DATE: APRIL 5, 2022
DEPARTMENT: FINANCE
FROM: MARK ROBERTS, Director of FINANCE
TITLE: FINANCIAL POLICIES AMENDMENTS & RESERVE BALANCE RECOMMENDATIONS RECOMMENDATION:
Staff requests the Finance Committee recommend the City Council adopt a resolution authorizing the amendment of City of Salinas Financial Policies Sections II, Reserve Policies, and V.C, Operating Budget Policies, and establishment of various reserve levels.
EXECUTIVE SUMMARY:
Reserve Policies amendments and reserve balance levels are recommended to ensure the City is able to withstand unexpected financial emergencies, such as those which may result from natural disasters, revenue shortfalls, or unanticipated expenditures of a non-recurring nature, and to accumulate funds for large-scale purchases. Operating Budget Policies are recommended to ensure facilities and infrastructure maintenance and repair needs are consistently addressed in the City’s annual budgets.
DISCUSSION:
Following are explanations of the amendments proposed to the Financial Policies and recommended reserve balance allocations.
Section II – Reserve Policies
General Funds Unassigned Fund Balances (Establishment of Minimum Balance Targets) & General Funds Economic Contingency Reserves (New Reserves) The minimum target level established for both the unassigned fund balances in the City’s General Fund, Measure E Fund, and Measure G Fund (collectively “general fund[s]”) and the proposed General Funds Economic Contingency Reserves would be twelve percent (12%) of budgeted general fund operating expenditures and non-capital transfers to other funds. The resulting combined minimum target balance would establish general-purpose reserves of twenty-four percent (24%) of general fund operating expenditures and transfers, compared to the eight percent (8%) target of the current operating reserve (Financial Policies Section II.C), which the unassigned fund balance target balances and General Funds Economic Contingency Reserves are proposed to replace. The twenty-four percent general-purpose reserve balance would also exceed the minimum unrestricted fund balance recommended by the Government Finance Officers Association for general-purpose governments, i.e., two months, or approximately seventeen percent (17%), of regular general fund operating revenues or regular general fund operating expenditures.
The unassigned fund balances would be used for smaller emergent needs, and amounts in excess of the minimum target level would be available to increase or replenish other reserves or to utilize for one-time purposes. The General Funds Economic Contingency Reserves would be available to mitigate the fiscal impact of a catastrophic event or significant downturn in the economy.
Formal City Council authorization would be required to increase the balances of the General Funds Economic Contingency Reserves or to authorize the use of any portions thereof.
Full funding of the minimum reserve target of $16.7 million is recommended for these reserves, $12.3 million, $1.7 million, and $2.7 million in the General, Measure E, & Measure G Funds, respectively.
General Fund Facilities Maintenance Reserve (New Reserve) The General Fund Facilities Maintenance Reserve, the minimum target balance of which would be three times the annual amount appropriated in the General Fund for major maintenance and repairs upon the City’s building assets, is proposed to set aside funds for emergency maintenance and repair costs for which existing appropriations are not sufficient and no other funding source is immediately available. This reserve and the General Funds Infrastructure Maintenance Reserves, described below, would replace the reserve requirement for City-financed capital projects (Financial Policies Section II.D).
Formal City Council action would be required to increase the balance of this reserve or to authorize the use of any portion thereof.
Initial funding of $1.6 million, approximately fifty percent (50%) of the minimum reserve target of $3.2 million, is recommended for this reserve.
General Funds Infrastructure Maintenance Reserves (New Reserves) The General Funds Infrastructure Maintenance Reserves, the minimum target balances of which would be five times the annual amounts appropriated in each of the general funds for the performance of major maintenance and repairs upon the City’s infrastructure assets, are proposed to set aside funds for emergency maintenance and repair costs for which existing appropriations are not sufficient and no other funding source is immediately available. As noted above, these reserves and the General Funds Facilities Maintenance Reserve replace the reserve requirement for City-financed capital projects.
Formal City Council action would be required to increase the balances in these reserves or to authorize the use of any portions thereof.
Initial funding of $3.8 million, approximately fifty percent (50%) of the minimum reserve target of $7.4 million, is recommended for these reserves, $2.7 million, $0.4 million, and $0.7 million in the General, Measure E, & Measure G Funds, respectively.
Vehicle Replacement Fund & Reserve (New Fund & Reserve) This new internal service fund and corresponding reserve are proposed to establish an internal service fund with a funding mechanism to internally finance vehicle purchases in a manner which accounts for the future replacement value of the vehicles and augments the reserve to increase its balance to its target range, which is an amount equal to between the accumulated depreciation and estimated replacement value of all City vehicles.
Initial funding of $9.0 million, approximately two-thirds (66%) of the minimum reserve target of $13.7 million, is recommended for this reserve. Future augmentation of this reserve would occur through internal service charges, proceeds from auctions of vehicles at the end of their useful lives, and budgetary and other transfers.
Workers’ Compensation Self-Insurance Reserve & General Liability Self-Insurance Reserve (New Reserve) The current reserve policy states, “Adequate reserves shall be maintained for all known liabilities, including payable employee pension costs, post-employment benefits, leave balances, workers' compensation, and self-insured retention limits” (Financial Policies Section II.A). However, neither a formal reserve nor a specific minimum reserve target level has been established for any of these obligations. Therefore, replacement of the existing requirement with the following reserves and target levels is proposed.
For the Workers’ Compensation Self-Insurance Reserve, assets in the Workers’ Compensation Self-Insurance Fund equal to the present value of estimated outstanding Workers’ Compensation Program claim losses as calculated by the City’s actuary is recommended. The proposed minimum standard for the General Liability Self-Insurance Reserve is General Liability Self-Insurance Fund assets equal to the present value of estimated outstanding Liability Program claim losses. (Confidence level is the statistical certainty funding is believed to be sufficient. For example, an 80% confidence level means that funding to accommodate payment of claims will be sufficient in eight years out of ten.) The current assets in the Workers’ Compensation Self-Insurance Fund and General Liability Self-Insurance Fund represent the balances of their corresponding reserves. No changes are proposed to the balances at this time. The Workers’ Compensation and General Liability Self-Insurance Funds are internal service funds, and future augmentation of the reserves will occur through internal service charges, as necessary.
Irrevocable Supplemental Pension Trust Reserve & Other Post-Employment Benefits (OPEB) Reserve (New Reserve) These reserves are intended to pre-fund post-employment benefit liabilities and/or to be used for payment of post-employment-benefit-related costs. Assets of the Irrevocable Supplemental Pension Trust Reserve, assets may be used only for pension-related costs.
As explained above, while the current reserve policy requires “adequate” reserves be maintained for all liabilities, it does not specify the standards of adequacy for the obligations. For both the Irrevocable Supplemental Pension Trust Reserve and the Other Post-Employment Benefits (OPEB) Reserve, target balances equal to the total net liabilities of the respective plans is recommended.
Formal City Council action would be required to increase the balances in these reserves or to authorize the use of any portions thereof.
As of the most recent valuation dates, the unfunded accrued liabilities (UALs) of the City’s CalPERS and New York Life (“NYL”) pension plans were $217.5 million and $13.9 million, respectively, a combined $231.4 million. The UAL of the City’s OPEB plan UAL was $27.8 million. Currently, the City has a general pension reserve (agreements have not yet been executed to establish the pension trust) and a NYL pension reserve, the balances of which are $3.0 million and $1.0 million, respectively, a combined $4.0 million. An OPEB reserve does not currently exist.
Consolidation of the general and NYL pension reserves into the Irrevocable Supplemental Pension Trust Reserve (once the trust has been established) and additional funding of $2.0 million is recommended, creating a single pension reserve/trust for which the balance would be $6.0 million. Initial funding of $1.0 million is recommended for OPEB Reserve.
Debt Service Reserves (New Reserves)
The Debt Service Reserves in each City fund from which debt service is paid are recommended to ensure sufficient cash is available to meet the City’s short-term debt service obligations. The target levels for these reserves, as proposed, would be the greater of an amount equal to the total reserves required by the applicable debt indentures or one year’s debt service requirement of all long-term City obligations, excluding inter-fund loans.
The current balances available for designation as reserves in each fund from which debt service is paid are under review. A recommendation for augmentation of the balances will be brought forward, if deemed necessary.
Allocation of Available Year-End Balances & Reserve Replenishment Guidelines Current Financial Policies Section II.J states, “General Fund Year-end carryover balances shall be allocated to reserves in the following priority order until all desirable reserve levels are achieved.” Since reserves are proposed for the Measures E and Measure G Funds, allocations of year-end balances to the reserves of those funds should also be included and, therefore, is also proposed. Removal of the prioritization of reserves is proposed, as its logic is unclear. In addition, with the increase of general-purpose balance targets from eight percent to twenty percent, sufficient assets would exist for Council to redistribute balances at its discretion.
To ensure reserve balances falling below their minimum target levels are replenished within a timeframe that is reasonable without creating undue financial stress upon the City, a graduated replenishment schedule is recommended which prescribes replenishment of reserves over longer periods, up to seven (7) years, as the levels to which the reserves fall below their target balances increases.
Elimination of Other Reserves & Requirements
The proposed reserves, as well as prudent financial practices followed by the City, render the following current sections of the Financial Policies unnecessary.
Section II.A – “Adequate reserves shall be maintained for all known liabilities, including payable employee pension costs, post-employment benefits, leave balances, workers' compensation, and self-insured retention limits.” This requirement is replaced by the Workers’ Compensation Self-Insurance Reserve, General Liability Self-Insurance Reserve, Irrevocable Supplemental Pension Trust Reserve, & OPEB Reserve.
Section II.B – “Adequate reserves shall be maintained for all lease purchases [a form of debt]. For each lease purchase, the City will make a down payment equal to one annual payment from current revenues. The balance of the lease purchase obligation shall be fully reserved.” Debt service payments are budgeted annually at the amounts required, and with approval of the Debt Service Reserves and general-purpose reserves proposed, sufficient assets would exist to cover debt service payments, should any adverse fiscal event arise which may otherwise impact the City’s ability to meet those obligations. For these reasons, the existing lease purchase requirements (i.e., Section II.B) are unnecessary.
Section II.C – “The City will endeavor to maintain an operating reserve equal to eight percent of the General Fund, Measure V, and Measure G Operating Budget to cover cash flow requirements and normal variances in revenue and expenditure estimates.” This requirement is replaced by the General Funds Unassigned Fund Balance Targets & General Funds Economic Contingency Reserves.
Section II.D – “The City will endeavor to maintain a reserve equal to twenty-five percent of the future City financed Capital Projects scheduled in the four out-years of the Six-Year Capital Improvement Program to cover variances in project revenue and expenditures.” This requirement is replaced by the General Fund Facilities Maintenance Reserve & General Funds Infrastructure Maintenance Reserves.
Section II.H – “The City will endeavor to make the recommended contributions to fund post-employment benefits and pension plans as established in the annual actuarial reports.” The City remits contributions as required by the CalPERS valuation reports and as needed to fund the New York Life and OPEB plans’ distributions, which render this section unnecessary. Establishing and funding the proposed Irrevocable Supplemental Pension Trust & OPEB Reserves will enhance the City’s ability to meet these obligations. Also, this requirement is unrelated to reserves.
Section II.J (partial) – “General Fund Year-end carryover balances shall be allocated to reserves in the following priority order until all desirable reserve levels are achieved. The Council may decide, on an exception basis, to use the carry over balances to offset revenue shortfalls that result from State and County budgetary actions.
Insurance reserves
Operating Budget reserve
Capital Improvement Program reserve
Funding of Pension Obligations
Funding of Post-employment benefit obligations”
As previously noted, elimination of the prioritization of reserves to which available fund balance is allocated is proposed because its logic is unclear and, with approval of the increase of general-purpose balance targets to twenty percent, sufficient assets would exist for Council to redistribute balances at its discretion. Removal of the provision allowing for available balances to be used to offset revenue shortfalls is also recommended, as the increase of general-purpose balance targets would enhance the City’s ability withstand or offset such shortfalls.
Since the existing sections of the Financial Policies listed are unnecessary, elimination is recommended.
In addition to the reserves and requirements currently designated in the Financial Policies, funds have been set aside for various other purposes. However, these funds have gone unused and/or will be unnecessary, if the proposed reserves are approved. Therefore, elimination of the funds’ designations and redistribution of the balances to the proposed new reserves is recommended.
Productivity Bank (Salinas Plan recommendation) – $0.5 million. Revolving loan program established with the goal of the incentivizing creative programs that increase revenues or save the City money and/or staff time. Although $0.5 million was to be allocated to the Productivity Bank each year from fiscal year 2020 through fiscal year 2023 and $1.0 million in fiscal year 2024, only the first year’s funding has been allocated, and the funds have remained unused.
Cannabis Revenue Reserve – $2 million. No documented definition/purpose or provisions for use found. No use has been directed to date.
General Fund Deficit Reduction Contingency Reserve – $425,000. No documented definition/purpose or provisions for use found. Although its purpose appears self-explanatory, conditions for its use are unknown.
New York Life Retirement Reserve - $1 million. Reserve for future retirement needs of employees under the New York Life Retirement Plan. As noted above, this reserve will be absorbed into the Irrevocable Supplemental Pension Trust Reserve, if approved.
Section V.C, Operating Budget Policies – Appropriations Facilities Maintenance Appropriations (New Requirement) The addition of facilities and infrastructure appropriation requirements is recommended to ensure City funds are allocated annually for major maintenance and repairs on permanent or non-permanent structures and permanent physical systems. Projects funded by these appropriations will be prioritized using a tiered system with health- and safety-related repairs and/or maintenance assigned the highest priority, followed, as applicable, by those determined to be most urgent on the bases of industry indices used for rating the conditions of assets. The requirement for these appropriations is an amount or amounts equal to one percent (1%) of operating revenues in the corresponding general funds.
In addition to the creation and elimination of the provisions and requirement of the Financial Policies proposed above, other amendments are recommended to improve the clarity of the existing provisions and requirements of the policies.
CEQA CONSIDERATION:
Not a Project. The City of Salinas has determined the proposed action is not a project as defined by the California Environmental Quality Act (CEQA) (CEQA Guidelines Section 15378).
STRATEGIC PLAN INITIATIVE:
Authorization of the recommended Financial Policies amendments and reserve balances achieves the Council 2022-2025 Strategic Goals of Effective Government.
DEPARTMENT COORDINATION:
The Department of Finance staff prepared the Financial Policies amendments and reserve balance recommendations with the assistance of the City Manager’s Office, City Attorney’s Office, and Public Works Department.
FISCAL AND SUSTAINABILITY IMPACT:
Approval of the recommended Financial Policies amendments and reserve balances will ensure the City is positioned to withstand financial emergencies and accumulate funds for large-scale purchases and consistently allocates resources to preserve the condition of the City’s facilities and infrastructure.
ATTACHMENTS:
Exhibit A – City of Salinas Financial Policies (Original) Exhibit B – City of Salinas Financial Policies (Draft)
Exhibit C – City of Salinas Financial Policies (Final)
Exhibit D – Recommended Reserve Requirements & Balances Page | 4
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