexpenditure,likepurchasingacapitalasset.Reserves also support a strongbond rating by signalingtoinvestorsthatthe local government hasresourcesto pay back debt even with potential disruptions to its financial position.

It haslong been thoughtthat havingsubstantialreservesis desirable. Often it isthoughtthat bigger is better. So why might weneed torethink reserves? The reasons are consistent with many ofthose cited for GFOA’sRethinkingBudgetinginitiative. Though,thesereasonstakeon specialsignificance when applied to reserves.

An increasingly volatile and uncertain world. Reserves play a role in buffering local government from volatility.However,ifvolatilityisincreasing,weshouldreexaminehowreservesaremanagedtoensure local government has an adequate buffer. For example, damagesfrom natural disasters have been on theriseinrecentdecades.1Reservesfundtheresponsetonaturaldisasters.Eveniffederalorstate/ provincialfinancialassistanceisavailable,reservesfillthegapuntilassistancearrives,whichcantake months or evenyears.

Lower trust in government and experts. Local government’s stakeholders may be suspicious of large reserves, especially if itis not clear why the governmentis holdingthese resourcesinsteadofspending themoncurrentservicesorcuttingtaxes.2In thepast,theexpertopinionofthefinanceofficer,perhaps citingGFOA’s“Best Practices,”mighthavebeen sufficienttojustify reserves,butexpertopinionmaynot besoreadilyacceptedinthefuture.3 Financeofficersmayneedtobepreparedtoprovidejustification for reservesthatrely less on appealstoexpertiseand more on thefundamental reasons why reserves are important.
* Typically comprising cash and investments that can be converted into cash. 208 of 266
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SHOULD WE RETHINK RESERVES?
Local governments are becoming more resource constrained. Local governments are expected to maintainasizablereserveby “industry standards”andbybondratingagencies.*Atthesame time, localgovernmentsarefacingmoreresourceconstraints,especiallywithemployeehealthcareand pensioncostsrising. Formanygovernments,theincreasesincostshaveconsumedrevenueincreases, whichmay soon leveloff.†In fact,someeconomistsbelievethattheUnitedStates’long-termgrowth trajectory willslow; indeed,thegeneraltrendhas been slowinggrowth sincethe 1970s.4 Further, longtermdemographictrendspointtowardanagingpopulation.ThoughtheUnitedStates’demographic outlook is not as dire as other developed countries, an aging population still does not bode well for localgovernmentrevenues.5Inaddition,legislativeconstraintslimitrevenuegrowth.Forexample,there isevidencethatlocalgovernmentrevenuesdonotrecoverasquicklyfromsetbacks, likerecessions, compared to the past, due to legislative constraints.6
Rising costs paired with stagnating revenue growth means Building reserves is a use
of current revenues, and
governmentsneedtoweigh
the opportunity costs of
doing so. Is it better to
provide services today or
save the money forlater?
thatlocalgovernmentsneedtomakeefficientuseof
resources, including reserves. Building reservesis a use ofcurrentrevenues,andgovernmentsneedtoweigh
the opportunity costs of doing so. Is it better to provide servicestoday or save the money for later?
None of this suggests that local government reserves
should always and everywhere be lower than they are
today.Instead, weshouldlookformoreandbetteroptions
toprovidebufferstolocalgovernmentsthanreserveshave
traditionallyprovided.Forexample,arethereopportunities
tomakemorecost-effectivecombinationsofcommercial
insuranceandreserves?This mightnot alwaysleadtoreservesgoingdown. In fact, itcouldcallfor reservestobeincreasedaspartofahigh-deductibleinsurancestrategyforsomeperilstoreducethe total cost of risk (insurance plusreserves).

Information technology makes rethinking reserves easier. Information technologies, like some we will describelater in thisreport,makeit easiertoanalyzereserve strategiesand optimizethe strategy tothe conditionsfaced by each local government.

In the next section, we will discuss how to rethink reserves, with emphasis on the reserve’s role in managingrisk. In Section3, wewillsuggestseveralactionslocalgovernmentscan taketorethink their reserves and get better value from reserves for their communities. * GFOA’s “Best Practices: Fund Balance Guidelines for the General Fund” recommends that, at a minimum, general-purpose governments, regardless of size, maintain unrestricted budgetary fund balance in their general fund of no less than two months of regular general fund operating revenues or regular general fund operating expenditures. Moody’s Rating Agency looks for fund balances above 35% of annual revenue to provide a Aaa rating for General Obligation debt. † Note: We are not referring to the impact of economic cycles (e.g., recessions) but rather the long-term trend across cycles. 4 Page
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RETHINKING IS LOCAL
Each local government will need to decide how to best apply the ideas in this paper to their circumstances. Forexample,alocalgovernment’s“reserves”arecommonlyassociatedwiththe generalfund. Yet,manyofthesame ideaspresentedin thispaper couldapply toother funds, like enterprise funds.

SHOULD WE RETHINK RESERVES?
SECTION 2
How Do We RethinkReserves?
We begin rethinking reserves by starting from “first principles”—that is, why do local governments havereservesin thefirst place? Theanswer istoreducevolatilityanduncertainty in publicfinances.

Uncertaintyexposesagovernmenttofinancialrisks. GFOAhasfoundthatframingthereserveexplicitly asariskmanagementtoolandlinkingthereservetoconcreterisksthatdecision-makerscanappreciate is agreat way tocommunicate why reservesare important. Let’sexaminethekey risksthatreserves guard against. We willsee that there are many possible risks, and it is difficult, if not impossible, to buy commercial insurance to protect against many of them.

Cashflowriskisaconcern,especiallyforgovernmentswhereamajorrevenuesource,likepropertytaxes, isreceivedonlyonceortwiceayearin largechunks, whileexpendituresoccurevenlythroughoutthe year.A similarproblemcanoccuriflargeportionsofstate-sharedrevenuehavetobeauthorizedbythe stateeach yearthroughthestatebudgetprocess.Delaysinapprovingthestatebudgetcouldresultin delaysinlocalgovernmentrevenues.Reserveshelpsmoothoutresourceavailabilityandhaveimportant advantages over other optionslike tax anticipation notes(TANs). TANscan entailthe risk of high interest rates, for example.

A big risk for many governments is revenue instability, with recessions being the major culprit. If a recessiondramaticallyreducesrevenue,thenreservescanbeusedtohelpagovernmentmakea“soft landing.”Forexample,theCityofSavannah’ssalestaxwasalargerevenuesourcethatwassensitiveto theeconomy.Thecity,therefore,developedasalestaxstabilizationreserve.WhentheGreatRecession hit, the city was able to draw from the reserve and avoid layoffs. 210 of 266
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SHOULD WE RETHINK RESERVES?
Therecouldbeothersourcesofrevenueinstability,too.Perhapsa majorrevenuesourceissubjectto changesinthepoliticalenvironment,asinthecaseofsomestate-sharedrevenue.Itmightalsobethe casethatalocalrevenuesourceissubjecttoperiodicreapprovalbythevoters.InonecitytheGFOA worked with,the potentialfor a major industrialemployertoclose was arisk because the city relies heavily on a local income tax.

Historically,reserveshavenot consistentlybeen usedby localgovernmentstooffsetrevenuelosses fromarecession.7 Thishasbeen,perhaps,theresultofstateandfederalgovernmentsupportduring thelasttworecessionsthatcame throughthe American RecoveryandReinvestmentActof 2009 andtheAmericanRescuePlanActof 2021.Whilethesepiecesoflegislation wereamajorhelpto localgovernmentfiscalhealth,localgovernmentsshouldnotexpectthesetobeavailableinfuture recessions.RecoveryfundsrequireCongressto
pass major legislation, and the rise of political
GFOA has found that framing
the reserve explicitly as a risk
management tool and linking
thereservetoconcreterisksthat
decision-makers can appreciate
isagreatwaytocommunicate
why reservesareimportant.
polarization and gridlock makes this far from
guaranteed.Evenifthefederalgovernmentoffers
relief,future funding might haverestrictions,and it
willbe impossiblefor localgovernmentstopredict
howmuchmoneytheywillreceive.Hence,local
governmentswouldbewisetopreparetohandle
the impacts of recession on their own. Reserves
provideanotheroption,besidesspendingcuts.

Another major risk category is natural disasters like
earthquakes, wildfires, floods, hurricanes, and the
like. These can result in urgent needs like overtime
for first responders or shelter, food, and supplies for displaced families. They also sustain recovery fromdisastersbycoveringunforeseenexpenditureslikethecleanupthatfollowstheinitialdevastation.

Sometimes, a local government will have some of its costs reimbursed by the Federal Emergency Management Agency (FEMA)and/orstateagencies. Ifthisisthecase, reservesarestill importantto coverthenonreimbursablecosts,includinglostrevenueandfeesandincreasedoperatingcosts,while also fronting the costs until reimbursement arrives. GFOA sampled several local governments that receivedFEMA reimbursementfor naturaldisastersandfoundittookan averageof 18 monthstobe reimbursed.

Some extreme weather events might not be declared an “emergency” by national or state government.

In thiscase,thelocalgovernmentmaybe on itsown. A common exampleofthisisan extremesnow seasonwhereanunusuallylargeamountofsnowmaycausethelocalgovernmenttodramatically exceeditssnowremovalbudget.Reservescouldbeusedtofundtheoverageandbereplenishedby surpluses from light snow seasons.

Man-made disasters are also a risk. The possibility of hazardous materialspillsthat cost a lot to clean up is one such risk that can have a material impact on local finances. Cyberattacks are another example of a man-made risk that might have implications for reserves. As of this writing, cyber insurance policiesarebecomingmoreexpensiveortotallyunavailabletosomegovernments.Soagovernment mightneedtoraisethedeductibleonacommercialpolicyorforgoapolicyaltogether. In thiscase, thegovernmentisself-insuring against cyberattacks eitherpartially or fully,and reservesprovide thefinancialbacking.Capital infrastructurealsopresentsrisksthatreservescanhelpmitigate.Debt isapowerfultoolforlocalgovernmentstofinanceinfrastructureacquisitions,andreservesprovide assurancestocreditorsthatthelocalgovernmentisnotatunacceptableriskofdefault.Reservescan also be used to pay for capital assets directly (i.e., cash financing). 6 Page
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RESERVES AREN’T ALWAYS THE ANSWER
We must recognize thatreserves are not the best way to manage all of the consequences of the risks local governments are subject to. Let’stake pensions. Though reserves could be used tocushion the initialshock from a reducedrate of returnand consequentincrease in required annual contributions, a government will, atsome point, need torealign its annualspending to accommodate increased pension costs.

SHOULD WE RETHINK RESERVES?
There may be other risks we haven’t coveredthat mightbe relevanttoreserves. These risks mightfall intocategoriesoffinancial/economic,healthcrises,security,reputational,andmore.Hereareafew examplesfromgovernmentsthe GFOA has worked with toanalyzetheir risk exposure. You mightthink of others that are relevant to your jurisdiction.

Financial/economic: For governments with large pension liabilities, a reduction in the rate of return on pension investments could increase the annually required pension payment.8 Reserves could be used to smooth out the impact on thebudget.

Public health: The COVID-19 pandemic is an extreme example of the potential financial impact ofahealthevent. Lessextremeoutbreakscouldstillhavefinancial impacts. Forexample,local governmentswithpublichealthresponsibilitiesinurbanareascouldfacelargecostsfromlocal outbreaks of serious diseases, likehepatitis.

Public safety: Terrorism and civil disorder can cause a spike in public safety costs. It is worth noting thatcivildisordereventscouldbecomemoredifficulttoinsureagainstbecausesocialmediacan spreadcivildisorderbeyondalocalphenomenon.9Inotherwords,civildisorderinonecommunity can easily spread to others. Insurance companies try to avoid insuring risks where this kind of “domino effect” is inplay.

Recognizingthatreservesareessentiallyatoolfor riskmanagementleadstoour nextpointon howto rethink reserves: Adjust your mentalmodel.

Amentalmodel isawayin whichweviewtheworld.Mentalmodelsguidehow wemakedecisions. If public finance officers can give decision-makers a better mental model, they will make better decisions.

The traditional mental model for reserves is a savings account.

Indeed,thesavingsaccounthasseveraladvantagesasamentalmodel.First,it’saneasyanalogyto graspforpeoplewhoarenotpublicfinanceexperts. Second,ithasaseeminglyobviousparalleltothe personal lives of local governments’stakeholders. Thisis particularly true forthe “sinkingfund” function ofreserves,as most people haveexperience withbuildinguptheirpersonalsavingstopay forsome consumer expenditure or personal investment (e.g., education, house, car, etc.).

However, the savings account model has disadvantages as well.

First,theanalogytopersonalsavingsasabufferagainstriskmightnotbeaspowerfulasitseems.Personal savingsrateshavebeeninlong-termdecline.10 Notonlythat,butmostconsumersalsostartsavingreactively, afteranadverseeventhasoccurred(e.g.,recession,pandemic).Obviously,thisisnotaviablestrategyfor localgovernmentreserves.11Giventhereactivestrategythatmostsaversadopt,itisnotsurprisingthat most Americans are well short of the amount of personal savings that personal finance experts recommend keepingfor an emergency.* Given the lack of emphasis on saving for an emergency, many people may now see personal savings more as a vehicle for saving up for future purchases than as a way to manage risk.12 * The average American’s monthly expenses are $5,111. Fifty-one percent of Americans have less than $5,000 in savings. Personal finance experts recommend more than one month’s worth of expenditures, with three months regarded as the minimum. Information taken from:

Backman, M. (2022, May 9). Study: Average American’s savings account balance is $4,500. The Ascent. https://www.fool.com/the-ascent/ research/average-savings-account-balance
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RESERVES AS INSURANCE AND THE ELECTED BOARD
One author of this paper was part of a discussion with a city council about reserve strategy.

Onecouncilmemberaskedwhatthepractical implicationsofspendingthereservewouldbe.

Reserves as insurance would point out that lower reserves would be the equivalent of taking a lower limit (or higher deductible) on your insurance policy. Reserves as savings account struggles with this question because an increasingly prevalent view is that savings exist to be spent.

SHOULD WE RETHINK RESERVES?
Thereisevidencethatfinancialmanagersaremorelikelytoviewtheirownpersonalsavingsasatool for managing risk compared to the average person. This means that the “saving account” metaphor for reservesmaybe moreimpactful in themindsoffinancialmanagersthan itisforotherpeople.13 Second,thesavingsaccountmentalmodelimpliesthathavingmoreinyouraccountisbetter.However, thisis notalwaystrue with localgovernmentreserves. Localgovernmentsarefaced withopportunity costs that are different from private individuals. Monies placed in reserves are resources that are removed from the private economy. It can be argued that excess* reserves could do better for the community ifthoseresources wereputto work in theprivateeconomy. Evenifexcessreserves weren’t returnedtotheprivateeconomy,agoodargumentcouldbemadethattheexcessamountsshouldbe usedbythegovernmenttobenefitthecurrentgenerationoftaxpayers(theones whoprovidedthe money to create the reserve). Further, there are diminishing returns to putting aside money to offset risk. We willmathematically demonstrate thislater in thispaper. For now,a simplethought experiment will do. Imagine a person had $10,000 in theirsavings account to offset personal risk. Thisis a healthy amount, but it is not hard to imagine circumstances where this amount proves insufficient. Now imagine anothersimilarperson had$1 millionin theirsavingsaccount. Itis much harder toimagine the circumstances where this would be insufficient. Now imagine each person was given an additional $10,000. It is easy to see how the first person could better insulate themselves from risk by using this moneytobuildtheirsavings.It wouldbehardtoarguethatthesecondpersonwouldexperiencean equal gain in risk mitigation from buildingtheirsavingsfurther. The $10,000 createsgreater marginal benefitforthefirstperson than thesecond. The same logicappliestogovernment.Wewilladdress howtoidentifythepointatwhichexcesshasbeenreachedlater,includingestablishingforfloorand ceiling amounts on the desired level in reserves.

Ifthesavingsaccountmentalmodelhasimportantlimitations, whatisthealternative?Wepropose insurance as a new mental model. This does not necessarily replace the savings account model but does supplementit by providing a new and better perspective on some ofthe mostimportant purposes of areserve.

Insurance has an obvious parallel to people’s personal lives. Given that local governments hold reservestomanagerisk,insuranceisanaccurateanalogyforreserves.Further,insuranceispurchased proactively,beforean adverseeventoccurs;much likereservesmustbe builtupaheadoftimeto prepare for future, unpredictableadverse events.

Anotheradvantageofinsuranceasamentalmodel isthatitinviteslocalgovernmentstothinkabout how commercial insurance and self-insurance can work together for an optimized risk financing strategy.Reservesareaself-insurancestrategy,butcommercialinsurancepolicies(thosepurchased fromabroker)can supplementreserves. Forexample,commercial insurancecouldbe usefulfor protecting against low probability but extreme consequence events. Later in this report, we will discussspecializedinsurancepoliciescalled“parametric”insurancethataredesignedtoprovidethe policyholder with compensation in the event of an extreme event. * Of course, defining the point of excess is key. We will address that later in this paper. 8 Page
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SHOULD WE RETHINK RESERVES?
Using insurance as a mental model also implies that there is an optimal amount to have on hand.

Nonexpertscan appreciate thatitis possibletoeither overinsureor underinsuretherisksthat you face.

Insurancealsoimpliesthatthereisapointat whichthe“policy” shouldbeused. Let’sconsiderrecessions asan example.Recessionsarethemostimportantsourceoffinancial instabilityfor localgovernments, soreservescan playacrucialroleincounteractingdownturnsineconomiccycles.However,thereis littleevidencethatlocalgovernmentsusereservesduringtimesofeconomicrecessions.14 Inthe Great Recession, the 30 largest U.S. cities used their fiscal reserves, but only 25% of the 600 smaller cities studied drew down their reserves (the remaining cut spending).15 Failure to use reserves likely caused distresstothe community in the form of interruption topublic services. While local governmentsshould considerspendingcutsduringarevenuedownturn,astrongreservecanhelpavoidthemostdamaging spending cuts.

Theinsurancementalmodelisnotwithoutitsdisadvantages,though.Insurancecanbeanabstractand difficultconcepttograsp,eveninourpersonal lives. Thismeanspeoplesometimesdon’tmakeoptimal personaldecisionsaboutinsurance,justliketheymakesuboptimaldecisionsaboutpersonalsavings.

Another disadvantage isthat the analogy becomes more complicated when commercial insurance and intergovernmentalaidisconsidered.Takingtheseotherriskmanagementtoolsintoaccountisnecessary for an optimal risk management strategy, but the trade-off is additional complexity.

Thereservesasinsurancementalmodeladdressestheriskmanagementfunctionofreserveswell. The reservesassavingsaccountmentalmodeladdressesthe“sinkingfund” functionofreserves,so wedo notsuggestdiscardingthesavingsaccountmentalmodelentirely.Rather,puttingthesetwomodels together offers a more comprehensive perspective on the role of reserves. + =
With better mental models in place, we are positioned to think about the actions we can take. 214 of 266
9 Savvy
Financial
Strategy
Reserves as Insurance
Addresses reserve’s role in
guarding against risks like
revenue instability, catastrophic
events, and cashflow instability.

Provides a lensthat encourages
new andsavvy waystomanage
risk across the government.

Reserves as Savings Account
Addresses reserve’s role in
accumulating cash to pay for
future costs that would not be
affordable within a single year’s
revenue. A capital asset is an
example of such a cost.

Provides a lens that encourages
multiyear financing strategies for
large costs.

SHOULD WE RETHINK RESERVES?
SECTION 3
What Actions Can We Take to Rethink Reserves?
In thissection, we’ll lookatthe stepslocalgovernmentscan taketorethink reserves. We’vesummarized themajorideasandwilldiscussthemindetail immediatelyafter.Theideasarepresentedinaroughorder of importance.

1. Risk-Based Reserve Analysis. A perennial question in local government finance about reserves is “howmuch isenough?” Thereservesasinsurancemodelwouldsayitdependson what yourrisksare.

We’ll discuss different optionsfor how local governments can take account of their risks.

2. Develop a Comprehensive Reserve Policy. A policy helps the government commit to savvy decisionmaking about reserves by showing why a smart risk-informed reserve strategy is good for the communityanddefiningtheboundariesofacceptableactionsaroundreserves.Mostimportant,a policyshouldaddresstheamountin reservesthatalocalgovernmentwillstrivetomaintain,including a minimum and maximum amount.

3. Optimize the Combination of Commercial Insurance and Self-Insurance. Commercial insurance andself-insuranceeachhaveadvantagesthatcancomplementtheother.Ifwethinkofreservesas self-insurance,itopensupnewwaysofthinkingabouttheapplicationofcommercialinsurancetothe risksthatlocalgovernmentsface.Byusingarisk-basedapproachtoidentifyhowmuchandforwhat severityofeventsreservefundsareneeded,itbecomeseasiertoidentifypricingefficienciesbetween holding funds and purchasing private insurance.

4. Optimize Investment Strategies. Reserves are constituted by cash held back from current spending.

Knowinghowmuchcashisnecessarytokeepliquidtoprovidereasonableassurancesforunplanned, unavoidableexpenditurestellsyouhowmuchcanbeinvestedinlong-term,lessliquidbuthigheryield instruments.

5. Pool Risk. Local governments often participate in external risk pools to save money. Local governmentsmayhaveunrealizedinternalriskpoolingopportunities. Thereservesasinsurancemodel highlights these opportunities.

6. Understand Bond Ratings and Reserves. Bond ratings are often used as a reason to maintain high reserves.However,theinterestrateadvantagewillonlybejustifiedundercertainconditions.Reserves asinsuranceasksustoconsider if higher reservesare“worth” thecosttoobtain ahigherbondrating. 10 215 of 266

SHOULD WE RETHINK RESERVES?
Risk-Based Reserve Analysis
GFOAstronglyrecommendsthatlocalgovernmentsadoptaformalpolicythatdescribeshowmuchitwill striveto maintain in itsreserve. A perennialquestion, though, is “how much is enough?” The reservesas insurance model would say it depends on what your risks are.

The first step toward a risk-aware reserve target is to think of the target as a range instead of a single point.Forexample,agovernmentmightsay,“Ourpolicyistomaintainreservesbetween15%and25%of annualrevenue,” ratherthan “…equalto20% of annual revenue.”A range hasseveraladvantages overa single point:
▪ Risksare difficult or often impossible to estimate exactly. A range expressesthat a government must have a margin of error to operate within. Conversely, a single point leaves ambiguity over whether actualreservesaretoohighortoolow.Totakeourexample:Ifthegovernment’spolicywasbasedon asinglepoint(20%)andtheactualreserveswereat17%ofrevenue,wouldthatbeacceptable?What ifreserveswere27%?Wouldthatbetoohigh?Thesingle-pointpolicyisnotclearaboutboundariesthe governmentshouldstaywithin.*Ifthepolicywasbasedontherange,we’dknow17%wasacceptable but 27% wastoo much. Thisfeatureof ranges not only helps withdiscussionsamong decision-makers about reserve strategies, but it might also help with explaining reserve strategy to the public. ▪ Arangeaccommodatesdifferentriskappetites.The“right”levelinreserveswillbeafunctionoftherisks agovernmentfacesandoflocalofficials’willingnesstobearthoserisks.Arangecanaccommodatethe viewsofrisk-averseelectedofficialsandlessrisk-averseofficials. Theycanfindgroundsforcompromise by negotiating a floor and ceiling that accommodates different appetitesfor risk. ▪ A range bettersupportsthe ongoing management of reserves. Reservesfluctuate from year to year.

If the reserve stays in range, there is little need to revisit whether the actual reserve is too high or low.Ifthereservefallsoutsidetherange, itsuggestsa clearcourseofaction (i.e.,do somethingtogetit back in range). This helps make sure that reservesstay where they need to be to manage risks. ▪ Arangeincludesafloorthatcommunicatesthatthereisaminimumamountnecessarytobeagood steward of the community but also a ceiling that communicates that there is an upper limit on the usefulnessofreservesandapointatwhichexcessresourcesshouldbedevotedtosomeotherpurpose. * Defining boundaries is essential to good financial public finance. See GFOA’s Financial Foundationsfor Thriving Communities, published May 2019.
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SHOULD WE RETHINK RESERVES?
The next step in developing a risk-aware reserves policy is to analyze the risks the local government is subjectto. A risk analysiscan takeplaceat varyinglevelsofsophistication.A qualitativeorsubjectiverisk assessmentisthemostaccessibleapproach.Alocalgovernmentcanreviewcategoriesofrisks,likethose described earlier in this report, and: A) assess their exposure in each category; and B) consider if their reservetargetaccommodatesthat exposure. GFOAhas developed a simple template tofacilitatethis kind of review.

The CityofBerkeley, California, illustrateshowthetemplatecanbeused. Thecity’sbudgetstaff ledthe riskassessmentandincludedparticipationfromthepublicworks,police,andfiredepartments. Thecity determinedthatthegreatestexposurewas“extremeeventsandpublicsafetyconcerns,”particularly earthquakes,fires, landslides,floods,hazardousmaterialspills,andterrorism.Otherimportantexposures included“expenditurevolatility,”duetoupcominglargeexpenditureobligationsthatdidnothavea funding source, and “other funds’ dependency on the general fund.” The city’s general fund was a backstopfor other city operationsoutsideofthegeneral fund,so thegeneral fund wouldbe relied upon if these operations were to encounter unplanned,
unavoidableexpendituresorrevenueinterruptions.By
A risk analysis can take
placeat varyinglevelsof
sophistication. A qualitative or
subjective risk assessment is
the most accessible approach.
reviewing all the risks on the GFOA template, Berkeley
determinedthatitfacedamoderatetohighlevelofrisk.

Thetemplatesuggestedthatbetween25%and35%of
annual revenues would be reasonable to buttress the
effectofroutinedownturnsintheeconomyandrespond
quickly and decisively to major emergencies.

Theadvantageofaqualitativeriskanalysisisaccessibility.

The CityofBerkeley(andmanyothergovernments)have
completedsuchananalysiswithintheirownresources.A
qualitativeanalysisalsocanbeeffectiveforacclimating
the government to being aware of risk as part of their
reserve strategy. Berkeley performed the analysis described above in 2016/17. The analysis helped convincethecity tocommittoreexaminingitsriskexposurefive yearslater,andthe city is doing so as of this writing (usingthe more sophisticated chance-based approach we’ll describe later).

The disadvantage of a qualitative risk assessment isthatthe resultsare subjective. This meansthatthere is likely to be a gap between: A) the reserve target suggested by the assessment and B) the optimal reserveamount,giventherisks. Thereisnowaytotellhowaccurateorinaccuratethesubjectiveestimate might be, relative to the optimal amount.

Thus, the nextstepforward in sophistication isto quantify risksto reach a more objective estimate. A localgovernmentcanlookathistoricalexperiences,theanalogousexperiencesofothergovernments, andothersourcesofdatatoestimatethepotentialcostoftherisksthelocalgovernmentissubjectto.

Aquantifiedapproachmightbeneededwhenthereiscontroversyabouttherightamountinreserves.

GFOA,forexample,has worked withlocalgovernmentswherereserveswerelow,andan objective analysiswasneededtoseeiftherewasacaseforraisingthem. GFOAhasalsoworkedwithandheard fromgovernmentswheresomefeltthereservesmightbetoohigh,soanobjectiveanalysiswasneeded to see if there was a case for lowering the reserves.
12 GFOA RISK ASSESSMENT TEMPLATE →
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SHOULD WE RETHINK RESERVES?
A LIMIT OF ANY RISK ANALYSIS—THE PROBLEM OF UNKNOWN UNKNOWNS A limit of any risk analysis is that you can only analyze the risks that you know of, or the “known unknowns.” Local governments could experience a loss from a totally unexpected source, or the“unknown unknowns.” For instance, five yearsago, nottoo manygovernments wouldhave anticipatedthe current tightening of the cyber insurance market, which might place pressure on local governments to partially or fully self-insure
cyber risks. The COVID-19 global pandemic is another
example of an unknownunknown.

Both examples illustrate how to deal with unknown
unknowns. First, a local government should
periodically update the risk analysis. Cyber risk
losseshavesteadilybeen increasingacrossall local
governments for several years, so cyber risk should
havebeen onlocalgovernmentradarsbeforethe
currenttighteningoftheinsurance market. Second,
a local government should use reserves to cover
multiple purposes. Though global pandemics were
not considered a high risk by most local governments
prior to 2019, recessions certainly were. The economic slowdown caused by the COVID-19 pandemic could be considered a kind of recession. By grouping multiple risks together into the reserve, the reserve will be more likely to withstand the addition of previously unknown risks. We’ll have more to say about this concept of “pooling” later in this report.

The easiest quantified approach to risk analysis is building a model where single numbers are used to represent the potential impact of risks. To illustrate, to estimate the risk from recessions, we might look back at past recessions to see the losses incurred from those recessions. We would see that the 2008 GreatRecessionrepresentsaparticularlybadrecession.Perhapsrevenuesdecreasedby$5million,which mightsuggest that a $5 million reserve could be necessary tobe preparedfor most future recessions.

Outside studies and the experiences of other local governments can also help. The Town of Bluffton, SouthCarolina,usedapubliclyavailableuniversitystudythatcalculatedthepercapitacosttorecover fromhurricanesatdifferentstormcategory levels.16 Thetownappliedthesenumbers,adjustedforinflation since the study was completed, to derive a figure that the town used as the target number to hold for emergency recovery reserves.

The GFOA report “A Risk-Based Analysis of General Fund Reserve Requirements” describes how to performthisanalysis, includinghow toaccountforthepossibilityof historicallyunprecedentedevents.

Theadvantageofthis“single-number”approachisthatmanygovernmentsshouldbeabletoperform suchananalysisusingtheirownresources.Infact,severalgovernmentshavecontactedGFOAtoletus know they have followed the methods described in the GFOA report.

The single-number approach has an important disadvantage, though. “Risks,” by definition, are uncertain quantities. However, this approach represents these uncertainties as single numbers. This obscures the full range of risk that the government faces.

Oneofthemostimportantconsequencesofobscuringthefullrangeofriskcomesin how atotalreserve goal is determined. A total reserve targetisthe sum of potential lossesfrom each risk a government is subjectto.However,becauserisksareuncertain numbers,thesum is notasstraightforwardasadding 218 of 266
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SHOULD WE RETHINK RESERVES?
the single-number estimates of risk together. The most important potential error is dramatically overestimatingthe sizeof reservethe government needs. An explanationof why thisisthe case is best providedwitha video,whichyoucanfindhere.* Forexample,imaginethatalocalgovernmentissubject tothreedifferenttypesofextremeevents,wherethereisa5%chanceofeachoccurringinathree-year period.Asimplesummationwouldleadagovernmenttopreparefora5%chanceofeachoccurring (5%+ 5%+ 5%).However,becausereservescanbeusedtorespondtoanyextremeevent,theoptimal strategy istothinkaboutthe totalrisk from all extreme eventsat once. There is a smallchance (lessthan 1%) of all three events occurring within a single three-year period (5% x 5% x 5%).

The waytoovercomethedisadvantagesofthesinglemethodistoevaluatethefullrangeofrisk,rather thancondensingriskdowntoasinglenumber.Wewillcallthis“chance-based”becausewecanusethe fullrangeofrisktoderivethechancethatanygivenreservelevelwillbeadequatetoprotectagainstthe risksinquestion. GFOAhas workedwithseveral localgovernmentstodevelopchance-basedreserve models,alsoknownas “probabilistic(orchance-based)simulations,”usingMicrosoft Excelandopen standardsforcomputersimulationfromProbabilityManagement.org. Theseprojectsincluded working with elected officials to bring the results of the simulation into policy decisions. A full explanation of whatchance-basedsimulationisand whatitlookslikeisbestaccomplishedwitha video,whichyoucan watchhere,andyoucan seeaseriesof videosaboutsimulationatgfoa.org/risk-savvy-thinking-aboutreserves-videos. The advantages of simulation are many, including:
▪ It isthe best way to estimate the potential of pooling risksinside of local government. We will have more to say on thislater in the paper. Suffice to say for now thatrisk pooling is a time honored and powerfulstrategy for reducingthecost of risk. Youcan learn moreaboutrisk poolingin this video. ▪ It will provide the best estimate of the range of optimal reservesfor addressingthe risksthat are includedin theanalysis. Italsoprovidesaclearillustrationofthedecreasingmarginalbenefitof accumulating too much in reserves and shows the point at which the marginal benefit decreases.

You can watch this video to see how.
▪ Thesimulationcanaddressamultiyeartimeframe. Thisisimportantbecausereservelevelsarenot easy to increase quickly. You can watch this video to see how.

All videos are available at:
gfoa.org/risk-savvy-thinkingabout-reserves-videos
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▪ A simulation can include forces that influence reserves outside of risk factors. For example, the simulation could include a local government’s willingness to cut its expenditures instead of using reserves.Orthesimulationcouldaddresshow likelyitisthatalocalgovernmentwillgeneratebudget surpluses that build up reserves and offset losses. The video on analyzing a multiyear time frame providesan illustration of how willingnesstocut expenditures can be integratedinto a simulation. ▪ Simulations can highlightthe full range of risk a local government is exposedto—from risksthat could be easily self-insured all the way to catastrophic risksthat are impossible to fully self-insure.

This helps highlight the need for strategies like preventative investments and a robust disaster response strategy.
▪ Chance-based simulation is the same method used by insurance companies to develop policies, so it has proven to be best suited to problems of insurance.

Themajordisadvantageofchance-basedsimulationisthatitismorecomplexthanthesingle-number analysismethod. Thoughchance-basedsimulationscanbeconductedinMicrosoftExcel,17GFOA is not aware of any local government that has conducted a simulation of reserves without outside consulting support. Also, the results are often expressed in odds and probabilities, and though odds andprobabilitiesareessentialforthebestunderstandingofrisk,theyarenotthefirstlanguageofmany people. Thus,explainingtheresultofthesimulationcanbemoredifficultthanasingle-numberanalysis.

Thatsaid,GFOA’sexperienceisthatitcanbedone—especiallywiththehelpofinteractivemodels,like thoseyoucanseeinthevideosabove.Infact, wehaveyettomeetanelectedofficialwhocouldnot grasp the essential ideas of a chance-based analysis.

RETHINKING RESERVE CHECKPOINTS
Develop a Risk-Aware Reserves Policy
Express your reserves policy as a range of desired reserves, with a floor and a ceiling.

Conduct a risk analysis to get a sense of how the risks you face impact the reserves you should hold.Wepresentedthreemethodsofreserveanalysisof varyingsophistication.Anyofthemwould provideareasonablebasisfora more informeddiscussion withpolicymakersabout whyreserves are necessary and how much should be kept in reserves.

Quantification of risk offers important advantages over subjective approaches. We described both “single-number analysis” and “chance-based simulation” methods of quantification. A quantified approachmightbeparticularlyusefulwhenthereisastrongsenseamongdecision-makersthat existing reserves are too high or too low.

Thesingle-numberanalysiswillbemoreaccessibletolocalgovernmentsthanachance-based simulation. However, a chance-based simulation is better; it is how insurance companies conduct theiranalysis. Thechoicebetweenthetwodependsonfactorssuchasagovernment’sabilityto payforoutsideconsultingsupport,demandfromtheaudienceforamorerigorousanalysis,and the number of risks and size of reservesin question (more/bigger risks and reserves means more potential to make the best use of funds by optimizing the size of the reserve). 220 of 266
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“THE BEST CONVERSATION WE’VE EVER HAD
ABOUT RESERVES”
GFOA worked with the City of Vista, California, which
wentfrom a policy wherethereservegoal wasdefined
by a single point to a policy with a risk-informed range.

Basedonthisnew approach,thecouncilengagedina
wide-ranging and thoughtfuldiscussionabout the city’s
reserves—with the Deputy Mayor characterizing it as
“thebestconversationwe’veeverhadaboutreserves.”
SHOULD WE RETHINK RESERVES?
Develop a Comprehensive ReservesPolicy
A reservespolicy isa methodto“pre-commit” theorganizationto wisedecisionsaboutreserves. Rather thandecidingonreservesstrategiesintheheatofamomentwhenatoughdecisionisrequired,apolicy canbedevelopedwhenthepressureisoff.Thatpolicythenprovidestheboundariesfordecision-making whendifficultdecisionsneedtobemadeaboutreserves.A policyshouldaddressthefollowing:1)why reserves should be accumulated; 2) how much should be accumulated; 3) what strategies should be used for accumulation; and 4) when and for what purpose reserves can be used.

Regardingthequestionof “why,”theansweristoprotectthelocalgovernmentagainstrisks,ranging fromweathereventslikeflooding,earthquakes,wildfires,andsnowstormstoman-madeproblemslike lawsuitsagainstthelocalgovernment.Citinginpolicylocally relevantrisksandthenotionofself-insurancecanhelpanswer
A reserves policy is a
methodto“pre-commit”
the organization to wise
decisions about reserves.
the question of “why” reserves are needed.

A policy should also address the “savings account” role of reserves in saving up for larger projects. Differentiating the “insurancepolicy”roleofreservesfromthe“savingsaccount”
function could help decision-makers be savvier with their reserve strategy.

Our prior section on risk-based reserve analysis addressed how much to accumulate, including a recommendation that reserve targets be expressed as a range. A policy can also discuss strategies to use for accumulation. This could be as formal as formulas tied to any yearly surplus or even a formal budget allocation to hold back some amount of a year’s revenue for building a reserve. A policy could also allow for a less structured approach by encouraging surpluses and one-time revenue to be used to build the reserve, if the local government is below its target range. In fact, a government could apply some of thesame risk savviness we’vebeen discussingin thispaper toitsforecastingin ordertoestimate the sizeofsurplusesthatcouldbeproducedbyagivenspendingplan.Youcanreadthearticle“Speaking Uncertainty to Power: Risk-Aware Forecasting and Budgeting” to see how one government did just that and use our mini stress test demonstration to conduct the same analysis featured in the article.

A policy shouldalsoaddresshow reservescan beused. Most important,apolicy shoulddiscourage reservesfrombeingusedforongoingexpenditures(e.g.,hiringmoreemployees)becausereservesare notanongoingresource.Anexceptionmightbemadeforsupportingcontinuityofpublicservicesinthe faceof arevenueinterruption, likearecession. This wouldbe temporary untilrevenuesrecoveror until expenditures can be restructuredtobe affordable under the revenuesthat are available.

A policy thataddressesthesepointshelpstofosterabetterandsharedunderstandingofreservesin relation to the maintenance of public services amid the risksthe government faces. 16 Page
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SHOULD WE RETHINK RESERVES?
A financeofficer willalsohavetoconsider whetherandhowtodescribethereserverelativetothe“fund balance”figuresthatareincludedintheannualfinancialreport.GovernmentalAccountingStandards Board(GASB)StatementNo.54providesaseriesofcategoriesoffundbalancethathavetobereported.

Usually,however,reserveswillhavetobereportedinthe“unassigned”fundbalancecategory.Thefinance officercanmakethelinkbetweenthereserve(i.e.,abudgetary/financialplanningstrategy)andfund balances(i.e.,anaccountingmechanism)inthenotestothefinancialstatementsorassupplementary informationintheannualfinancialreport,orinbudgetdocumentsInthisway,decision-makerscanseethe linkbetweenthefundbalance thefinancialstatementsanddifferentiatebetweennetresourcesthatare availableforuseasselfinsurance,andthosethat thatarebeingputasideforspendingonafutureproject, for example.

Finance officers could positively influence how stakeholders think about reserves by developing a comprehensivepolicythatdescribeswhyreservesareimportanttothecommunityamidabudgetary shortfallorothercontingency,therangeofreservesthatisprudenttomaintain,andtransparencyonhow reserves(abudgetarystrategy)connecttothetotalfundbalanceavailableinfinancialreports.Youcan access a template for developing a reserve policy here.

RETHINKING RESERVE CHECKPOINTS
Develop a Comprehensive Reserves Policy
A reserves policy is a method to “pre-commit” the organization to wise decisions about reserves.

A policy should address the following: 1) why reserves should be accumulated; 2) how much should be accumulated; 3) what strategies should be used for accumulation; and 4) when and for what purpose reserves can be used.

Thefinanceofficershouldstrivefortransparencyin howreserves(abudgetarypolicy)arereflectedin thereporting of fund balancesin the annual financial report(anaccounting mechanism).

Optimize the Combination of Commercial Insurance and Self-Insurance Commercialinsuranceisavaluablecomplementtoreserves.Ausefulanalogueisself-insuranceprograms foremployeehealthcare. Self-insuranceofemployeehealthcarehasbeen showntoprovidepotential savingsforemployerscomparedtocommercial insurance.18However,fewgovernmentswouldself-insure every lastdollar ofpotential loss. Instead,self-insuredgovernmentsoftenpurchase“stoplosscoverage,” whereacommercial insurancepolicykicksinafteracertain sizeoflossisreached. Thus,thegovernmentis spared: A)thecostofcoveringextremely largelossesandB)thecostofthemore expensivepremiumsthat would come with using commercial coverage for more routine losses.

A similar conceptcan be applied tothe risksareserve is “self-insuring”against. Reserves willbe most usefulfor lower magnitude, higher frequency risks. Commercial insurance is ofthe greatest value whenthelossesfromcatastrophicriskwouldbeunaffordable.Let’sexaminesomepracticalapplications of this idea.

The moststraightforwardexampleistopurchasehigherdeductible insurancepoliciesfor liabilitiesthat arecommerciallyinsured. Thisstrategyisusefulforinsurancepoliciesthathavebecomemoreexpensive duetomarketconditions.Insuranceagainstcyberattacksisaprimeexample,withsomegovernments experiencing100% year-over-year increasesin pricesas ofthis writing. For example,because of the increasing cost of policies, Mecklenburg County, North Carolina (covering Charlotte and surrounding areas), wentfroma$1 milliondeductible with $15 millionin coveragetoa$5 milliondeductible with $10 millionin coverage.* Thecountyhassubstantialgeneralfundreserves,soitcan “self-insure”thelargerdeductible and the lowerlimit.
* The county also negotiated several exclusions and limitations to the policy. This means the final price of the new versus the old policy is not comparable.
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SHOULD WE RETHINK RESERVES?
Anotherapplicationmightbe“parametricinsurance.”Parametricinsurancepoliciespayoutasetsumof moneywhenagivenconditioncomestopass. Forinstance,apolicymightpayout$10millionifhurricane wind speeds in the community reach 120 miles per hour. Parametric policies are in wide use in many other sectors but are a relatively new instrument for local governments. Parametric policies might be mostusefulforcatastrophiceventswherealocalgovernment’sreservewouldbestretchedtorespond.

Ofcourse,federaland/orstateassistanceoften isavailableforthesekindsofeventsbutalsooften take overayeartoarrive.* Further,somecostsofacatastrophiceventmaynotbereimbursablebythestateor federalgovernment.Forinstance,ifthetaxbaseissodamagedthattaxrevenuesdonotrecoverquickly, thefundsfromaparametricpolicycouldhelpfillthegap.Also,parametricpoliciesprovidefullcoverage ondayoneafterthepolicygoesintoeffect, whereasitcouldtakeyearstobuildupareservesufficientto coverthefullimpactofacatastrophicevent.Parametricpolicescanalsobedesignedaroundaspecific geographicarea.Forexample,perhapsanareawherelow-incomepeopleliveisparticularlyvulnerable to a certain kind of hazard. A policy could be developed to provide a payout for an occurrence of that hazard in that area. That would allow the local government to provide additional support to the people who live there.
†
YoucanreadmoreaboutparametricinsuranceintheGFOAreport“ParametricInsurance:AnEmerging Toolfor Financial Risk Management.” The reportincludescase studiesof localgovernmentsthat have purchasedparametricpoliciesand how insurancepoliciescomplement FEMA reimbursement.

RETHINKING RESERVE CHECKPOINTS
Optimize Commercial Insurance Combined With Reserves
Consider if you have commercial insurance policies where a higher deductible could be self-insured by reserves. The highest potential willusuallybe withpolicies wherepremium pricesare goingup substantially.

Considerifaparametricinsurancepolicycouldsupplementreserves.Parametricinsurancemight be particularly useful when a government finds that it is underinsuredfor a catastrophic risk. Thisis because parametric insurance can provide additional coverage immediately, while it couldtake years to build an equivalentreserve.
* According to a sample of data obtained by GFOA, it takes 18 months, on average, for a local government to obtain FEMA reimbursement. † Kousky, C., & Wiley, H. (2021, January). Improving the post-flood financial resilience of lower-income households through insurance.

Wharton Risk Management and Decision Process Center Issue Brief. 18 Page
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SHOULD WE RETHINK RESERVES?
Optimize Investment Strategies
Insurance companies invest the monies collected from premiums to make substantial profits.19 A government’sreservesarebasicallypremiumscollectedfromthecommunitytostabilizetheirgovernment servicesagainstrisk. Those monies heldin reserves willbe idle most ofthetime,so governmentscan adopt savvy investment strategies for theirreserves.

A risk analysis, like we described earlier, is essential for a savvy investment strategy. A government can dividetheiridlefundsintotranches,whereeachtrancherepresentsadifferentlikelihoodofthegovernment needingtoaccessthemoneyforemergencypurposes.Asasimpleexample,let’sassumeagovernment hasonly twoinvestmentoptions: 1)short-term, lowerearning; 2)long-term,higherearning, wheretheterm of the investment is three years. Let’s assume a government does a risk analysis that suggests that $10 million is a good ceiling amount for itsreserve, and the government has $10 million in itsreserve. The risk analysisalsosuggeststhatthereisonlya10%chancethatthegovernmentwouldneedtousemorethan $9 million of itsreserve in the next three years. Thus, decision-makersconclude that putting $1 million in investmentoption2 is worththerisk. Thisleaves$9 million in the shorter-term, lower-earning investments, but which Thedecisiontoinvestinany
combination of assets with
different risk/reward profiles
will, at some point, depend
onthesubjectiveappetitefor
risk of the decision-maker.
providesgreaterabilitytoaccessthecashiftheneedarises.

Researchbyonefinancialtechnologyfirmthathelpslocal
governmentsdeterminetheirinvestableresourcessuggests
thattherearelargegainsin investmentreturnsavailableby
following a more risk-savvy investment strategy, like that describedabove.Dataprovidedbythisfirm suggeststhat
thepotential improvementin returnsareas muchas 35%to
40% more than what most governmentsget currently from
the resources that comprise theirreserves.20
Ourexampleassumesaprobabilisticriskanalysis,butalessrigorousriskanalysiscouldstillhelpreacha similarconclusion.Forexample,ifalessrigorousanalysissuggeststhat$10millionistheceilingamountfor reserves,then weknow thatamountsclosertotheceilingarefar lesslikely tobe usedthan the“first dollar” thatcomprisesthereserve. Thus, agovernment wouldstillhavethebulkofthe$10 million investedin more liquidassets, while placing a smaller amount in a lessliquid, higher return asset.

Our examplealsorevealsapotentially stickyquestion. The decisiontoinvestin anycombinationofassets with different risk/reward profiles will, at some point, depend on the subjective appetite for risk of the decision-maker.Goingback toourexample,whoistosaythata10%chanceof needingmorethan$9 million is the objectively correct threshold for investing the remaining $1 million in longer-term securities? Perhaps some people would be comfortable with a 15% or 20% chance, while others may be uncomfortable withas high as 10%. These decisions willhavetobe discussed with therelevantdecision-makerstocome toa consensus. GFOA’sexperience has been thatreaching agreement is easier when based on an objective analysis, like a risk assessment. GFOA has done this kind of analysis with its own finances and found thatreachingagreementon thepreferredinvestmentstrategywasnotthatdifficult,astheriskanalysis provided objective criteria and data for decision-makers.

RETHINKING RESERVE CHECKPOINTS
Optimize Investment of Reserve Funds
Use a risk analysistoidentify tranches of funding, ranging from more likely tobe needed tocover unplanned,unavoidableneedstolesslikely.Thelesslikelytranchesmaybecandidatesforlessliquid, higher return investments.

Conveneadiscussion withtherelevantdecision-makerstodeterminethelevelofrisk thegovernmentis willingtotakeon with respecttoinvestmentliquidity versusthe potential need todraw upon reserves. 224 of 266
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MENTAL ACCOUNTING AND RESERVES
“Mental accounting” referstothepracticeof dividing money intoseparatebucketsin our personal lives, such as the “vacation money” versus “the kids’ college fund.” Economists have shown that mentalaccountingleadstosuboptimalfinancialdecisions, thoughthereis a good argumenttobe made that mental accounting is useful for navigating life, even if financially suboptimal.22 Mental accounting may not be so different from when local governments place monies into different categories. Thetrick toavoidingthe worstconsequencesof mentalaccountingisavoidingexcessive limitations on fungibility of money while still being clear about the government’s plans for its funds and why those plans are important. Risk analysis does this by making clear why it is important to have funds in reserve and how much should be kept in reserve.

SHOULD WE RETHINK RESERVES?
Pool Risk
Risk poolingis widely recognizedand atime-honoredstrategy for reducingthecost of risk. The reason pooling works is diversification. Put simply, it is unlikely that a loss event will happen to all the pool participants at the same time. For a more in-depth explanation, you can watch this video.

Localgovernmentsoftenpoolriskacrossmultiplelocalgovernments(regional insurancepools). Local governments also pool risk inside their own organizations. Let’s return to our example of employee self-insurance.Localgovernmentsdonotsetupseparateself-insurancepoolsforeachdepartmentor foreachaccountingfund.Allemployeesfallunderthesameself-insuranceprogram.Thissavesmoney becausethetotalamountneededtoinsuretheentireorganizationislessthanyou wouldneedif you insured each department separately. We also addressed this concept earlier—that risks don’t add up the way you might think. We also explain the concept in more detail in this video.

Similarly,localgovernmentscouldrealizesomeadvantagesfrompoolingreserves.Therearemany opportunitiestoapplypooling,though these opportunitieshavevarying degrees of difficulty.

The first and easiest way is to make sure there are no unrealized opportunities for pooling within the general fund. For example, some governments set up one reserve for economic uncertainty (e.g., recessions)andanotherforextremeevents(e.g.,naturaldisasters). Thesetworeservescouldbepooled.

Because recessions and natural disasters are unlikely to occur at the same time, a combined reserve should be more cost-effective.* The combined reserve could still be labeled as a reserve for extreme eventsandeconomicuncertaintytomaketheintentclearbutwithoutkeepingthetworeservesseparate.

The most accurate way tojudge the potentialsavingsisthe probabilisticrisk analysisdescribedearlier.

Combiningreservesin ordertomakethe money in thereservesmorefungiblecouldimprovecosteffectiveness for the same reasons we described in our employee health plan self-insurance example.

Another possibility is to define policies for emergency interfund borrowing. The idea is that the total reservedacrosstheentiregovernmentcouldbelessifeachfunddidnot havetoprepareforthemost extremecircumstancebutcouldrelyuponfinancialbackupfromotherfundsinextremecases.Youcan read the GFOA article “The Last Line of Financial Defense? Internal Loans in Emergency Situations”for more on how to develop a policy.

Anoptionthatcouldpresentsomechallengesalsopresentslargepotentialpayoffs—andthatistopool reservesacrossfunds. Ithasalargepotentialpayoffbecausetheamountsinvolvedwillbelarge.Itcan bechallengingbecausemoniesmaybesegregatedintodifferentfundsforlegalreasonssuchthat theremightbe practicalbarrierstooperatingsuchapool. Poolingfunds willbe mosteffective when * For more on this point, see the video that describes pooling. 20 Page
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twoconditionsaremet:1)thefundsinvolveddonothavelegalrestrictionsinplacethatmakepooling impractical; and 2) the risks faced by funds are not overly similar. If the risk profiles of the funds are similar,thenpooling willnotbeofgreatbenefit. Thisisbecauseeachfund willreceiveashock whena givenriskhappens.However,ifthefunds havesubstantialdifferencesin their riskprofiles,thenpooling couldbequitevaluable.Agivenriskmaygiveashock toonefundbutnottheother. Thefundthatwas not shocked can support the fund that was shocked.

Many local governments maybe unwittinglypooling the reserverisks ofseveral funds. In our work with localgovernments,wefoundthatanimportantrisk forthegeneralfundisthatthegeneralfundisoftena de facto “backstop” for other funds. If those funds run into unplanned, unavoidable emergency financial needs,thenthegeneralfundison thehook. Ratherthanbuildingupseparatereservesineachfund, it maybebettertoformalizethecurrentstateofaffairsandenhancethepooledapproachbypullinginthe pool of other funds that have their own reserves.

WewillnotethatGFOAisnottheonlyonetoadvocate
for the potential of pooling reserves. In Moody’s
Thereasonpoolingworksis
diversification. Put simply, it
is unlikely that a loss event
will happen to all the pool
participantsatthesametime.

November 2022 “US Cities and Counties [Bond Rating]
Methodology,” Moody’s introduced a governmentwide
evaluation of fund balance into its rating methodology.

The strength of fund balances and held cash combined
acrossallfundsis worth 30% thefoundationalscore when
Moody’s evaluates a government’s creditworthiness.*
Moody’sfoundthatthefundbalancesindifferentfunds
areoftenflexibleenoughthatdifferentfundscansupport
each other. Moody’s believesthat there is enough potential for interfundsupporttojustify evaluating acrossthe entiregovernmentinsteadof fund by fund. This marksan evolution of Moody’s approach, which usedto be focused on specific funds.

Finally,let’saddressregionalpooling. Localgovernmentsoftenparticipateinregional insurancepools, so why not regional arrangements for the risks the reserves guard against? The reason this may not provideas muchbenefit as one mightexpectisthatthetypesofrisksthereservesguardagainst(e.g., naturalcatastrophes,recessions)impacttheentireregion.Ifallmembersofapoolareimpactedatthe same time by the same risk, thenapool losesits value. Another way tothinkaboutitisthata pool within governmentbringstogetherfundsthatmighthavedifferentexposures.A poolbetweengovernments bringstogether funds (e.g., multiple general funds) that have the same exposures.

RETHINKING RESERVE CHECKPOINTS
Apply Risk Pooling to Reserves
If youhaveseparatereservesin thegeneralfundfordifferentrisks,combinethose reserves.

Develop a policy for emergency interfund borrowing.

Considerpoolingreservesacrossfunds withinyourgovernment.In somecases, youmayalreadybe defactopoolingthegeneralfundwithfinanciallyweakerfunds.Improveyourriskportfoliobyadding other strong funds to thepool.
* We should note that Moody’s separates “fund balance ratio” and “liquidity ratio,” but both cover all funds. Also, it is important to note that the base score is a starting point, and Moody’s analysts may adjust a final rating up or down based on contextual factors particular to the local government being evaluated.
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SHOULD WE RETHINK RESERVES?
Understand Bond Ratings andReserves
A rationale for holding a higher amount in reservesisthat it willsupport a strong bondrating, which will translatetolower interestcosts on the moneya governmentborrows. Reservesplayan importantrole in the ratings process. We can illustrate with Moody’s Investors Service: According to Moody’s rating methodology,availablefundbalanceratio* is worth20%oftherating.Moody’salsoexaminesliquidity ratio
† because fund balance is an accounting term that can include assets not available for current spending.Theliquidityratioconstitutesanadditional10%oftheratingmethodology.Thus,fundbalance and cash together comprise 30% of the total ratings methodology.

First,itis worthrememberingthat “fundbalance”and“reserves”aren’tthesame,thoughtheyare related.Fundbalanceincludesawiderscopeofresources,soitwillbealargernumberthanreserves.

Withthisinmind, wecan seethatfundbalance/cashplaysanimportantrolein theratingsmethod.

But what is considered a good level of fund balance? According to Moody’s, the “Aaa” rating (the highest) is associated with fund balances in excess of 35% of revenues. The “Aa” rating is associated withfundbalancesbetween35%and25%,andthe“A”rating with25%to15%. Thatsaid, itisimportant torememberthat while30% ofratingsevaluationis comprisedoffundbalancesandcash, 70%is not.

Further,theMoody’sdocumentation isclearthatratingsanalysts willconsiderlocal factorsandother idiosyncrasiestoarriveatthefinalrating. Thus, itispossibletohavefundbalances/cashbelowtherange for a given rating yet still achieve that rating (or even a better rating).

We also examined rating methodology documentation from S&P Global. Though the specifics of their method are different, the general conclusion is the same: Fund balances play an important, but not decisive, role in arriving at a final rating. A higher amount of fund balance will contribute to a higher rating, but it may not be sufficient to guarantee a higher rating. Similarly, a lower fund balance is not guaranteed to consign a local government to a lower rating. Other factors weigh more heavily, and ratings analysts have some discretion in assigning ratings based on local context.

Now that we know the role of fund balance in bond ratings, the next question to ask is: “Is a higher bondrating‘worth’thecosttoobtainit?”Abondratingupgradehasaquantifiablebenefit,whichisthe interestsavingsavailableatthenexthighestbondrating. Totheextentthathigherfundbalance(and higher reserves)can movealocalgovernmentfromone bondratingtothenext,then itis possibleto measure the benefit.
* The formula is: Available Fund Balance + Net Current Assets/Revenue † The formula is: Unrestricted cash/revenue
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Let’sgetasenseoftheinterestratedifferencesbetweenbondratings. Exhibit 1 showsthedifferences between interestrates(percentagepoints)atdifferentbondratingsfrom1993 to2022.Weshow a90% confidencerange, whichomitsoutliersonboththehighandlowside.Italsoisnotablethatthemidpoint (median)is closertothelow side oftherange. This means, most ofthetime,thedifferencesbetween ratings are closer to the low value than the high value.

EXHIBIT 1 | HISTORY OF INTEREST RATE DIFFERENCES BETWEEN BOND RATINGS, 1993 TO 2022 23 Percentage point differences from
going from a higher to lower rating →
AAA → AA AA → A A → BAA
Notice that the
midpoint is closer to
the low side of the
range. This means
 most of the time the
differences between
ratings are closer to
the low value than
the high value.
90% of the time, the
difference is between
these points.

Low 0.09% 0.10% 0.12%
Mid 0.11% 0.20% 0.38%
High 0.25% 0.62% 0.97%
What are the implications of the differencesin interestrates? First, let’sget a sense of the differencesin thetotalcostofbondissuedue toan interestratedifference. Let’simaginea30-year, $200-million bond issue at 3% annual interest with a rating of A. The total cost of interest over the life of the bond issue wouldbe about $106 million. If thatsame bondissue weretobe issued witha ratingof AA, let’sassume it wouldenjoyan interestrate thatis better by 0.20% (the midpoint on our table). In that case, the total interestratepaidoverthelifeofthebond wouldbe about $98 million,oradifferenceofabout $8 million.

Thisequatestoanaverageofabout$260,000peryear.Conveniently,themidpointforchangesbetween ratingsin the other columns on our table isroughly half or double the midpoint in Exhibit 1,so it is easy to imagine the financial benefit at other bond rating levels. 228 of 266
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The question of whether these benefits are worth the cost of accumulating more fund balance depends on several factors, such as:
▪ How much debt a governmentissues.If agovernmentissuesmoredebt, it willgetmorebenefit from a lower interest rate (assuming it will issue the same amount of debt no matter itsrating). ▪ The duration of the payback period for the debt. A longer payback period will result in the governmentpayingmoretotal interestoverthelifeofthebond,makingalowerinterestratemore impactful.
▪ How high a bond rating would be without accumulating a large amount in reserves. For example, we can see in Exhibit 1 that the interest rate benefit between: 1) AAA and AA is much smaller than 2) A and BAA. This means that, all else being equal, a government that can improve from BAA to A by accumulating fund balance would benefit more than a government that can go from AA to AAA. ▪ The opportunity costs of holdingfund balances and reserves. Fundbalances/reservesarenot costlesstohold.Moneyheldbythegovernmentismoneytakenoutoftheprivateeconomy.Aless abstract opportunitycost isthepublic service forgone bynotspendingthismoney. In a private firm, the opportunity cost of idle funds is, essentially, the rate of profit that could be made by directingthefundstoa businessopportunity.Unfortunately,thereis not yeta widelyaccepted, useful way to measure opportunitycostsof idlefundsin local government. The effect ofthis has been thatthe cost of holding idle funds in local government is often underestimated. ▪ Secondary benefits of a higher bond rating. A higher bond rating might confer prestige to the localgovernment,perhapsresultingingreatertrustandconfidencefromthepublicormakingthe locality more attractive tobusinesses.
▪ How much additional “coverage” from risk more reserves will buy. This speaks to the marginal valuefromaccumulatingmorereserves.Iftheadditionalreservesareunlikelytobeused,thenthe potentialbenefit from the standpointof risk mitigation islow. Thatsaid, weshouldremember that ratingagenciesaremeasuringfund balanceand cash. A localgovernmentcouldalsoaccumulate reservesas part ofa sinkingfundtopay foraspecialproject. The moniesin thesinkingfund would count positively in the rating agency evaluation.

RETHINKING RESERVE CHECKPOINTS
Understand Bond Ratings and Reserves
Fund balances and cash are an important but not an overwhelming determinant of bond ratings.

Because fund balances/cash are not costless to accumulate and hold, governments should ask if ahigherbondratingis worththecostof holding. Thecost versusbenefit ofahigherbondrating isafunctionoftheamountanddurationofdebtthegovernmentissues,thelikelyimprovement ininterestratesavailablefromaratingincrease,themarginal improvementinriskmanagement availablefromholdingmorereserves,andtheopportunitycostofholdingfundbalance/cash.

Conclusion
Reserves help local governments manage risks by making resources available for unplanned, unavoidableexpendituresandrevenueinterruptions. Thismakesreservesaformofself-insurance.We have advocated that local governments treat reserves more like self-insurance, including using insurance metaphorstodiscussand plan reserve strategies, using risk analysistodetermine the size of the reserve, complementingreserves withcommercial insurancestrategies,poolingrisksthatreservesareusedto cover,andmore.Thiswillhelplocalgovernmentsmakesavvierfinancialdecisionsabouthowtomanage risk and make their communities more prepared for a volatile and uncertain world. 24 Page
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ENDNOTES
1 For examplesofresearchexaminingthe relationshipbetween naturaldisastersandreserves,pleaseseethe followingjournalarticles:

Chen, G.(2019).Assessingthefinancial impactofnaturaldisasterson localgovernments. Public Budgeting& Finance, 40(1), 22–44.

Lee, S., & Chen, G. (2022).Disaster experienceand governments’savings: The moderatingroleof organizationalcapacity. Journal of Public Administration Research & Theory, 32(3), 591–609.

Pope, J. V., & Leland, S. M. (2019). Isn’t a flood a “rainy day”? Does the political nature of disasters impact the uses of states’ rainy day funds? Social Science Quarterly, 100(7), 2555–2565.
2 For furtherdiscussion,see, for example: Stewart, L. M., Hildreth, R. W.,& Antwi-Boasiako, K. B. (2017). Thefund balance conundrum: An ethical perspective. Administration & Society, 47(8), 915–942.
3 For data on declining trust in experts, see: Funk, C., Tyson, A., Kennedy, B., & Johnson, C. (2020, September 29). Science and scientists held inhighesteemacrossglobalpublics: 1. Scientistsareamongthemosttrustedgroupsinsociety,thoughmanyvaluepracticalexperienceover expertise. PewResearchCenter. https://www.pewresearch.org/science/2020/09/29/scientists-are-among-the-most-trusted-groups-in-societythough-many-value-practical-experience-over-expertise/ 4 Foranexampleofananalysisofgrowthratesovertime,seetheworkofeconomistRobert J.Gordon.https://gordon.economics.northwestern. edu/
5 Pisano, M. A. (2017). The puzzle of the American economy: How changing demographics will affect our future and influence our politics. Praeger. 6 See, for example, empirical research on state governments analyzing time to fiscal recovery following economic recessions:

Buerger, C. (2020). The effect of economic downturns on statebudgets: A counterfactualanalysisofthegreatrecession. AppliedEconomic Letters, 28(21), 1852–1859.

Buerger, C., Sandel, R., Reitano, V., Jones, P., & Lofton, M. (2021). Extending difference-in-differences frameworks to Granger equations:

Evidence from cutback management during three recessions. International Journal of Public Sector Management, 34(6), 688–705.

Rueben, K., Randall, M., & Boddupalli, A. (2018). Budget processes and the great recession: How fiscal institutions shape tax and spending decisions. Urban Institute, Washington, DC. Retrieved from https://www.taxpolicycenter.org/publications/budget-processes-and-greatrecession.

Rosewicz,B.(2018).Overlongterm,revenuelagsbehindexpensesin10states. ThePewCenterforCharitableTrusts,Washington,DC.Retrieved from https://www.pewtrusts.org/en/research-and-analysis/articles/2018/11/19/over-long-term-revenue-lags-behind-expenses-in-10-states. 7 See, for example, the following journal articles empirically examining local government expenditure stabilization:

Marlowe, J.(2005). Fiscalslackand counter-cyclicalexpenditurestabilization:A first lookat thelocal level. Public Budgeting& Finance, 25(3), 48–72.

Wang,W.,& Hou, Y.(2012).Dolocalgovernmentssaveandspendacrossbudgetcycles?EvidencefromNorthCarolina.AmericanReview of Public Administration, 42(2),152–169.
8 For research examining the relationship between public pensions and reserves retained in budgetstabilization funds,see the following:

St.Clair,T.(2013).Theimpactofbudgetstabilizationfundsonstatepensioncontributions.PublicBudgeting&Finance,33(3),55–74. 9 This was the view expressed by an insurance industry expert at a live educational event hosted by GFOA in 2022. 10 From1960 totheearly 1990s, personalsavingsrates werearoundorabove10% butthensharplydropped, reachingalow ofaround3% to4% in 2005 to 2008. Savingsincreasedafterthe 2008 Great Recession, averaging around 7.5% untilthe COVID-19 pandemic, when it jumpedto historically high levels. After the pandemic,savings rates dropped dramatically, plummeting to the all-time lows of 2005 to 2008. 11 Forafewmorerecentexamplesofresearchanalyzinggovernmentsavingspatternsovertime,andinrelationtothebusinesscycle,pleasesee the following journalarticles:

Arapis,T.,&Reitano,V.(2018).Aglimmerofoptimismingovernmentsavingsaccumulation?Anempiricalexaminationofmunicipalunassigned fund balance in Florida. Public Finance Review, 46(3), 389–420.

Barrett,N., Fowles, J., Jones,P.,& Reitano, V.(2019).Forecastbiasandfiscalslackaccumulationinschooldistricts.AmericanReviewofPublic Administration, 49(5), 601–613.

Stewart, L. M., Hamman, J. A., & Pink-Harper, S. A. (2017). The stabilization effect of local government savings: The case of Illinois counties.

Public Budgeting & Finance, 38(2), 23–39.

Wang, S., & Scorsone, E. (2019). Economic resilience after the Great Recession: An examination of unreserved fund balance in Michigan counties.

Local Government Studies, 46(5), 716–733.
12 Forexample,accordingtoasurveyconductedbyBankratein2021, 46% ofAmericansaresavingforaspecificfinancialgoalsuchasahome purchase, vacation, or education, while only 28% are saving for an emergency fund. 13 Please see the following research for further related discussion:

Fenimore, A., & McCue, C. (2021). Are public managers wired for risk aversion? Public Finance & Management, 20(1).

Hildreth, B. W., Yeager, S. J., Miller,G. J., & Rabin, J. (2017). Finance managers’propensity tosave. Journal of Public Budgeting,Accounting& Financial Management, 24(2),1–35.
14 See, for example, the following journal articles for examples of how to empirically analyze reserves:

Marlowe, J.(2005). Fiscalslackandcounter-cyclicalexpenditurestabilization:Afirstlookatthelocal level.PublicBudgeting&Finance, 25(3), 48–72.

Wang,W.,&Hou, Y.(2012).Dolocalgovernmentssaveandspendacrossbudgetcycles?EvidencefromNorthCarolina.AmericanReviewof Public Administration, 42(2),152–169.
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15 For a study of the 30 largest U.S. cities, please see the following research:

The Pew Charitable Trusts. (2013). America’s big cities in volatile times: Meeting fiscal challenges and preparing for the future.

For a study of 600 municipalities, please see the following book chapter:

Marlowe,J.(2014).Fiscalslack,reserves,andrainy-dayfunds. InLevine,H., Justice, J. B.,&Scorsone,E.(Eds.),Handbookof LocalGovernment Fiscal Health (321–342). Jones & Bartlett Learning.
16 Boswell, M. R., Deyle, R. E., Smith, R. A., & Baker, E. J. (1999, April). A quantitative method for estimating probable public costs of hurricanes.

Environmental Management, 23(3), 359–372.
17 Visit probabilitymanagement.org for resources on how to do this. 18 Kavanagh, K. (2018, October). Smart practices for self-funded employee health insurance. Government Finance Review. 19 An inquiry with OpenAI’s GPT 4.0 replied that “investment income accounts for about 25% to 30% of the profits of a typical property and casualty insurance company.” Further, GPT showed that some insurance companies even derive most of their revenue from investments. 20Dataobtainedby GFOAfromthefirmthree+one.Wenotethatthree+onesellsasoftwareservicethat helpslocalgovernments optimizethe amount of money invested in higher return instruments.
21 Mental accounting. BehaviorEconomics.com. https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/mental-accounting 22 The positive effects of mental accounting include reduced impulsive spending, increased saving and mental well-being, and support for achievingfinancialgoals.Anexampleofresearchon thispointcomesfromBehavioral Economicsandis knownasthe“endowmenteffect,” which,whenappliedtosavings,sayspeopletendtobemorecautiousaboutusingmoneylabeledspecificallyas “savings.” 23 Data sourced from SDC All Municipals, an online data portal from Refinitiv. 26 Page
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gfoa.org/rethinking-budgeting
Government Finance Officers Association
203 N. LaSalle Street, Suite 2700
Chicago, IL 60601
312-977-9700 | gfoa.org
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A Case Study of the City of Colorado Springs
A Risk-Based Analysis
Gene
o
r
f
al Fund Reserve
Requirements
Government Finance Officers Association
May 2013
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By Shayne C. Kavanagh, Senior Manager of Research, GFOA Reviewers: MarcD. Joffe,Principal Consultant,PublicSectorCreditSolutions, andBillStatler, Consultantand Trainer;retired Director ofFinance&Information Technology, City ofSan LuisObispo, California.

The GFOA would like to thank the City of Colorado Springs for allowing us to share this information, and Public Sector Digest for their assistance.

The Research and Consulting Centeris the management analysis and consulting arm of the Government Finance Officers Association and is nationally recognized forits comprehensive analytical and advisory services,and specialized research on stateand local government finance.Since beginning operations in 1977, the GFOA Research andConsultingCenter has provided advisory services to hundreds of local, county, and state governments; publicutilities;elementaryandsecondary educationsystems;andtransitauthorities.

The GFOA’s Research and Consulting Center encourages enquires about this study or about repeating the analysis for other governments — please contact Shayne Kavanagh at 312-977-9700 or [email protected].

Copyright 2013 by the
Government Finance Officers Association
203 N. LaSalle Street, Suite 2700
Chicago, Illinois 60601
www.gfoa.org
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The Case of the City of Colorado Springs
Executive Summary ...........................................................................................................4

1. Introduction ...................................................................................................................7

2. Primary Risk Factor Analysis ........................................................................................9 Revenue Source Stability.......................................................................................9 Infrastructure........................................................................................................14 Vulnerability to Extreme Events and Public Safety Concerns........................... 15

3. Secondary Risk Factor Analysis..................................................................................17 Leverage ...............................................................................................................17 Expenditure Volatility .......................................................................................... 19 Growth of the Community................................................................................... 20 Liquidity................................................................................................................ 20

4. Recommendations..................................................................................................... 22 Recommended Reserve Target for Colorado Springs....................................... 22 Other Ideas to Support the General Fund Reserve Strategy ............................ 26 Appendix 1. Sales Tax Revenues in Boulder, Colorado.................................................31 Endnotes ......................................................................................................................... 32

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Accounting for Uncertainty – The “Triple-A” Approach
Sizing a reserve requires estimating highly uncertain events, like natural disasters and economic downturns. To develop an adequate response, the GFOA used the “Triple-A” approach:1 • Accept. First, we must accept that we are subject to uncertainty, including events that we haven’t even imagined.
• Assess. Next, we must assess the potential impact of the uncertainty. Historical reference cases are a useful baseline.
• Augment. The range of uncertainty we really face will almost always be greater than we assess it to be, so we should augment that range. Historical reference cases provide a baseline, but that baseline may not be adequate to account for all future possibilities.

Executive Summary
Reserves are the cornerstone of financial flexibility. Reserves provide a government with options for responding to unexpected issues and a buffer against shocks and other forms of risk. Managing reserves, however, can be a challenge. The main question is how much money to maintain in reserve – how much is enough, and when does it become too much? This can be a sensitive question, since money held in reserve is money taken from constituents, and it can be argued that excessive reserves should be returned to citizens in the form of lower taxes.

The City of Colorado Springs, Colorado, has been considering this question, especially in light of its volatile revenue portfolio and the fact that it cannot easily increase taxes to compensate for other changes in its financial condition; for example, the Taxpayer Bill of Rights – a statewide provision restricting all governments in the state from raising tax rates without voter approval – limits the City’s ability to increase taxes. The City engaged the Government Finance Officers Association to help produce an answer. The GFOA is a non-profit association of approximately 17,500 state and local government finance professionals and elected officials from across North America, and a key part of its mission is to promote best practices and good public finance, including reserve policies.

The GFOA worked with Colorado Springs to analyze the risks (based on the model originally described in the GFOA publication, Financial Policies) that influence the level of reserves the City needs as a hedge against uncertainty and loss. Three primary risks were identified: volatility of sales tax revenue; the potential forthe City’s storm sewer and bridge infrastructure to fail; and the City’s vulnerability to extreme events such as wildfires, floods, and, to a lesser extent, snowstorms. Secondary risk factors were also examined, including cash flow and the potential for unexpected spikes in expenditures. In addition, a benchmarking survey of the reserves held by comparable cities provided context.

CALCULATING THE RESERVE
The GFOA reviewed three primary risk factors in order to assess the potential magnitude of the City's exposure. The "Triple-A” approach to accounting for uncertainties was an important part of GFOA's analysis.
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Revenue Volatility. TheCity’sprimary concernwas the volatilityof sales tax income, and itsmostimportant vulnerability in this area would be an economic downturn. The GFOA reviewed sales tax volatility back to 1996 in order to observe monthly variations and longer-term trends. Past experiences suggested that Colorado Springs should prepare for a 20 percent decline in sales tax revenues over 25 months as a plausible worst-case scenario; this would equal about $23 million in reserves.

However, since the City would presumably reduce its spending in the event of such a severe downturn, the reserve fund wouldn’t have to coverthe entire decline in revenue. The City budget office estimated that the budget could be reduced by almost $10 million without creating a major disruption to services (although there would of course be some degree of negative impact on service quality).

Thus, Colorado Springs should maintain a reserve of at least $13 million to coverthe remaining portion of the worst-case revenue gap and to help the City make a “soft landing” under those circumstances. An additional $7.5 million is required to coverthe other revenues that make up the general fund; these were found to be considerably less volatile than the sales tax.

InfrastructureRisks.Agovernmentmightneedgeneralfundreserves torepairorreplaceanassetthat fails unexpectedly. In Colorado Springs, the two major asset classes deemed to have the greatest associated risk were bridges and storm sewers. Thirteen bridge structures had a high risk rating, with an estimated replacement value of almost $23 million – an average of roughly $1.75 million per bridge. A reserve that covers one or two bridges should be adequate, but covering three might be more prudent, for a $5.25 million reserve. No installation dates or condition assessments were available for the 406 miles of storm lines the City manages, but the estimated replacement cost for all storm sewers was a little more than $588 million.2 Since this lack of information made it impossible to assess the risk of failure, the best that could be done was to make an assumption. The GFOA did know that about 10 percent of the total dollar value of the City’s bridge inventory is in the higher-risk category, so it started with that number for storm sewers, which translates to $58 million. The recommended reserve amount is about 20 percent of the high-risk bridges, which equates to $11.6 million for stormsewers.

Extreme Events. Finally,the City is subjectto extreme events that pose significantthreatto life and property, particularly wildfires and floods. Historically, however, the financial impact of these events has been manageable. For example, the 2012 wildfire was the worst in Colorado history, but the total cost to the City was only $3.75 million – out of an annual budget of approximately $220 million. Of course, the scale of future events is uncertain, as is the timing of FEMA reimbursement and the portion of eventresponse costs that would likely already be covered by existing budgeted resources. Taking this into account, a reserve of $5 million to $7.5 million for extreme events appears reasonable.

Adding It Up. The analysis above, along with the analysis of the secondary risk factors (particularly uncertainty regarding future payments for pension liabilities and expenditures for unfavorable lawsuit judgments) led to the following reserve components. The GFOA further recommended that the reserve amounts be categorized by component, making the purpose of the reserve more transparent.

For example, having a reserve for emergencies and a reserve for economic uncertainty would make their purpose more clear than one all-encompassing reserve.4 5

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Budgetary Uncertainty Reserve
$13 million for sales tax economic uncertainty +
$7.5 million for economic uncertainty in other revenues + $6.25 million for pension payment uncertainty =
$27 million, or approximately 12.5 percent of general fund revenues3 as budgetary uncertainty reserve
Emergency Reserve
$5.25 million for critical bridge failure +
$11.6 million for critical storm sewer replacement +
$5 million to $7.5 million for extreme events +
$2 million to $4 million for expenditure spikes from lawsuits = $27 million, or approximately 12.5 percent of general fund revenues as an emergency reserve
Combining the components gives us a target of approximately 25 percent of general fund revenues, which is in line with the range of reserves actually maintained by other cities that are comparable to Colorado Springs. It is also greater than the 16 percent the GFOA considers a minimum baseline level.5
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The Origin of this Report
This report was originally developed as a consulting product for the City of Colorado Springs. The City graciously gave the GFOA its permission to use the report for more general education and information sharing about riskbased assessment of reserve requirements.

1. Introduction
Reserves are the cornerstone of financial flexibility. Reserves provide a government with options to respond to unexpected issues and afford a buffer against shocks and other forms of risk. Managing reserves, though, can be a challenge. Foremost is the question of how much money to maintain in reserve. How much is enough and when does a reserve become too much? This can be a sensitive question because money held in reserve is money taken from constituents and the argument could be made that excessive reserves should be returned to citizens in the form of lower taxes.

The City of Colorado Springs (the “City”) has been considering this question recently, especially in light of the volatility of its revenue portfolio and the fact that the City cannot easily increase its taxes to compensate for other changes in its financial condition.6 The City engaged the Government Finance Officers Association (GFOA) to help produce an answer. The GFOA is a nonprofit association of over 17,000 state and local government finance professionals and elected officials from across North America. A key part of GFOA’s mission is to promote best practices in good public finance, including reserve policies.

The GFOA’s approach to reserves does not suppose “one-size-fits-all.” GFOA’s Best Practice on general fund reserves recommends, at a minimum, that general-purpose governments, regardless of size, maintain unrestricted fund balance in their general fund of no less than two months of regular general fund operating revenues or regular general fund operating expenditures (i.e., reserves equal to about 16 percent of revenues).7 However, this 16 percent is only intended as a baseline, and it needs to be adjusted according to local conditions. To make the adjustment, the GFOA worked with the City to conduct an analysis of the risks that influence the need for reserves as a hedge against uncertainty and loss.

A risk is defined as the probability and magnitude of a loss, disaster, or other undesirable event.8 The GFOA’s framework of risk assessment is based on the risk management cycle: identify risks; assess risks; identify risk mitigation approaches; assess expected risk reduction; and select and implement mitigation method. The framework focuses primarily on risk retention, or using reserves, to manage risk. However, the framework also encourages the City to think about how other risk management methods might alleviate the need to retain risk. For example, perhaps a risk could be transferred by 7

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Exhibit 1.1
Categorization of Risk Factors that Influence Reserve Levels for Colorado Springs Primary Risk Factors
Revenue (Sales Tax) Volatility
Infrastructure Upkeep
Vulnerability to Extreme Events and Public Safety Concerns Secondary Risk Factors
Leverage
Expenditure Volatility
Liquidity/Cash Flow
Growth of the Community
purchasing insurance or relying on another organization or accounting fund to manage the risk. It might also be possible to avoid a risk by discontinuing activities that are creating a risk for the general fund. Hence, a thorough examination of the risk factors should not only help lead to customized reserve target size, but also should improve the City’s understanding of the risks it faces and its overall financial risk profile.

As a first step in this project, the GFOA conducted a basic review of the risk factors that generally influence the amount of reserves a municipal government should hold.9 This review enabled the City and the GFOA to classify factors as either primary risks or as secondary risks. Exhibit 1.1 lists how the risk factors were classified.

The next section presents an overview of the primary risk factors and the City’s level of exposure.

The third section reviews secondary risk factors that have less weighty implications for the City’s general fund reserve strategy, but which still should be considered. The fourth and final section of the report presents the findings of the analysis, including a customized targetreserve level forthe City’s general fund and other ideas to improve the financial health of the City. 8

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2. Primary Risk Factor Analysis
This section presents the three most important risk factors examined by the GFOA and the City’s exposure: the volatility of the City’s revenue portfolio, maintenance/replacement of the City’s infrastructure (focusing on bridges and storm sewers), and vulnerability to extreme events and public safety concerns.

REVENUE SOURCE STABILITY
Volatile revenue sources call for a higher reserve level in order to avoid the need for sudden service cutbacks should revenues drop unexpectedly. Some revenues are inherently volatile. The sales tax is usually considered to be a volatile revenue source because it is much more sensitive to swings in the economy than a revenue source like the property tax, for instance. This is an important consideration for Colorado Springs, considering that sales taxes (and the closely associated use tax) account for over half of the general fund’s revenues.10 No other revenue source comprises more than a fifth of general fund revenue (the next largest is transfers from other funds, at about 17 percent); the property tax, normally a large revenue source for municipal governments, accounts for less than 10 percent.

This section will first analyze the volatility of the sales tax, as well as two closely associated revenues – the use tax and sales tax audit revenue. Following that, the stability of the general fund’s other important revenue sources will beexamined.

Sales and Use Tax
A first step is to understand the level and nature of volatility in the sales tax. The sales tax appears to follow fairly predictable seasonal patterns. Exhibit 2.1 shows annual sales tax revenues for 2007 through 2011 and Exhibit 2.2 shows monthly sales tax revenue since 2006.11 In Exhibit 2.1, use tax and revenues from sales tax audits are removed. These revenues add “noise” to the pure sales tax data, making it more difficult to analyze. They are also much smaller revenue sources – use tax is 7 percent the size of sales tax and audit revenues are 3 percent of all sales tax revenue. These revenues will be discussed later in the report.

Exhibit 2.1
Five-Year Trends for Sales Tax
2011 2010 2009 2008 2007
Revenue $111,735,533 $108,212,533 $101,247,887 $107,356,298 $113,211,788 Annual Change 3.3% 6.9% -5.7% -5.2% 1.7%
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Exhibit 2.2
Seasonal Peaks in City Sales Tax Revenue
The red circles in Exhibit 2.2 denote January revenues, which are always the highest of the year due to holiday shopping. The green circles show revenues from July, October, and April, which all see revenue spikes (due to quarterly sales tax filings for smaller vendors). This pattern and even the relative magnitude of the spikes are quite consistent from year to year, even as far back as 1996. In fact, a statistical analysis shows that only a 2 percent change in sales tax revenue is attributable to random variation. About 91 percent is due to fundamental economic trends/business cycles (also known simply as “trend-cycle”), and 7 percent is explained by seasonal variation.12 This means that random fluctuations in the sales tax should not concern the City. However, it also means that the influence of economic cycles is very strong. An unexpected shift in the economy could have serious ramifications for City revenues, as the City has experienced in the wake of the 2001 recession and the more recent Great Recession. Exhibit 2.3 (on the following page) shows the trend-cycle line for sales tax13 overlaid on monthly sales tax revenues. The red arrows show the beginning and end-points of significant downtrends. The first one started in April 2001 and lasted until May 2003. The trend-cycle declined 6.6 percent over 25 months, or about a quarter percent per month. The second started in July 2007 and lasted until April 2009. The trend-cycle declined 11.2 percent, or just over half a percent per month.

Obviously, the decline associated with the Great Recession was much sharper than the 2001 recession, both in terms of overall decline and speed of the decline. In fact, so severe was some of the financial fallout from the Great Recession that some have dubbed it what acclaimed financial thinker Nasim Talib has termed a “Black Swan” event – a rare and unpredictable event that has an extreme impact.14 Black Swans are, by definition, impossible to predict, so the best that anyone can do is to be prepared. The accomplished forecasting scientist Spyros Makridakis has suggested a “Triple-A” approach (described on the next page) for dealing with this kind of uncertainty.15 10 There are four consistent spikes in sales tax revenue during the year, with January being the most important. The other spikes occur in July, October, and April.

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1. Accept. First we must accept that we are subject to uncertainty. Even though the sales tax is subject to relatively little random variation, it is clearly subject to Black Swans. Because it is relatively easy to imagine scenarios that could cause the Colorado Springs economy to suffer (e.g., European financial crisis, federal debt crisis, a significant reduction in military spending due to federal budget shortfalls, etc.), we must also accept that the economy is subject to additional potentially dangerous unknowns that we cannot imagine.

2. Assess. Next we must assess the potential impact of the uncertainty. Past history can provide a useful reference point. We saw earlier that a downturn in the trend-cycle has lasted as long as 25 months and has been as severe as a 0.53 percent monthly decline. The rate of decline is more relevant to the discussion of general fund reserves because a more protracted decline should be dealt with by restructuring the budget, not necessarily with continuous use of fund balance. Even so, it is important to consider both.

3. Augment. The range of uncertainty we really face will almost always be greaterthan we assess it to be, so we should augment that range. For example, we used the experience of the Great Recession as a reference point for our worst-case monthly decline (0.53 percent). However, many economists believe that the effects of the Great Recession would have been much worse had the federal government not taken the actions that it did.16 Who is to say that continued gridlock in the federal political system (or other circumstances) won’t prevent an effective mitigating response to the next crisis? As a rule of thumb, Makridakis suggests doubling your range of uncertainty if you have little historical data to rely on or multiplying it by 1.5 if you have more. We have a good deal of data, so a 1.5 multiplier seems appropriate, giving us a 0.8 percent monthly decline. That translates to a potential 20 percent decline over 25 months. This does not necessarily mean that the City should reserve this entire amount, though, because Exhibit 2.3
Sales Tax Monthly Revenue and Trend-Cycle
The City has experienced two major downturns in the sales tax trend-cycle. The first one started in April 2001 and lasted until May 2003. The trend-cycle declined 6.6 percent over 25 months. The second started in July 2007 and lasted until April 2009.

The trend-cycle declined 11.2 percent.
11

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Sales Tax Point of Comparison
Appendix 1 provides a similar analysis of monthly sales tax data from the City of Boulder, Colorado, in order to provide a sense of context for how volatile sales tax revenue is in another jurisdiction. presumably, in the event of a financial Black Swan, the City would take action to reduce spending – not just continue to spend as it had before. The implications of the sales tax analysis, along with the other analyses performed by the GFOA, for the City’s reserve strategy will be addressed in the fourth section of this report.

As mentioned earlier, audit revenues were removed from the sales tax data for purposes of this analysis. As Exhibit 2.4 shows, from 2007 through 2011, audit revenues ranged between $3.3 million and $2.2 million. It has experienced some fairly significant swings in this time as well. However, a $1 million potential for variation is probably not material in the entire City revenue portfolio. The City expects sales tax audit revenues to continue into the future within the same general range that they have occurred in the past.

Use taxes were also removed from the sales tax data. Exhibit 2.5 (on the following page) shows the five-yeartrend analysis for use taxes. Use taxes are not quite as volatile as auditrevenues, but are still rather volatile. In fact, GFOA’s statistical analysis showed that almost 15 percent of the variation in use tax is attributable to simple randomness (compared to 2 percent for sales tax). However, more importantly, the use tax has experienced a notable decline since 2008. Examination of the long-term history shows that the revenue experienced a rapid increase in 2005, coinciding with the construction boom and use taxes from commercial construction and manufacturing equipment. Revenue stayed at about this level until 2008, when tax revenue declined considerably as these industries experienced a slowdown in their growth. Hence, the change we see in Exhibit 2.5 is less a product of random variation and more a product of a fundamental change in the tax base. Hence, use taxes have likely settled in at a new, lower level of yield that is reflective of reduced economic activity in commercial construction and manufacturing equipment (in fact, the lowest level since 1996). As such, there is probably little risk of another significant downside move.17 In fact, an analysis of the sources of the use tax shows that income from construction-related trades has fallen substantially in recent years. For example, revenue from building general contractors in 2011 was 12 percent of what it was in 2007, and revenue from subcontractors was 27 percent of 2007 levels. Also, total vacancy rates for commercial properties have hovered around 10 percent for the last two years, up from 7.7 percent in 2008. This indicates that there may be excess capacity in Colorado Springs, such that a significant uptick in building is not likely in the near term.

Exhibit 2.4
Five-Year Trends for Sales Tax Audit Revenue
2011 2010 2009 2008 2007
Revenue $3,284,390 $2,369,723 $3,250,245 $2,189,116 $2,210,099 Annual Change 32.8% -27.1% 48.5% -0.9% 51.3%
12

While sales tax is clearly the most important revenue, an analysis of reserve requirements should take account of other revenues as well, given that other revenues comprise half of the City’s budget.

Below is a summary of other major sources of revenue and their associated volatility risk.

Property Taxes. Property taxes comprise only about 9 to 10 percent of theCity’s budget. TheCity has experienced a steady decline in property tax revenues in recent years, with a primary cause being a reassessment and lower property values owing to the decline in the housing market. Nationally, the housing market seems to have stabilized, at least to the point where another major decline is unlikely.18 An examination of Colorado Springs’ housing prices shows that Colorado Springs seems to essentially follow national trends.19
Charges forService.Charges for service are about6to7 percentofthegeneralfund budget. Revenues from charges for service have fallen substantially in recent years, now budgeted at 70 percent of the 2009 actual revenues. This is mostly due to a sharp decline in charges for services for construction/development regulation. Hence, the user fees do have some vulnerability to economic cycles. A reserve could be useful, but the City might also consider other policies to mitigate risk. For example, a policy that sets cost recovery goals for fees would prompt a discussion of how to reduce costs if revenues were not up to expectations. Regardless, it may be helpful to have a small reserve in order to allow gradual adjustments to drop-offs in revenues. In recent history, the total charges for service revenues have dropped $3 million in one year. At this point, fees that are more sensitive to economic conditions (e.g., construction-related fees) have probably reached or are approaching a bottom. Accordingly, a $3 million reserve should probably be more than adequate.

IntergovernmentalRevenue.Intergovernmentalrevenueisabout9to10percentofthegeneralfund budget. By far, the most important component of this is the highway users tax, at about 90 percent of the total. The highway users tax is intended to support traffic safety and road maintenance programs.

There has been political pressure at the state level to reduce the resources that support the tax, but, so far, this has not happened. However, if one of these efforts were successful the City would find itself with reduced revenue. City staff believes that the Funding Advancements for Surface Transportation and Economic Recovery (FASTER) portion of the highway users tax is the most vulnerable to being eliminated (about $1.5 million), so reserve strategy could focus on replacing that amount for one year (after which point the City would presumably have adapted).

The City also receives a number of grants for capital projects, and some for operations. These grants are not accounted for in the general fund, but if the grants were to be lost there could be some pressure on the general fund to continue the associated service. For capital projects, the City would likely cancel or defer the project or find another source of funding, rather than using reserve to make up the shortfall from a lost grant. Lost grants for operations may require some support from the general fund in order to provide continuity in service (assuming the City cannot simply discontinue the service). A reserve of $3 million appears to be adequate to cover this risk, based on the level of grants used to support core operating programs currently.

Exhibit 2.5
Five-Year Trends for Use Tax
2011 2010 2009 2008 2007$
Revenue $6,024,785 $6,454,560 $5,668,451 $8,490,105 $9,264,952 Annual Change -6.7% 13.9% -33.2% -8.4% -12.4%
13

Exhibit 2.6
Risk Profile for Bridges and Culverts
Transfers from Other Funds. TheCity receives about17 percentof its revenue from transfers from other funds (from City utilities). This transfer is a matter of City Council policy. There do not appear to be any major threats to the continued economic viability of this policy, so any change would have a political genesis. A decision to reduce the transfer should be made in the context of how it will impact the budget, so a reserve should not be necessary.

INFRASTRUCTURE
Healthy infrastructure makes for an economically vital community. However, worn infrastructure poses a potential risk of untimely failure. General fund reserves may be needed to repair or replace an asset that fails unexpectedly. In Colorado Springs, the two asset classes that were deemed to be of the greatest importance are bridges and storm sewers.

Exhibit 2.6 shows a risk profile for bridges and culverts. Risk is defined as the product of probability of failure and the consequences of failure. Probability of failure is based on the bridge sufficiency index (BSI) provided by the City staff. A lower BSI indicates a bridge that is in worse condition and ultimately a higher risk (probability) to fail. Consequence is based on cost – the higher the replacement cost of an asset, the higher the consequence to the City if that asset were to fail.20 As can be seen in the exhibit, 13 bridge structures have been identified as having a high risk rating (those bridges in the red area, which have a total score of between 8 and 10, when the scores from each axis are added together). These bridges have an estimated replacement value of $22,752,672. This averages to about $1.75 million per bridge. A reserve that covers one or two bridges should be adequate, 14 Grant Policy
The City auditors have pointed out that overreliance on grants is a potential risk for the City. A policy that limits the City’s exposure to the risky elements of grants could be helpful. Section 4 of this report describes how grant policies might be helpful.

but using the “Triple-A” rule (described earlier) of doubling our expectation for uncertainty, preparing for the premature failure of three of these bridges might be more prudent. This equates to a $5.25 million reserve.

In addition to the bridges and culverts, the City manages 406 miles of storm lines. However, neither install dates nor condition assessments were available for any storm lines. The estimated replacement cost for all storm sewers is $588,052,836.21 Since the information necessary to assess risk of failure is not available, the best that can be done is to make an assumption. We do know that about 10 percent of the total dollar value of the City’s bridge inventory is in the higher risk category, so it may be reasonable to start with that number for storm sewers, which would translate to $58 million. We also know that about 20 percent high risk category of bridges was recommended as a reserve amount, which would equate to $11.6million.

We will review how this analysis for bridges and storm sewers fits into an overall reserve strategy in Section 4 of this report.

VULNERABILITY TO EXTREME EVENTS AND PUBLIC SAFETY CONCERNS This factor concerns the extreme events (e.g., natural disasters) the City is vulnerable to, the public safety programs that must be funded during the occurrence of an extreme event, and the federal or state programs that would help and how long it would take to get assistance. For example, reimbursement from the Federal Emergency Management Agency (FEMA) does not always occur right away, so it is important to have reserves to absorb the cost in the meantime, and FEMA does not necessarily reimburse 100 percent of the cost of responding to an event.

Discussions with the City’s Emergency Operations Manager reveal that Colorado Springs is most at risk for wildfires and floods. Wildfires are probably the most important risk, as the fires of 2012 underlined. About 20-25 percent of homes in Colorado Springs are subject to wildfire risk, although fires that damage homes are not that common. The most recent fire was the most destructive in Colorado history. It impacted around 12,000 acres and burned 347 homes. By comparison, the most recent other fires of an extreme size were in 2005 and 2000 and impacted 35 and 800 acres, respectively. No homes were burned in either of those fires – in fact, one must look back to around 1950 to find the last time before 2012 that homes in the City of Colorado Springs were burned by wildfire.

Large wild fires can be expensive to respond to, requiring police and fire personnel for suppression of the fire and evacuation of people. Many other city departments are involved in the recovery efforts.

FEMA reimbursement is not immediate and does not typically cover all the City’s costs of responding. Further, a fire is likely to interrupt the City’s sales tax revenue.

Currently, the City only has estimated costs for the most recent fire, which is $3.75 million in personnel time, mutual aid costs, and other direct expenses. The estimate pertains to the actual firefighting within the City limits and the emergency protective measures taken (e.g., evacuation, security, activation of the emergency operations center, etc.). Of this, the expenses eligible for a 75 percent FEMA reimbursement are estimated to be $2.15 million. Adding together the FEMA ineligible expenses, plus the 25 percent unreimbursed expenses results in a figure of $2.14 million. At least some of this represents expenses that the City would have incurred anyhow (e.g., firefighters on duty). The City government did not incur any significant direct property damage as a result of the fire (probably around $30,000), but there may be some indirect damage to storm sewers later on, as a result of increased run-off, from the fire-damaged areas. The City engages in mitigation efforts, such as deforestation of areas that are atrisk for wildfire, but it is still important for the City to retain a reserve to be prepared for futurewildfires.
15

Floods are also a concern because they damage infrastructure, require a City emergency response, and require debris removal afterwards. The most severe floods were in 1935 and 1965. Otherwise, smaller floods occur about 6 or 7 times in a 10-year period. The last flood that qualified as a FEMA disaster occurred in 1999, though it wasn’t on the scale of the 1965 or 1935 floods. The cost to the City to address the flood damage of 1999 was $2,670,158. The federal share of the project was 75 percent, or $2,002,619; the state share was 12.5 percent, or $333,770; and the City share was the remaining 12.5 percent, or $333,770. This would equate to about $3.67 million in total costs and $460,000 for the City’s final share in today’sdollars.

Blizzards represent a final, less severe risk. The magnitude of impact is not as great as for fires or floods, but the City still incurs an unexpected cost. The last significant cost was in 2007, when the City needed to appropriate an additional $400,000 to deal with snow storms.

In summary, Colorado Springs faces a risk from several types of extreme events that have the potential to cause loss of life and property and to disrupt business. The City has taken steps to protect the health, safety, and welfare of the community in light of these risks. Fortunately, however, these extreme events do not appear to constitute a large risk to the City’s financial position. For example, a reserve of $4 million (compared to annual City revenues of about $220 million) would be more than adequate to cover the cost of either the most recent fire or a flood of similar severity to the 1999 flood, before FEMA reimbursement.

However, using Makridakis’s “Triple-A” approach (described earlier), it may behoove the City to augment the level of risk it is preparing for. We have a very limited number of data points to inform us, so a higher multiplier seems appropriate. If we multiplied $3.75 million by 2 we would get $7.5 million. However, much of an extreme event’s cost would be reimbursed by other parties (e.g., a 75 percentreimbursement from FEMA) and some of this figure would represent costs the City would incur anyhow (e.g., regular salaries for public safety personnel), so a $7.5 million reserve might be excessive. Discussions with City staff indicated that the City would have incurred about one third of the most recent fire’s costs in the normal cost of doing business, and that about half of the reimbursement from FEMA can be expected to be received within six months of the expenditure. Using this as a reference point, a reserve of $3.3 million might represent the minimum prudent reserve amount because it accounts for the fact that the City will have to bear some of the costs of responding to an extreme event in its regular budget, and that another significant portion of the cost will be reimbursed quickly by FEMA. A reserve of $5 million might be a middle ground because it does not account for FEMA reimbursement (which is outside the control of the City).

Section 3 will consider the all the foregoing analyses together in order to present a final recommended reserve target for theCity. 16

3. Secondary Risk Factor Analysis
This section presents an overview of risk factors that are less complex or of lower magnitude than the primary risk factors, but that also have implications for the City’s general fund reserve strategy.

LEVERAGE
A highly leveraged organization has less flexibility. Examples of leverage include long-term debt, pension obligations, and obligations for post-employment health care. Reserves are a critical source of financial flexibility, so high leverage may call for higher reserves. This section will address each of the aforementioned sources of leverage.

Debt
The City has very little debt. Exhibit 3.1 demonstrates this by comparing the City’s level of indebtedness to other cities. Exhibit 3.1 includes a group of cities that Colorado Springs has identified as “Best in Class” for the purpose of comparing the City’s business practices to those of other, similar cities.

Exhibit 3.1 also includes two “sales tax comparable” cities – Colorado cities that receive a large portion of their revenue from sales taxes, but are not otherwise as similar to Colorado Springs. Finally, the exhibit provides summary statistics of all these municipalities. Exhibit 3.1 compares debt along Exhibit 3.1
Comparison of Colorado Springs’ Indebtedness with Other Cities “Best in Class Cities”
Colorado Fort Collins Oklahoma Denver Indianapolis
Springs City
Population 422,816 144,875 580,000 619,968 820,445
Charlotte
731,424
Debt per Capita 256 342 1,072 2,702 1,445 1,829
Debt Service as a
% of Expenditures 5.9% 3.5% 10.2% 10% 13.8% 15.2%
Sales Tax Comparables Summary Statistics
Colorado Lone Tree Centennial Average Median
Springs
Population 422,816 11.097 100,377 553,255 599,984
Debt per Capita 256 2,558 28 1,274 1,258
Debt Service as a
% of Expenditures 5.9% 10.4% 0.3% 9.8% 10.1%
The City has substantially lower debt levels than the average of the comparison group. 17

two commonly used measures of indebtedness. The first, debt per capita, measures the burden placed on citizens by municipal indebtedness. The second measure is debt service (principal and interest payments) as a percent of city expenditures. This figure measures the pressure placed on the budget by debt payments. Colorado Springs is well below the average on both of these measures.

This means that Colorado Springs should not find its financial flexibility reduced by excess debt. In fact, the City’s debt capacity could offer an alternative source of financial flexibility. For example, if the City were found liable for an exceedingly large judgment that was due immediately, it might be able to use debt instruments to pay the amount over time.

The reader should note that the GFOA did not use only the general fund financial information to calculate these ratios, but rather used the broader categories of “governmental activities” and “governmental funds,” which can be found in any comprehensive annual financial report. This is because all the cities accounted for debt in different funds, so looking at just the general fund would provide a partial, and inaccurate, impression. However, the aforementioned categories have fairly standard meanings across government and they include most of the general government services one would typically associate with a municipality, such as public safety and public works. Therefore, they address debt of a general nature, which does have direct relevance to the financial flexibility of the general fund.

These general government categories, though, exclude utilities and other more business-like activities. The business-like category of services was excluded for two main reasons. First, municipalities do not provide these types of services as consistently as they do general government services. Second, these services, particularly utilities, often carry large amounts of debt, and would therefore have had a major impact on the indebtedness measures. However, this debt has a much more indirect relationship to the financial flexibility of the general fund.

Pensions
The City is involved in four different self-funded pension arrangements, all of which are closed to new participants.
• The Old Hire Police Pension Fund has been closed and has 166 total members. The plan is 81 percent funded as of January 1, 2012. GFOA Best Practices call for 100 percent funding of pension liabilities.22 The plan has an unfunded liability of $16.1 million, which translates into an annual actuarial required contribution (ARC) of $1.5 million for 2013, up from $1.4 million in 2012.
• The New Hire Pension Plan – Police Component has 650 members and a funded ratio of 80.2 percent. The plan has an unfunded liability of $48.8 million, which translates into an annual ARC of $10.6 million for 2013, up from $9.6 million in 2012. • The Old Hire Fire Pension Fund has 193 members and is 84.1 percent funded. The plan has an unfunded liability of $15.5 million, which translates into an annual ARC of $1.5 million for 2013, which is about the same as 2012.
• The New Hire Pension Plan – Fire Component has 286 members and is 79.2 percent funded.

The plan has an unfunded liability of $25.9 million, which translates into an annual ARC of $4.7 million for 2013, which is down from $ 5.2 million in 2012.

The City also participates in two statewide plans. The Colorado Public Employees Retirement Association for is for civilian employees. As of December 31, 2011, the PERA Local Government Division’s funded ratio was 69.3 percent, with an unfunded liability of $1.277 billion. Of course, this underfunding could have some impact on the City in the form of increased contribution rates in the future. The Fire and Police Pension Association of Colorado provides a defined benefit plan for sworn officers. It is funded at over 100 percent as of January 1, 2011.
18

Another issue common to all pension funds is the assumed rate of return on pension fund assets.

Pension funds often assume return rates of around 7 to 8 percent annually. The recent performance of investment markets has led some to question the return assumptions the Colorado Public Employees Retirement Association uses. If circumstances were to require the association to lower its return assumptions, then member governments would have to increase contributions to make up the difference.23
Assuming that the City keeps up with its ARC payments, the unfunded accrued liabilities should, in theory,24 be covered by the end of the amortization period (which can vary with the plan, but typically is between 20 and 30 years). Keeping up with the ARC payments is a matter of City budgetary policy, and not really an issue that should be addressed through using reserves. However, given the uncertainty around pension issues, it is difficult to say when increases would occur or how much they might be. Accordingly, it would be prudent to hold some reserve to help make a more gradual adjustment to any potential large increases in contribution rates. The City currently pays about $10.5 million in annual contributions to the Colorado Public Employees Retirement Association and about $14.5 million to the other pensions, for total of about $25 million. A reserve of $6.25 million would cover a 25 percent increase in pension costs. Of course, an increase in the City’s contribution would be felt over many years, but the reserve will allow the City to make a gradual adjustment or to more easily absorb a larger increase in contributions in one year.

The City has considered different actions to mitigate its pension liabilities, including increasing the contributions required from employees and switching to a defined contribution pension plan. It has also shifted away from a single-employer plan to the state plan for the most newly hired sworn officers, which should be less volatile and help mitigate risk.

Other Post-Employment Benefits (OPEB)
The City allows retired sworn police officers to stay on a City-sponsored medical plan. The cost of this benefit is paid for by the City as it is incurred. The City’s annual required contribution for OPEB is $2.2 million and there is a net obligation of $11.2 million. The City has taken steps to contain its OPEB liability, such as eliminating the City-provided subsidy forretiree health care for new hires and going to a flat (instead of variable) subsidy for existing employees. Hence, similar to pensions, the City will likely not experience near-term, large expenditure spikes or a drastic decrease in the City’s financial flexibility owing to OPEB liabilities. Also, like pensions, the financial pressure created by OPEB liabilities is best addressed through the budget process, not general fund reserves.

EXPENDITURE VOLATILITY
This risk factorrefers to potential spikes in expenditure, usually arising from a special, non-recurring circumstance. Expenditures of a recurring nature should not be addressed through the use of reserves, since reserves do not represent a sustainable source of funding for recurring expenditures.

Rather, recurring expenditures should be accommodated in the operating budget.

In Colorado Springs, lawsuits appear to be the most important potential source of expenditure spikes, especially because the City’s risk management funds do not carry a large amount of reserves themselves, requiring the general fund to backstopthem.

Discussions with the City’s attorney and risk management professional reveal the following:
• The City faces a number of litigation cases each year. The average potential liability tends to be pretty consistent from year to year. The City normally budgets between $600,000 and $800,000 each year for claims, which generally has proven sufficient. In more recent years, the number of litigation cases has risen somewhat, but this does not appear to be a significant trend. 19

• The City is a facing a couple of extraordinary special cases. Due to the sensitivity of the cases, they will not be discussed in detail in this report, but there is a significant degree of uncertainty around the amount the City could be liable for and if the City will be liable for anything at all. Hypothetically, the liability could represent tens of millions of dollars, but the City Attorney believes that an amount of between $2 million and $4 million is a more realistic estimate of the City’s potential risk. Also, under certain circumstances the City could negotiate a multi-year payment schedule for a large liability.
• In the State of Colorado, certain forms of cancer have been designated as work-related injuries for firefighters. Hence, the City’s worker’s compensation fund will face an increased liability, which will, in part, be covered by the general fund (since the general fund is one of the contributing funds to the worker’s compensation fund). This would not create an expenditure spike, but rather would manifest as an increased annual contribution (probably not to exceed $1 million to $2 million per year). Accordingly, this change to the City’ recurring expenditure structure should be handled through the City’s budget process.

In conclusion, it would seem prudent for the City to account for at least some of the risk associated with the extraordinary lawsuits in its reserves. The final section of this report will address how this risk fits in with the City’s total reserve goals.

GROWTH OF THE COMMUNITY
Rapid growth of the community could call for larger levels of reserves, lest service requirements expand beyond the City’s ability to continue services in the face of revenue interruption. For instance, property tax revenues may not be received until a couple of years after development occurs, yet the government will still need to provide for the public safety, health, and welfare of these members of the community in the meantime. Colorado Springs is a moderate growth community in a higher growth region. The City averages 1.5 percent growth in a region that grows 2 percent annually. The City does not rely heavily on property taxes, so is not heavily impacted by a lag between when services are required by a new development and when revenues are received. Also, the City requires developers to build much of the infrastructure associated with development (roads, parks, etc.), so it does not have to cover that expense. In conclusion, the fact that Colorado Springs is only expecting moderate growth in the next few years and that its development financing approach does notrequire City resources for large capital outlays means that the implications of growth for the City’s reserves are minimal.

LIQUIDITY
A larger amount of unreserved fund balance may be needed to avoid cash flow problems if the average maturity of receivables significantly exceeds the average maturity of payables. A common example of this can be found in governments that are heavily reliant on property taxes. The bulk of taxes may only be received at one or two times during the year, requiring reserves to bridge the months with lower receipts. As stated, Colorado Springs is not very reliant on property taxes at all. In fact, its revenue tends to come in fairly evenly over the year. Exhibit 3.2 (on the following page) shows the projected monthly balances for 2012. As the chart shows, the City’s ending balance actually moves steady upwards for almost the entire year, eventually dropping near the end (due to bond repayments), but still ending up higher than it started. Hence, the City does not appear to have a liquidity problem that requires reserves to coverthe gap.
20

21 The City’s ending balances rise steadily throughout most of the year. 140,000,000
120,000,000
100,000,000
80,000,000
60,000,000
40,000,000
20,000,000
0 Exhibit 3.2
The City’s Projected Monthly Ending Balances for 2012 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12
Nov-12
Dec-12

4. Recommendations
This section provides GFOA’s recommendations to Colorado Springs, based on the analysis presented in this paper. The first sub-section addresses the primary purpose of this report: to recommend a reserve target for Colorado Springs. The second sub-section provides other ideas related to reserve management strategy that Colorado Springs might find helpful, based on GFOA’s experience with best practices in public finance.

RECOMMENDED RESERVE TARGET FOR COLORADO SPRINGS
This section establishes the recommended reserve target for Colorado Springs. As a first step, the report will review the essential findings of the analysis for each risk factor. Next, the report will provide some helpful comparative information, such as the reserve levels maintained by other cities as well as rating agency standards. Finally, all of this information will be synthesized to reach a reserve target.

Comparative Reserve Information
When considering a reserve target it is helpful to consult outside standards. Two widely cited standards are GFOA’s Best Practices and rating agency guidelines. The GFOA Best Practice recommends, at a minimum, that general-purpose governments, regardless of size, maintain unrestricted fund balance in their general fund of no less than two months (16 percent) of regular general fund operating revenues or regular general fund operating expenditures.25 Standard & Poor’s considers reserves of between 1 percent and 4 percent of revenues to be “adequate,” while reserves above 15 percent are “very strong.”26
It is also useful to consider the experiences of other governments. Exhibit 4.1 compares Colorado Springs’ unrestricted fund balances as a percent of general fund revenues to the same cities that appeared in the debt comparison (Exhibit 3.1). “Unrestricted fund balance” is usually used to describe the portion of fund balance that is available to serve as a reserve for the types of risk mitigation purposes that were described in this report (i.e., respond to extreme events, protect against revenue downturns, etc.). This is because unrestricted fund balance is the portion of fund balance that does not have restrictions placed on its use by outside authorities. 22

As Exhibit 4.1 shows, the typical unrestricted fund balance falls somewhere in between 20 percent and 25 percent of general fund revenues. Most of the cities in the analysis were closer to 20 percent, but two outliers (Indianapolis and Centennial) pulled up the average.

The average level of unrestricted fund balance (i.e., reserves) falls between 20 percent and 25 percent for the comparable group. Colorado Springs falls within this range right now. The outliers in the comparable group (Indianapolis and Centennial) have special circumstances.

Indianapolis had a very large amount of “committed” fund balance, which is a subcategory of “unrestricted” fund balance. “Committed” fund balance is considered to be the most constrained of three subcategories of unrestricted fund balance because the City’s management has committed those reserves for a very specific purpose (the other two subcategories are “assigned” and “unassigned”).

While it is impossible to say from Indianapolis’s public reports, it could be that this unusually large amount has been accumulated to pay for a special project of some kind or is otherwise not intended as a hedge againstrisk. In fact, if this amount is removed, Indianapolis’s reserve drops to 22 percent – much more consistent with the other cities. None of the other cities had nearly as large an amount, by any measure, of committed reserves. For example, 61 percent of Indianapolis’s reserves are committed, while Colorado Springs only has about 3 percent in this category and Denver has about 8 percent, making Denver’s fund balances the most highly committed after Indianapolis.

As for Centennial, about 75 percent of Centennial’s reserves are in the “unassigned” subcategory (the least constrained of the three), which suggests that Centennial has simply accumulated a much higher relative level of reserves than the other governments in Exhibit 4.1. Interestingly, Centennial also has, by far, the lowest debt burden of any of the cities (see Exhibit 3.1). This high reserve, coupled with an extremely low debt burden suggests that Centennial has a significantly different economic base than the other cities. For example, the median household income in Centennial is $85,500, compared to $51,000 in Colorado Springs and $55,400 in the State of Colorado. The median home value in Centennial is $260,000, compared to $182,000 in Colorado Springs and $205,000 in the State of Colorado.27 In 2010, the unemployment rate in Centennial was 4.8 percent, compared to 9.4 percent in Colorado Springs. Although neither municipality relies very heavily on property taxes, it is interesting to note that the total assessed value of properties in Centennial is 34 percent greater on a per person basis than in Colorado Springs. Finally, Centennial’s general fund revenues are, on a per capita basis, 20 percent greater than those of Colorado Springs, even though Centennial appears to Exhibit 4.1
Unrestricted Fund Balance Comparison
“Best in Class Cities”
Unrestricted Fund Balance
as a % of Revenues
Colorado
Springs

22.6%
Fort Collins

23.1%
Oklahoma
City

12.7%
Denver

18.3%
Indianapolis

56.9%
Charlotte

17.3%
Sales Tax Comparables Summary Statistics
Colorado Lone Tree Centennial Average Median
Springs
Unrestricted Fund Balance
as a% of Revenues 22.6% 29.6% 52.9% 25.2% 20.5%
The average level of unrestricted fund balance (i.e., reserves) falls between 20 percent and 25 percent for the comparable group. Colorado Springs falls within this range right now. The outliers in the comparable group (Indianapolis and Centennial) have special circumstances.
23

provide a more limited set of services to its citizens (for example, Centennial is served by a separate fire protection district and recreation district, while Colorado Springs provides these service directly). These distinctive characteristics have likely made it more practical for Centennial to accumulate a sizablereserve.

Putting it All Together: The Reserve Recommendation
In order to reach the final recommendation for a reserve target for Colorado Springs, let’s firstreview the individual analysis results from each of the risk factors.

Primary Risk Factor – Revenue (Sales Tax) Volatility. While the sales tax does show some volatility,this is due almost entirely to economic cycles and seasonal effects (as opposed to random variation).

Therefore, the most important vulnerability the City has with respect to sales taxes is an economic downturn. A review of past economic downturns leads us to believe that the City should prepare for a potential 20 percent decline in sales tax revenues over 25 months as a plausible “worst case scenario” (this amounts to about $23 million in reduced revenue). However, the City would presumably reduce its spending in the event of such a severe downturn, such that a reserve to cover the entire amount of the revenue decline would not be necessary. The City budget office estimates that the budget could be reduced by just under $10 million without creating a major disruption to services (though service quality would be negatively affected to some degree, of course). This means the City should maintain a reserve of at least $13 million to fill the remaining portion of the revenue gap and to help the City make a “soft landing” in the case of a major revenue decline.

The City’s other revenue sources are fairly stable as a group, but as a prudent measure the GFOA has recommended establishing some reserves to account for volatility. These reserves added up to $7.3 million.

Primary Risk Factor – Infrastructure. General fund reserves may be needed to repair or replace an asset that fails unexpectedly. In Colorado Springs, the two asset classes that were deemed to be of the greatest importance are bridges and storm sewers.

Thirteen bridge structures have been identified as having a high risk rating. These bridges have an estimated replacement value of $22,752,672, an average of about $1.75 million per bridge. A reserve that covers one or two bridges should be adequate; it might be more prudent, however, to use the “Triple-A”rule of doubling our expectation for uncertainty and prepare for the premature failure of three of these bridges. This equates to a $5.25 million reserve.

The City manages 406 miles of storm lines. Installation dates and condition assessments were unavailable for any storm lines. The estimated replacement cost for all storm sewers is $588,052,836.28 Since the information necessary to assess risk of failure is not available, the best that can be done is to make an assumption. We do know that about 10 percent of the total dollar value of the City’s bridge inventory is in the higher risk category, so it may be reasonable to start with that number for storm sewers, which would translate to $58 million. We also know that about 20 percent high risk category of bridges was recommended as a reserve amount, which would equate to $11.6 million.

Primary Risk Factor – Vulnerability to Extreme Events. Although theCity is subjectto extreme events that pose a significant threat to life and property, historical experience has demonstrated that the financial impacts of these events have been manageable. For example, the most recent fire was the worst in Colorado history, but the total cost to the City was only $3.75 million (the City’s annual budget is about $220 million). Taking into account the uncertainty associated with the scale of future extreme events as well, as well as the timing of FEMA reimbursement and the portion of event response costs that are likely going to be already covered by existing budgeted resources a reserve for extreme events of $5 million seems reasonable, but an argument for a reserve of up to $7.5 million could also be made.
24

SecondaryRiskFactor–Leverage.TheCityhasverylittledebt,sotheCity’sreservestrategydoesnot need to account for reduced financial flexibility from debt.

The City has some financial pressure from pension obligations. It participates in a number of plans, none of which is 100 percent funded. The Colorado Public Employees Retirement Association is a particular concern for City officials because it has a low funding ratio and its assumptions around the return on plan assets have been publicly questioned for being too high. Both of these factors mean that the Association may require significantly increased contributions from its member governments.

Assuming that the City keeps up with its annual pension payments, the unfunded accrued liabilities should, in theory, be covered by the end of the amortization period (which can vary with the plan, but typically is between 20 and 30 years). Keeping up with the ARC payments is a matter of City budgetary policy, and not really an issue that should be addressed through using reserves. However, given the uncertainty around pension issues, it is difficult to say when increases would occur or how much they might be. Accordingly, it would be prudent to hold some reserve to help make a more gradual adjustment to any potential large increases in contribution rates. The City currently pays about $10.5 million in annual contributions to the Colorado Public Employees Retirement Association and about $14.5 million to the other pensions, for total of about $25 million. A reserve of $6.25 million would cover a 25 percent increase in pension costs. Of course, an increase in the City’s contribution will be felt over many years, but the reserve will allow the City to make a gradual adjustment or to more easily absorb a larger increase in contributions in one year.

Secondary Risk Factor – Expenditure Volatility. The City is facing a few large lawsuits that could entail significant settlement costs if judgment goes against the City. The City attorney believes that $2 million to $4 million is a reasonable range to prepare for.

Secondary Risk Factor – Liquidity/Cash Flow. The City faces no important liquidity or cash flow problems that create a shortage of working capital.

Secondary Risk Factor – Growth of the Community. The factthat Colorado Springs is only expecting moderate growth in the next few years and that its development financing approach does notrequire City resources for large capital outlays means that the implications of growth for the City’s reserves are minimal.

In summary, the components of a recommended reserve are:
• $13 million for sales tax economic uncertainty
• $7.5 million for economic uncertainty in other revenues • $6.25 million for pension paymentuncertainty
• $5.25 million for critical bridge failure and $11.6 million critical storm sewerreplacement, for a total of $16.85 million
• $5 million to $7.5 million for extreme events
• $2 million to $4 million for expenditure spikes from law suits Many cities express their reserve policy target as single number (e.g., 16 percent of revenues). However, the GFOA has found that leading municipalities often find it helpful to segment their reserves into different categories because this makes the purpose of the reserve more transparent. For example, a reserve for “emergencies” and a reserve for “economic uncertainty” would provide more clarity on the purpose of the reserves than one all-encompassing reserve. The first three bullets above could comprise the budgetary uncertainty reserve, while the last three would form the emergency reserve, 25

leading to the following targets (which have been rounded to the nearest whole numbers for ease of use in policymaking):29
Budgetary Uncertainty Reserve
$13 million for sales tax economic uncertainty +
$7.5 million for economic uncertainty in other revenues + $6.25 million for pension payment uncertainty =
$27 million or about 12.5% of general fund revenues30 as budgetary uncertainty reserve Emergency Reserve
$5.25 million for critical bridge failure and $11.6 million critical storm sewerreplacement, for a total of $16.85 million +
$5-7.5 million for extreme events +
$2-4 million for expenditure spikes from lawsuits =
$27 million or about 12.5% of general fund revenues as an emergency reserve This provides a target of about 25 percent of general fund revenues, which is also in line with the range of reserves maintained by cities comparable to Colorado Springs and is above what the GFOA considers to be the minimum baseline level that a government should maintain (16 percent).31 These reserves would be considered part of the “unrestricted” portion of the City’s fund balance.32

OTHER IDEAS TO SUPPORT THE GENERAL FUND RESERVE STRATEGY This section presents other ideas that Colorado Springs may wish to consider, relative to its reserve strategy. These ideas include: enhanced sales tax monitoring, a user fee cost recovery policy, a volatile revenue policy, a short-term borrowing policy, and a grants policy.

Sales Tax Monitoring
Because a potential decline in sales tax revenue is the major driver for the City’s need to retain reserves, it might consider additional methods to monitor the potential direction of its sales tax revenue. The City already employs some fairly sophisticated long-range forecasting methods. It should continue to refine these practices, and continue looking for leading indicators of sales tax performance. However, the GFOA did not conduct an in-depth examination of the City’s long-range forecasting methods, so this report will focus on how some of the techniques presented in this paper might be helpful going forward.

First, the City might monitor a 12-month, centered moving average, updating it each month. As Exhibit 2.3 demonstrated, the 12-month moving average reveals long-term trends that are not as readily apparent from monthly data, especially when month-to-month fluctuations are so dramatic (even if the fluctuations are rather predictable). If the moving average starts to turn down, it could indicate a real trend. Of course, the problem with this approach is that a moving average will always be five to six months behind, since the analysis must wait for the historical data to become available. A more immediately useful technique would be to compare monthly fluctuations to the average. If a month that is normally a high-yield month does not come in as strong as expected or if a month with normally low yield is particularly bad, it could portend trouble. Exhibit 4.2 (on the following page) shows how the months of the year compare to both the 12-month moving average and to the month before it (e.g., how January compared to December, etc.). The month-to-month numbers are often larger because revenues sometimes go from peak to valley and vice versa very quickly. The month-tomonth numbers will also be easier to use, because they don’t rely on the availability of moving average data. 26

Exhibit 4.2
Average Monthly Variations in Sales Tax Revenue
User Fee Cost Recovery Policy
User fees represent about 6 percent of all general fund revenue. User fees are an increasingly popular way to fund municipal services because they assign the cost of the service directly to the customer, as opposed to the general taxpayer. The City could strengthen its user fee base by adopting an official policy on the extent to which it will seek to recoverthe costs of providing services through a user fee.

A user fee costrecovery policy could be very detailed – setting precise targets forthe percent of cost to recover for different types of services.33 However, most governments take an approach that allows for more discretion, where the policy establishes full recovery as the goal for user fees, but recognizes that there will be occasional exceptions. This policy from Minneapolis, Minnesota, illustrates:

The city shall establish user charges and fees at a level that reflects the service costs… Full cost charges shall be imposed unless it is determined that policy, legal, or market factors require lower fees.

This policy approach will require that it be decided, on a case-by-case basis, where subsidization of a service with general tax dollars is appropriate.

User fees can be a complex and, sometimes, controversial revenue source. It may be helpful to establish a policy that describes the fundamental goals of user fees and a mechanism for regular fee review. The GFOA has made available considerable detailed information on fee policies.34 Volatile Revenue Policy
As we have seen, the sales tax can be strongly influenced by the state of the economy. Just as an economic downturn can depress sales taxes, a buoyant economy can lead to a rapid increase. This presents a financial risk if these new revenues are used to fund recurring expenditures (e.g., new on-going programs and their associated personnel) and if these new revenues stem from an unsustainable level of consumer spending. A volatile revenue policy encourages a government to examine its past revenue trends to determine when it may next experience an anomalously high level of revenue income, and then to apply this revenue toward non-recurring uses, such as paying off debt, building up a reserve, or special projects that will reduce future operating costs.

Average % Difference
from Previous Month
Average % of the
12-Month Moving Average
January 35.7% 125.0%
February -33.8% 82.5%
March 3.1% 84.4%
April 22.1% 103.1%
May -10.9% 91.4%
June 7.8% 98.5%
July 15.2% 113.0%
August -8.2% 102.5%
September -0.3% 102.2%
October 5.6% 107.4%
November -8.0% 95.4%
December -4.5% 92.4%
27

The policy for the City and County of Denver, Colorado, illustrates this type of policy:

It is not prudent to allocate sales tax revenue that exceeds the normal growth rate (defined as the aver‐ age annual growth rate over the last ten years) to ongoing programs. Therefore, sales tax revenues that exceed the normal growth rate should be used for one‐time expenditures or to increase reserves for the inevitable economic downturns.

Short-term Borrowing Policy
As Exhibit 3.1 showed, the City has a very low level of debt. Debt can be a source of financial flexibility, thereby mitigating the need to hold reserves. Short-term debt could be useful if the City finds itself with the need for a temporary cash infusion (to deal with an unexpected situation). However, short-term borrowing from external sources is usually considered undesirable due to, among other things, the administrative costs of arranging the deal. Accordingly, a policy usually places limits on short-term external borrowing. For example, a policy might specify that short-term instruments be used only if the transaction costs plus interest of the short-term debt are less than the cost of internal financing and if available cash is insufficient to meet working capital requirements. A policy could also state that short-term debt issued for operating purposes will be limited to cases where there is reasonable certainty that a known revenue source will be received in the current fiscal year sufficient to repay the debt, or where there is a clear financial emergency.

For many governments, interfund borrowing is preferred to external borrowing. For example, the City’s utility may make a loan to the general fund or vice versa. This is another way to increase financial flexibility, beyond that provided by reserves. A policy for interfund loans is useful because, if not carefully managed, the loans can become a cross-fund subsidization, which could lead to one group of taxpayers or ratepayers subsidizing another group. A policy can establish terms and guidelines to help avoid overly burdensome loans. The following are suggested elements for an internal loan policy:

DefinitionofaLoanvs.aTransfer.Apolicyshoulddifferentiatealoanfromatransfersincetheimplications of each are different. Essentially, the difference is that operating transfers move financial resources from one fund to another, permanently, while interfund borrowings are usually made for temporary cash flow reasons and are not intended to result in a transfer of financial resources by the end of the fiscal year.

CriteriaforMakingLoans.Justasaprivate lenderwouldapplycriteriatoapotentialborrower,apolicy should describe the general conditions under which an internal loan is permissible. A policy should describe these conditions and designate the appropriate authority responsible for authorizing the loan. Here are some examples of such conditions:
• The lending fund has funds available.
• The borrowing will not adversely impact the lending fund’s long-term financial condition. • A specific source of repayment has been identified in the borrowing fund. • The loan can be repaid within a specified period of time. • Any legal requirements/restrictions are satisfied.

Interest Rates and Terms. Apolicy shouldalsoprovide guidelinesonterms and interestrates.Typically, interest rates would match prevailing rates, with the exact rate set by the finance office. For long-term loans, a repayment schedule must be set, but the loan should typically be fully amortized, preferably on a level or accelerated repayment schedule. 28

Grants Policy
Grants are an attractive form of funding for many local governments because they offer the possibility to reduce reliance on taxes and fees drawn from the community. On the other hand, grants can harm the government’s long-term financial position if they lead to implementation of an ongoing program that later requires support from general tax dollars when the grant expires. Further, many grants require matching funds and overhead costs that might end up diverting funds from higherpriority services. A policy can encourage grant-seeking, but should also recognize the risks of overreliance on grants and direct the organization to manage those risks. The policy from the City of Long Beach, California, instructs staff to analyze the long-term costs and benefits of a grant before accepting it:

City staff will seek out, apply for, and effectively administer federal, state, and other grants that ad‐ dress the city’s priorities and policy objectives and provide a positive benefit to the city. Before any grant above $50,000 is pursued, staff shall provide a detailed pro‐forma to the city manager that ad‐ dresses the immediate and long‐term costs and benefits to the city. A pro‐forma must be submitted to the city manager for all grants prior to accepting the grant award.

A policy should direct that any grants pursued are consistent with the government’s mission and strategic priorities. Spotsylvania County’s policy states that “before applying for and accepting intergovernmental aid, the county will assess the merits of a particular program as if it were funded with local tax dollars.”
After the grant has been accepted, a policy should address the possibility that the grant will end, leaving the government to decide whether to continue the program. Spotsylvania County’s policy reads that “local tax dollars will not be used to make up for losses of intergovernmental aid without first reviewing the program and its merits as a budgetary increment.” Infrastructure Maintenance/Replacement Schedule
Rather than reserving funds to guard against the failure of worn assets, the City should develop a plan and schedule to maintain and replace assets, as needed. Exhibit 4.3 (on the following page) shows what yearly capital expenditures would be to keep up with bridge and culvert replacements.

Obviously, the pattern is quite volatile. The City might consider translating this into a regular schedule, with a set annual contribution to funding that schedule. The GFOA estimates that a $10.9 million approximate annual contribution would be necessary to fund the schedule. Not only would this reduce the amount the City would have to hold in reserve (since assets would not deteriorate to critical condition), but it would greatly reduce the actual risk the City faces. 29

30 2033 2035 2037 2039 2041 2043 2045 2047 2049
For storm sewers, the average annual contribution for a regular maintenance/replacement schedule would be about $36 million, though this is a less precise figure because the underlying information on asset condition is not as detailed. 2032 2034 2036 2038 2040 2042 2044 2046 2048 2050
18,000,000
16,000,000
14,000,000
12,000,000
10,000,000
8,000,000
6,000,000
4,000,000
2,000,000
0 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030
2013 2015 2017 2019 2021 2023 2025 2027 2029 2031
Failure Cost
18,000,000
16,000,000
14,000,000
12,000,000
10,000,000
8,000,000
6,000,000
4,000,000
2,000,000
0 Exhibit 4.3:

Estimate of Annual Bridge and Culvert Replacement Costs

Exhibit A1
Monthly Sales Tax Revenue from the City of Boulder, Colorado Appendix 1. Sales Tax Revenues in Boulder, Colorado
In order to provide a little better comparative context for examining Colorado Springs’ sales tax, the GFOA requested permission from the City of Boulder to use its monthly sales tax data in a similar analysis to Colorado Springs.’ Exhibit A1.1 shows Boulder’s revenues since June 2004. Like Colorado Springs, Boulder has four “spikes” during the year, with a holiday spike being the largest. Boulder’s sales tax revenue is a little more volatile, with about 4 percent of the variation attributable to random factors.

Boulder also experienced a protracted decline in its trend-cycle in the wake of the Great Recession – a 10 percent drop over 21 months. This is just under half a percent per month, not too different from Colorado Springs.
31

Endnotes
1 TheTriple-Aapproachisadaptedfrom:SpyrosMakridakis,RobinHogarth,andAnil Gaba.DancewithChance: MakingLuckWork forYou (OneworldPublications:Oxford,England, 2009). 2 Drainage basins, open drainage features, discharge points, and point features are not included in the replacement cost. Adding these items would likely push it to more than $1 billion. 3 Targets have been rounded to nearest “whole” numbers for ease of use in policymaking.

Also, see the main body of the report for a discussion of the independence of the risk factors and the implication for sizing the reserve.
4 Based on the 2012 budget estimate of approximately $220 million in general fund revenue. 5 See the GFOAbest practice, Appropriate Level of Unrestricted Fund Balance in the GeneralFund,availableatwww.gfoa.org.Accordingtothisbestpracticedocument, governments shouldestablishaformalpolicyofmaintainingreservesequaltoabout16percentofrevenuesorexpenditures,andtheactualtargetshouldbebasedonananalysisofthesalient risksthegovernmentfaces–whichinmanycasescallsforareservelevelofmorethan16 percent.
6 TABOR, for example, limits the City’s ability to increase taxes. 7 GFOABestPractice,“Appropriate LevelofUnrestrictedFundBalanceintheGeneral Fund” (2009).
8 Definition of risk taken from Douglas W. Hubbard, The Failure of Risk Management: Why It’sBrokenandHow toFix It(Hoboken,NewJersey: JohnWiley andSons,Inc., 2009). 9 The risk factors and basic review method were developed and published in: Shayne C.

Kavanagh,FinancialPolicies (Chicago:GovernmentFinanceOfficersAssociation, 2012). 10 The use tax is much smaller than the sales tax – comprising only around 5 percent of the total of the two.
11 This is City general fund only and excludes other sales tax revenues, such as the 2002 public safety sales tax (which is accounted for outside of the general fund, in a special revenue fund). 12 TheGFOAusedamethodofdatade-seasonalization known asmultiplicativedecomposition to arrive at this conclusion. 13 The trend-cycle line is calculated by taking a 12-month centered moving average of actual monthly sales tax revenue. For example, the moving average for January 2005 would be 32

anaverageofAugust2004throughJuly 2005.February 2005wouldbe an averageofSeptember2004 throughAugust 2005, and so on.A12-month moving average smooths out seasonal variation, leaving only the trend-cycle.
14 The term “Black Swan” derives from a belief held in England before 1697 that all swans werewhite–infact,theterm“BlackSwan”wasacommonmetaphorforanimpossibility.

Black swanswerediscovered inAustraliain 1697,demonstrating the limits ofhumanknowledge about the world. 15 See Makridakis, Hogarth, and Gaba, Dance with Chance, 2009. 16 Of course, the long-term impacts of those actions are still unknown. 17 AccordingtotheCase-ShillerHousingIndex,homepricesnationally since2009havevaried in a range consistent with housing values in 2003. As of this writing, values have experienced increases for six consecutive months. 18 According to David M. Blitzer, Chairman of the Index Committee at S&P Dow Jones Indices (whichincludes the Case-ShillerHousing Index),“the housing market seems to be stabilizing, but we are definitely in a wait-and-see mode for the next few months.” 19 Based on sales prices from Zillow.com.
20 Note that further analysis could be conducted with City staff to refine assetreplacement costs, as well as reviewing the risk rating to incorporate more factors into the consequence (i.e., traffic count, location, major structure,etc.).
21 Drainage basins, open drainage features, discharge points, and point features are not included in the replacement cost, which would likely push it over $1 billion. 22 See GFOA Best Practice, “Sustainable Funding Practices of Defined Benefit Pension Plans”(2009), www.gfoa.org. An 80 percent funded ratio is often cited as an acceptable funding benchmark, but this figure does not have a sound actuarial basis. See, for example, GirardMiller,“PensionPuffery,”www.governing.com.Millerdoes statethatan80percent funding ratio might be acceptable at the bottom of an investment market because the funded ratiowillpresumablyrisewiththemarket.Conversely,though,thefundedratioshouldbe above 100 percent at the top of a market to protect against a fall. 23 Ontopofthis,theCityisleasingitshospitalsystem,sotheemployeeswillnolongerbe contributingtotheColoradoPublicEmployeesRetirementAssociation,whichaddsfurtheruncertainty to the City’s future pension position. 24 Even if all ARC payments are made, an employer could still end up with an unfunded liability at the end of the amortization period if the actuarial assumptions used to calculate the ARC do not hold up (e.g., the rate of return on plan investments). 25 GFOABestPractice,“Appropriate LevelofUnrestrictedFundBalanceintheGeneral Fund” (2009), www.gfoa.org.
26 DavidG.Hitchcock,KarlJacob,and JamesWiemken,KeyGeneralObligation Ratio Credit Ranges – Analysis vs. Reality (New York: Standard & Poor’s, 2008). 27 Based on values from Zillow.com.
28 Drainage basins, open drainage features, discharge points, and point features are not included in the replacement cost, which would likely push it over $1 billion. 29 Note that many of the risks listed in the table can be considered “independent,” meaning that the occurrence of one risk has little to do with the potential occurrence of another risk. For example, the occurrence of an extreme event has little or nothing to do with whether the City 33

also experiences an increase in its pension payments. In these cases, there could be a justification for holding less reserves than the total of the two numbers because it is rather unlikely that the City will experience both of these problems at once. However, other risks are not independent.For example, an economic downturn that causes a reduction in sales tax revenue would likely also impact other revenues, a natural disaster could make the City more likely to experience a critical infrastructure failure, or a natural disaster could result in interruption to sales tax revenue. Because the risk factors appear to have at least some level of significant inter-dependency (a level which is difficult to know), the approach of adding the reserve componentstogetherrepresentsaconservativeapproachtosizingreserves forColoradoSprings.

This approach would leave the City without any exposure to risk arising from risk factor dependency.NotethatzeroexposuretoriskalsomeansthattheCitywillholdmorereserves that it will probably need at any onetime.
30 Based on about $220 million general fund revenue, as per 2012 budget estimates. 31 SeeGFOABestPractice,“Appropriate LevelofUnrestrictedFundBalance intheGeneral Fund”(2009),www.gfoa.org. TheBestPractice states thatreserves equalto about 16percent of revenues or expenditures is the minimum a government should consider for its policy and that the actual target that a government adopts should be based on an analysis of the salient risksthatagovernmentfaces(whichinmanycasesmaycallforahigherreservelevelthan 16 percent).
32 Within the “unrestricted” portion of fund balance, the City could choose to locate the reserves within the “unassigned” or“committed” categories. Municipal governments typically choose the unassigned category because the accounting requirements to place funds in the committed category are more stringent(e.g., the commitment must be made by formalaction of the City Council and the language describing the conditions for using the reserves must meet a high level of precision).
33 See for example, the policy of the City of San Luis Obispo, California, which is available on the GFOA website atwww.gfoa.org/finanicalpolicies.
34 See Kavanagh, Financial Policies, 2009.
34