Loading...
HomeMy WebLinkAbout09 - Amending City Council Reserve Policy F-2CITY OF ?�PORr NEWPORT BEACH City Council Staff Report September 25, 2018 Agenda Item No. 9 TO: HONORABLE MAYOR AND MEMBERS OF THE CITY COUNCIL FROM: Dan Matusiewicz, Finance Director - 949-644-3123, dmatusiewicz@newportbeachca.gov PREPARED BY: Steve Montano, Deputy Finance Director, smontano@newportbeachca.gov PHONE: 949-644-3240 TITLE: Resolution No. 2018-72: Amending City Council Reserve Policy F-2 ABSTRACT: The Finance Committee ("Committee") recently considered the appropriateness of the General Fund Contingency Reserve ("the Reserve") level. A study by the Government Finance Officer's Association (GFOA) was commissioned to assess risks. Based on the findings identified in the report and other factors, staff and the Committee recommends to maintain the current Reserve funding level at 25% of operating expenditures. The Committee also recommends a change in how the annual contributions to the Reserve is calculated. In the past two years, the City Manager has recommended, and the City Council has approved, the exclusion of additional discretional pension payments (ADP) to CalPERS from the annual reserve calculation because doing so inflates the required Reserve contribution thereby leaving less appropriations available for program funding. The Committee recommends codifying this exclusion in Council Reserve Policy F-2 ("F-2"). RECOMMENDATION: a) Determine this action is exempt from the California Environmental Quality Act (CEQA) pursuant to Sections 15060(c)(2) and 15060(c)(3) of the CEQA Guidelines because this action will not result in a physical change to the environment, directly or indirectly; and b) Adopt Resolution No. 2018-72, A Resolution of the City Council of the City of Newport Beach, California, Amending City Council Reserve Policy F-2. FUNDING REQUIREMENTS: There are no direct expenditures associated with the policy amendment. 9-1 Resolution No. 2018-72: Amending City Council Reserve Policy F-2 September 25, 2018 Page 2 DISCUSSION: The GFOA recently assisted staff with analyzing risks through an analytical framework intended to determine a Reserve level appropriate for the City of Newport Beach. GFOA, working closely with staff, facilitated staff's thorough examination of the City's primary and secondary risk factors that generally influence the amount of reserves the City should hold. These factors included risk from earthquakes, floods, fires, and decreased revenues and increased pension costs due to an economic downturn over a ten-year period. GFOA determined that the range at which the Reserve would produce the best value for the City is between $14.8 million and $25.5 million. This range is far below the current Reserve balance of just over $50 million, which, pursuant to F-2, is equivalent to 25% of budgeted expenditures. GFOA 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 expenditures, which is equivalent to a 16% Reserve in Newport Beach. According to the GFOA, the adequacy of the General Fund unreserved fund balance should be assessed based upon a government's own specific circumstances. The GFOA analysis was not inclusive of every risk the City could possibly face and credit rating agencies value fund balance as a measure of financial flexibility. Pension benefit levels and pension losses subsequent to the 2008 recession has and will continue to absorb a significant level of the City's financial capacity over the many years to come. Credit rating agencies also consider an adequate level of "fund balance" to be a credit strength because the level of fund balance measures the flexibility of an issuer to meet essential services during transitionary periods. On this basis staff recommended, and the Committee agreed, to maintain the current Reserve level of 25% of operating expenditures. While the Committee recommended no changes to the Reserve level, the Committee did recommend a change in how the annual contributions to the General Fund Contingency Reserve is calculated. Purpose of the Reserve and How Annual Contributions to the Reserve are Determined The purpose of F-2 is to establish City Council policy for the administration of Reserves defined as fund balances in governmental funds and net working capital in proprietary funds. The policy was last amended by the City Council on May 12, 2015. F-2 contains the policy that governs the use of the Reserve. The basic purpose of the Reserve (a.k.a. rainy day reserve) is to protect the budget from unexpected or unforeseen fiscal disruptions such as catastrophic loss of critical infrastructure, unanticipated revenue shortfalls, and actions by another government that eliminates or shifts revenues from the City. Appropriations and access to these funds are reserved for emergencies only, but may be accessed by Council by simple budget appropriation. 9-2 Resolution No. 2018-72: Amending City Council Reserve Policy F-2 September 25, 2018 Page 3 Examples may include but are not limited to the following: a. A catastrophic loss of critical infrastructure. b. A State or Federally declared state of emergency. c. Any settlement arising from a claim or judgment. d. Deviation from budgeted revenue projections. e. Any action by another government that eliminates or shifts revenues from the City. f. Inability of the City to meet its debt service obligations in any given year. g. Other circumstances deemed necessary by City Council to meet the claims and obligations of the City. Should the Reserve be used, the City Manager shall present a plan to City Council to replenish the reserve within five years. As mentioned above, F-2 indicates that the Reserve shall have a target balance of twenty five percent (25%) of General Fund "Operating Budget" as originally adopted. For purposes of calculating the annual contributions to the Reserve, the operating budget includes planned expenditure appropriations and excludes capital improvement projects and transfers out. They are excluded because, unlike operating expenditures, they are discretionary in nature and can vary from year to year, especially during downturns in economic cycles. Excluding the Additional Unfunded Pension Liability Contributions from the Annual Reserve Calculation F-2 directs the City to: 1) amortize the unfunded actuarial liability in accordance with the actuary's funding recommendations; and 2) make an effort at maintaining its unfunded actuarial liability within a range that is considered acceptable to actuarial standards. Our actuary indicates that an 80% funded ratio is a good target, leaving room for market value adjustments in either direction. F-2 further prescribes that the City Council shall consider increasing the annual CalPERS contribution should the Unfunded Actuarial Liability (UAL) status fall below acceptable actuarial standards. To that end, the City has contributed additional discretionary pension payments (ADP) to CalPERS in recent years. An ADP of $8.8 million was applied towards the UAL in Fiscal Year 2018-2019. In so doing, the City is addressing the escalating nature of UAL costs by increasing the City's funded ratio (currently 69%). In the past two years, the City Manager has recommended, and the City Council has approved, the exclusion of ADP contributions from the annual reserve calculation because it inflates the required reserve contribution thereby leaving fewer resources available for program funding. The Committee recommends that this exclusion continue in the development of subsequent budgets and recommends the following change (underlined) F-2: Contingency Reserve: The Contingency Reserve shall have a target balance of twenty five percent (25%) of General Fund "Operating Budget" as originally adopted. Operating Budget for this purpose shall include current expenditure appropriations and shall exclude Capital Improvement Projects, Transfers Out, and additional discretionary payments to the City's unfunded pension liability. 9-3 Resolution No. 2018-72: Amending City Council Reserve Policy F-2 September 25, 2018 Page 4 ENVIRONMENTAL REVIEW: Staff recommends the City Council find this action is not subject to the California Environmental Quality Act (CEQA) pursuant to Sections 15060(c)(2) (the activity will not result in a direct or reasonably foreseeable indirect physical change in the environment) and 15060(c)(3) (the activity is not a project as defined in Section 15378) of the CEQA Guidelines, California Code of Regulations, Title 14, Chapter 3, because it has no potential for resulting in physical change to the environment, directly or indirectly. The agenda item has been noticed according to the Brown Act (72 hours in advance of the meeting at which the City Council considers the item). ATTACHMENTS: Attachment A — Resolution No. 2018-72 (redline version) Attachment B — Resolution No. 2018-72 (clean version) Attachment A Resolution No. 2018-72 authorizing revisions to Council Policy F-2 (Redline Version) 9-5 RESOLUTION NO. 2018-72 A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF NEWPORT BEACH, CALIFORNIA, AMENDING CITY COUNCIL RESERVE POLICY F-2 WHEREAS, the City Council of the City of Newport Beach ("City") has a long and established history of being good guardians and stewards of the public's money, WHEREAS, appropriations, expenditures and other budgetary matters are a primary concern of the City Council, WHEREAS, the City Council has adopted various policies regarding financial matters, WHEREAS, the City Council has adopted City Council Reserve Policy F-2 for the administration of "Reserves." which are defined within the policy as fund balances in governmental funds and net working capital in proprietary funds, WHEREAS, on December 12, 1994, the City Council adopted Resolution No. 94- 110 establishing the Finance Committee, whose duties and responsibilities have been amended throughout the years to further protect and safe guard the public's money, WHEREAS, the existing Finance Committee is charged with a variety of tasks, including, but not limited to: reviewing and monitoring events and issues which may affect the financial status of the City, and making recommendations to the City Council regarding amendments to financial and budgetary policies, and WHEREAS, the Finance Committee has recommended an amendment to City Council Reserve Policy F-2 that excludes the additional discretionary payments to the City's unfunded pension liability from the annual Contingency Reserve calculation. NOW, THEREFORE, the City Council of the City of Newport Beach resolves as follows: Section 1: The City Council hereby amends theCi Council Reserve Policy F-2 as described in Attachment "A," which is attached hereto and incorporated herein by reference. Section 2: The City Council hereby repeals all prior versions of rese{utaeNs-relate to -City Council Reserve Policy F-2 that are in conflict with this resolution. Section 3: If any section, subsection, sentence, clause or phrase of this resolution is for any reason held to be invalid or unconstitutional, such decision shall not affectthe validity or constitutionality of the remaining portions of this resolution. The City Formatted: Line spacing: single Formatted: Different first page header Resolution 2018- Formatted: Font: (Default) Arial Pae Of Formatted: Right Council hereby declares that it would have passed this resolution and each. section, Formatted: Font: (Default) Arial �Formatted:Font: (Default)Arial subsection, sentence, clause or phrase hereof, irrespective of the fact that any one or more sections, subsections, sentences, clauses ora444 phrases be declared invalid or unconstitutional. Section 4: The recitals provided in this resolution are true and correct and are incorporated into the substantive portion of this resolution. Section 5: The City Council find the adoption of this resolution and the amendment of City Council Reserve Policy F-2 is not subject to the California Environmental Quality Act ("CEQA") pursuantto Sections 15060(c)(2) (the activitywill not result in a direct or reasonably foreseeable indirect physical change in the environment) and 15060(c)(3) (the activity is not a project as defined in Section 15378) of the CEQA Guidelines, California Code of Regulations, Title 14, Chapter 3, because it has no potential for resulting in physical change to the environment, directly or indirectly. Section 6: This resolution shall take effect immediately upon its adoption by the City Council, and the City Clerk shall certify the vote adopting this resolution. ADOPTED this 25th day of September, 2018. Marshall "Duffy" Duffield Mayor ,ATTEST: Formatted: Font: Bold Leilani I. Brown, City Clerk APPROVED AS TO FORM: Formatted: Font: Bold Aaron C. Harp City Attorney Attachment A: Amended Reserve City Council Policy F -2F RaRGR -AFRFR #RR ^^S^F Pt an 9-7 Resolution 2018- Formatted: Font:(Default) Arial P8 e 3 Of Formatted: Right of u n u ro �naa as iTToo Formatted: Font: (Default) Arial Formatted: Font: (Default) Arial :�J Resolution 2018- Formatted: Font:(Default) Arial Pa e 4 of Formatted: Right Formatted: Font: (Default) Arial Formatted: Font: (Default) Arial Resolution 2018- Formatted: Font:(Default) Arial P8 e 5 Of Formatted: Right Formatted: Font: (Default) Arial FFR FF d Formatted: Font:(Default) Arial PA. Make F@ .....J..I9R6 to the 9t. ' 9961RG I R aRy p@Gt of the ii.a4wia � GAY - 9 -10 RESERVE POLICY PURPOSE F-2 To establish City Council policy for the administration of Reserves defined as fund balances in governmental funds and net working capital in proprietary funds. BACKGROUND Prudent financial management dictates that some portion of the funds available to the City be reserved for future use. As a general budget principle concerning the use of reserves, the City Council decides whether to appropriate funds from Reserve accounts. Even though a project or other expenditure qualifies as a proper use of Reserves, the Council may decide that it is more beneficial to use current year operating revenues or bond proceeds instead, thereby retaining the Reserve funds for future use. Reserve funds will not be spent for any function other than the specific purpose of the Reserve account from which they are drawn without specific direction in the annual budget; or by a separate City Council action. Information regarding Annual Budget Adoption and Administration is contained in City Council Policy F-3. GOVERNMENTAL FUNDS AND FUND BALANCE DEFINED Governmental Funds including the General Fund, Special Revenue Funds, Capital Projects Funds, Debt Service Funds and Permanent Funds have a short- term or current flow of financial resources, measurement focus and basis of accounting and therefore, exclude long-term assets and long-term liabilities. The term Fund Balance, used to describe the resources that accumulate in these funds, is the difference between the fund assets and fund liabilities of these funds. Fund Balance is similar to the measure of net working capital that isxxsecelis used in private sector accounting. By definition, both Fund Balance and Net Working Capital exclude long-term assets and long-term liabilities. PROPRIETARY FUNDS AND NET WORKING CAPITAL DEFINED Proprietary Funds including Enterprise Funds and Internal Service Funds have a long- term or economic resources measurement focus and basis of accounting 9-11 F-2 and therefore, include long-term assets and liabilities. This basis of accounting is very similar to that used in private sector. However, instead of Retained Earnings, the term Net Assets is used to describe the difference between fund assets and fund liabilities. Since Net Assets include both long-term assets and liabilities, the most comparable measure of proprietary fund financial resources to governmental Fund Balance is Net Working Capital, which is the difference between current assets and current liabilities. Net Working Capital, like Fund Balance, excludes long-term assets and long-term liabilities. GOVERNMENTAL FUND RESERVES (FUND BALANCE) For Governmental Funds, the Governmental Accounting Standards Board ("GASB") Statement No. 54 defines five specific classifications of fund balance. The five classifications are intended to identify whether the specific components of fund balance are available for appropriation and are therefore "Spendable." The classifications also are intended to identify the extent to which fund balance is constrained by special restrictions, if any. Applicable only to governmental funds, the five classifications of fund balance are as follows: CLASSIFICATIONS NATURE OF RESTRICTION Non -spendable Cannot be readily converted to cash Restricted Externally imposed restrictions Committed City Council imposed commitment Assigned City Manager assigned purpose/intent Unassigned Residual balance not otherwise restricted A. Non -spendable fund balance: That portion of fund balance that includes amounts that are either (a) not in a spendable form, or (b) legally or contractually required to be maintained intact. Examples of Non -spendable fund balance include: 1. Reserve for Inventories: The value of inventories purchased by the City but not yet issued to the operating Departments is reflected in this account. 2 9-12 F-2 2. Reserve for Long Term Receivables and Advances: This Reserve is used loidentify and segregate that portion of the City's financial assets which are not due to be received for an extended period, so are not available for appropriation during the budget year. 3. Reserve for Prepaid Assets: This reserve represents resources that have been paid to another entity in advance of the accounting period in which the resource is deducted from fund balance. A common example is an insurance premium, which is typically payable in advance of the coverage period. Although prepaid assets have yet to be deducted from fund balance, they are no longer available for appropriation. 4. Reserve for Permanent Endowment - Bay Dredging: The endowment specifiesthat the principal amount will not be depleted and represents the asset amounts to be held in the Bay Dredging Fund. Reserve for Permanent Endowment - Ackerman Fund: The exbmimt specifies that the principal amount will not be depleted and represents the asset amount to be held in the Ackerman Fund. B. Restricted fund balance: The portion of fund balance that reflects constraints placed on the use of resources (other than non -spendable items) that are either (a) externally imposed by creditors, grantors, contributors, or laws or regulations of other governments; or (b) imposed by law through constitutional provisions or enabling legislation. Examples of restricted fund balance are: 1. Reserve for Debt Service: Funds are placed in this Reserve at the time debt is issued. The provisions governing the Reserve, if established, are in the Bond Indenture and the Reserve itself is typically controlled by the Trustee. 2. Affordable Housing: A principal provision of the Newport Beach Housing Element requires developers to provide housing units for lower income households, the number of which is to be negotiated for each development project. In lieu of constructing affordable housing, developers have paid into this reserve which is used at the City Council's discretion to provide alternate methods for the delivery of affordable housing for lower income households. 9-13 F-2 3. Park In Lieu: Per NBMC 19.52 and California Government Code Section 664777 (The 1975 "Quimby Act"), a dedication of land or payment of fees for park or recreational purposes in conjunction with residential development is required. The fees collected can only be used for specific park or recreation purposes as outlined in NBMC 19.52.030 and 19.52.070. 4. Upper Newport Bay Restoration Reserve: This reserve is the repository for funds mandated by S13573, as well as special fees charged to permit holders as an alternative to meeting certain specified mitigation criteria. In addition to the mitigation fees, ten percent (10%) of Beacon Bay lease revenue is placedin this Reserve. Funds in the Reserve are restricted for Upper Newport Bay restoration projects. 5. Permanent Endowment for Bay Dredging: The endowment also specifies that the interest earnings on the principal amount can only be used for dredging projects in the Newport Bay. 6. Permanent Endowment for Ackerman Fund: The endowment also specifies that the interest earnings on the principal amount can only be used for scholarships provided by the City and high-tech library equipment. 7. Oceanfront Encroachment Reserve: In the early 1990's, it was discovered by survey that improvements to several ocean front parcels were encroaching onto the public beach. The encroachment was relatively minor. The negotiated solution was for the property owners to pay a permit fee each year to the City. Revenue thus generated may only be used for ocean front restoration projects and incidental costs of improvements and maintenance to enhance public access and use of ocean beaches as approved by the City Council. This Reserve is the repository for those funds. City Council Policy L- 12 contains additional background and details about the encroachment issue The external restriction on this balance is imposed by the Local Coastal Plan (LCP). C. Committed fund balance: That portion of a fund balance that includes amounts that can only be used for specific purposes pursuant to constraints imposed by formal action by the government's highest level of decision making authority, and remain binding unless removed in the same manner. The City considers a resolution to constitute a formal action for the purposes of establishing committed fund balance. The action to constrain resources 9-14 F-2 must occur within the fiscal reporting period; however the amount can be determined subsequently. City Council imposed Commitments are as follows: 1. Facilities Financial Planning (FFP) Fund: In conjunction with the City's Facilities Financial Plan, a sinking fund has been established to amortize the cost of critical City facilities such as, but not limited to, the Civic Center, Police Department buildings, Fire Stations, Library Branches and otherFacility Improvement Projects. The Facilities Financial Planning Program establishes a level charge to the General Fund that will perpetually replenish the cash flows necessary to finance the construction of critical City facilities. This plan will be updated annually as part of the budget process, or as conditions change. The City shall strive to maintain fund balance in the Facilities Financial Planning Reserve at a level equal to or greater than the maximum annual debt service on existing obligations. The eligible uses of this reserve include the cash funding of public facility improvements or the servicing of related debt. 2. Off Street Parking: Per NBMC 12.44.025 the City Council may direct revenues into the off-street parking facilities fund for purposes of the acquisition, development and improvement of off street parking facilities, and for any expenditures necessary or convenient to accomplish such purposes. 3. In Lieu Parking: Per NBMC 12.44.125 the City requires commercial businesses to provide adequate off-street parking or where this is not possible, businesses are afforded the opportunity to pay an annual fee and use parking spaces in a municipal lot, providing such a lot is located within specified proximity to the business. These funds can only be used to provide additional parking. 4. Neighborhood Enhancement - A: Funds previously accumulated to Neighborhood Enhancement Area"A" pursuant to a prior version of NBMC 12.44.027 shall continue to be used only for the purpose of enhancing and supplementing services to the West Newport area. Both the nature of the supplemental services and the definition of the area served are set forth in NBMC 12.44.027. 9-15 F-2 5. Neighborhood Enhancement - B: Funds previously accumulated to Neighborhood Enhancement Area "B" pursuant to a prior version of NBMC 12.44.027 shall continue to be used only for the purpose of enhancing and supplementing services in the Balboa Peninsula. Both the nature of the supplemental services and the definition of the area served are set forth in NBMC 12.44.027. 6. Cable Franchise: Pursuant to the provisions of the Newport Beach Municipal Code, Title 5, Business Licenses & Regulations, Chapter 5.44, in return for the use of the City's streets and public ways for the purpose of installing, operating, maintaining, or reconstructing a cable system to provide cable service, fees are collected by the City from cable providers. Those fees are to be used by the City for support of Public, Education, and Government access programming only. 7. Oil and Gas Reserve: The annual $40,000 which is being set aside from the oil and gas field production revenues is to be used to fund abandoned wells and facilities as they go out of service. 8. Capital Reappropriation: This reserve represents an administrative procedure that recognizes a portion of fund balance is not readily available to fund new endeavors because it has been reappropriated through the budget adoption process or amendment process. D. Assigned fund balance: That portion of a fund balance that includes amounts that are constrained by the City's intent to be used for specific purposes but that are not restricted or committed. This policy hereby delegates the authority to the City Manager or designee to modify or create new assignments of fund balance. Constraints imposed on the use of assigned amounts may be changed by the City Manager or his designee. Appropriations of balances are subject to Council Policy F-3 concerning budget adoption and administration. E. Unassigned fund balance Conten enc Keserve: lne Contrngency Keserve shall nave a tar et Formatted: Not balance of twenty five percent (25%) of General Fund "Operating Formatted: Not Budget" as originally adopted. Operating Budget for this purpose shall include current expenditure appropriations and shall exclude Capital Improvement Projects.Transfers Out, and additional discretionary payments to the City's unfunded pension liability. Appropriation and/ 9-16 F-2 or access to these funds are generally reserved for emergency or unforeseen situations but may be accessed by Council by simple budget appropriation. Examples may include but are not limited to the following: a. A catastrophic loss of critical infrastructure. b. AState or Federally declared state of emergency. c. Any settlement arising from a claim or judgment. d. Deviation from budgeted revenue projections. e. Any action by another government that eliminates or shifts revenues from the City. I. Inability of the City to meet its debt service obligations in any given year. g. Other circumstances deemed necessary by City Council to meet the claims and obligations of the City. Should the Contingency Reserve be used, the City Manager shall present a plan to City Council to replenish the reserve within five years. 2. Residual Fund Balance: The residual portion of available fund balance that is not otherwise restricted, committed or assigned and is above and beyond the Contingency Reserve target reserve balance. PROPRIETARY FUND RESERVES (NET WORKING CAPITAL) In the case of Proprietary Funds (Enterprise and Internal Service Funds), Generally Accepted Accounting Principles ("GAAP") does not permit the reporting of reserves on the face of City financial statements. However, this does not preclude the City from setting policies to accumulate financial resources for prudent financial management of its proprietary fund operations. Since proprietary funds may include both long-term capital assets and long-term liabilities, the most comparable measure of liquid financial resources that is similar to fund balance in proprietary funds is net working capital which is the difference between current assets and current liabilities. For all further references to reserves in Proprietary Funds, Net Working Capital is the intended meaning. 7 9-17 F-2 A. Water Enterprise Fund 1. Stabilization and Contineency Reserve: This Reserve is used to provide sufficient funds to support seasonal variations in cash flows and in more extreme conditions, to maintain operations for a reasonable period of time so the City may reorganize in an orderly manner or effectuate a rate increase to offset sustained cost increases. The intent of the Reserve is to provide funds to offset cost increases that are projected to be short-lived, thereby partially eliminating the volatility in annual rate adjustments. It is not intended to offset ongoing, long-term pricing structure changes. The target level of this reserve is fifty percent (50%) of the annual operating budget. This reserve level is intended to provide a reorganization period of 6 months with zero income or 24 months at a twenty-five percent (25%) loss rate. The City Council must approve the use of these funds, based on City Manager recommendation. Funds collected in excess of the Stabilization reserve target would be available to offset future rate adjustments, while extended reserve shortfalls would be recovered from future rate increases. Should catastrophic losses to the infrastructure system occur, the Stabilization and Contingency Reserve may be called upon to avoid disruption to water distribution. 2. Infrastructure Replacement Funding Policy: This funding policy is intended to be a temporary repository for cash flows associated with the funding of infrastructure replacement projects provided by the Water Master Plan. The contribution rate is intended to level -amortize the cost of infrastructure replacement projects over a long period. The annual funding rate of the Water Master Plan is targeted at an amount that, when combined with prior or future year contributions, is sufficient to provide for the eventual replacement of assets as scheduled in the plan. This contribution policy is based on the funding requirements of the most current Water Master Plan. There are no minimum or maximum balances contemplated by this funding policy. However, the contributions level should be reviewed periodically or as major updates to the Water Master Plan occur. Annual funding is contingent on many factors and may ultimately involve a combined strategy of cash funding and debt issuance with the intent to normalize the burden on Water customer rates. B. Wastewater Enterprise Fund 1. Stabilization and Contineency Reserve: This Reserve is used to provide 8 Em F-2 sufficient funds to support seasonal variations in cash flows and in more extreme conditions, to maintain operations for a reasonable period of time so the City may reorganize in an orderly manner or effectuate a rate increase to offset sustained cost increases. The intent of the Reserve is to provide funds to offset cost increases that are projected to be short-lived, thereby partially eliminating the volatility in annual rate adjustments. It is not intended to offset ongoing, long-term pricing structure changes. The target level of this reserve is fifty percent (50%) of the annual operating budget. This reserve level is intended to provide a reorganization period of 6 months with zero income or 24 months at a twenty-five percent (25%) loss rate. The City Council must approve use of these funds, based on City Manager recommendation. Funds collected in excess of the Stabilization reserve target would be available to offset future rate adjustments, while extended reserve shortfalls would be recovered from future rate increases. Should catastrophic losses to the infrastructure system occur, the Stabilization and Contingency Reserve may be called upon to avoid disruption to wastewater service. 2. Infrastructure Replacement Funding Policy: This funding policy is intended to be a temporary repository for cash flows associated with the funding of infrastructure replacement projects provided by the Wastewater Master Plan. The contribution rate is intended to level - amortize the cost of infrastructure replacement projects over along period of time. The annual funding rate of the Wastewater Master Plan is targeted at an amount that, when combined with prior or future year contributions, is sufficient to provide for the eventual replacement of assets as scheduled in the plan. This contribution policy should be updated periodically based on the most current Wastewater Master Plan. There are no minimum or maximum balances contemplated by this funding policy. However, the contributions level should be reviewed periodically or as major updates to the Wastewater Master Plan occur. Annual funding is contingent on many factors and may ultimately involve a combined strategy of cash funding and debt issuance with the intent to normalize the burden on Wastewater customer rates. C. Internal Service Funds Background. Internal Service Funds are used to centrally manage and account for specific 9 9-19 F-2 program activity in a centralized cost center. Their revenue generally comes from internal charges to departmental operating budgets rather than external revenue sources. They have several functions. --They work well in normalizing departmental budgeting for programs that have life -cycles greater than one year; thereby facilitating level budgeting for expenditures that will, by their nature, be erratic from year to year. This also facilitates easier identification of long term trends. --They act as a strategic savings plan for long-term assets and liabilities. --From an analytical standpoint, they enable appropriate distribution of city- wide costs to individual departments, thereby more readily establishing true costs of various operations. Since departmental charges to the internal service fund duplicate the ultimate expenditure from the internal service fund, they are eliminated when consolidating entity -wide totals. The measurement criteria, cash flow patterns, funding horizon and acceptable funding levels are unique to each program being funded. Policy regarding target balance and/ or_contribution policy, gain/loss amortization assumption, source data, and governance for each ofthe City's Internal Service Funds is setforth as follows: 1. For all Internal Service Funds: The Finance Director may transfer part or all of any unencumbered fund balance between the Internal Service Funds provided that the withdrawal of funds from the transferred fund would not cause insufficient reserve levels or insufficient resources to carry out its intended purpose. This action is appropriate when the decline in cash balance in any fund is precipitated by an off -trend non-recurring event. The Finance Director will make such recommendations as part of the annual budget adoption or through separate Council action. 2. Equipment Maintenance Fund and Equipment Replacement Fund: The Equipment Maintenance and Replacement Funds receive operating money from the Departments to provide equipment maintenance and to fund the regular replacement of major pieces of equipment (mostly vehicles) at their economic obsolescence. a. Equipment Maintenance Fund: The Equipment Maintenance Fund acts solely as a cost allocation center (vs. a pre -funding center) and is funded 10 9-20 F-2 on a pay- as -you -go basis by departmental maintenance charges by vehicle type and usage requirement. Because of this limited function, the target year-end balance is zero. Contribution rates (departmental charges) are set to include the direct costs associated with maintaining the City vehicle fleet, including fleet maintenance employee salary and benefits, operating expenses and maintenance related capital outlay. Administrative overhead and maintenance facility improvements and replacement costs are to be provided outside of this cost unit.- Governance is achieved through annual management adjustment of contriution rates on the basis of maintenance cost by vehicle and distribution of costs based on fleet use by department. b. Equipment Replacement Fund: Operating Departments are charged annual amounts sufficient to accumulate funds for the replacement of vehicles, communications equipment, parking equipment and other equipment replacement determined appropriate by the Finance Director. The City Manager recommends annual rate adjustments as part of the budget preparation process. These adjustments are based on pricing, future replacement schedules and other variables. The age and needs of the equipment inventory vary from year to year. Therefore the year-end fund balance will fluctuate in direct correlation to accumulated depreciation. In general, it will increase in the years preceding the scheduled replacement of relatively large percentage of the equipment, on a dollar value basis. However, rising equipment costs, dissimilar future needs, replacing equipment faster than their expected life or maintaining equipment longer than their expected life all contribute to variation from the projected schedule. Target funding levels shall be determined by the Finance Director after considering the age, expected life and cash flow anticipated by the replacement equipment being funded. If departmental replacement charges for equipment prove to be excessive or insufficient with regard to this target funding level, new rates established during the next budget cycle will be adjusted with a view toward bringing the balance back to the target level over a three-year period. 3. Insurance Reserve Funds: The Insurance Reserve funds account for the activities of general liability and workers' compensation claims. 11 9-21 F-2 Background The City employs an actuary to estimate the liabilities associated with the general liability and workers compensation activities. The costs typically associated with these programs include: claims administration, legal defense, insurance premiums, self insured retention and the establishment of appropriate loss reserves including "incurred -but -not reported" (IBNR) claims. Ina prescribed measurement methodology, the Actuary estimates the liabilities in conformity with Generally Accepted Accounting Principles (GAAP). The Actuary refers to this measurement level in his report as the "Expected Level." However, because actuarial estimates are subject to significant uncertainties, actuaries typically recommend that a target funding level be set at an amount in excess of expected liability as a margin to cover contingencies. A typical target funding level would be set to obtain a specified confidence level (the percent chance that resources set-aside will be sufficient to cover existing claims). Full funding of the Actuary's "Target Funding Level" establishes a seventy- five percent (75%) confidence there will be sufficient resources (including projected interest) to pay the full amount of existing claims without future contributions. Funding at the "Expected Level" produces a confidence level of only fifty percent to sixty-five percent (50%-65% ). Therefore, the target funding of insurance reserves should exceed the "Expected Level" to account for adverse estimate deviation. Policy & Practice. The City should target funding of its risk management obligations at not less than the Expected Level, described above; and not more than an amount sufficient to establish a seventy-five percent (75%) Confidence Level. Actuarial losses should be recovered over a rolling3-year basis while actuarial gains should be amortized over a rolling 5 -year basis. As part of the operating budget, each department will be charged a rate equal to its proportionate share of the total "revenue" required to fund the Insurance Reserve Fund at this level. To lessen the impact of short-term annual rate change fluctuation, City management may implement one-time fund transfers (rather than department rate increases) when funding shortfalls appear to be due to 12 9-22 F-2 unusually sharp and non-recurring factors. Excess reserves in other areas may be transferred to the internal service fund in these instances but such transfers should not exceed the funding necessary to reach a seventy-five (75%) confidence level interval. 4. Compensated Absences Fund: Background. The primary purpose of flex leave, vacation leave and sick leave is to provide compensated time off as appropriate and approved. However, under certain circumstances, typically at separation from service, some employees have the option of receiving cash -out payments for some accumulated leave balances. The Compensated Absences Fund is utilized primarily as a budget smoothing technique for any such leave bank liquidations. The primary purpose of the Compensated Absences Fund is to maintain a balance sufficient to facilitate this smoothing. Policy and Practice. The contribution rate will be set to cover estimated annual cash flows based on a three-year trailing average. The minimum cash reserve should not fall below that three-year average. The maximum cash reserve should not exceed fifty percent (50%) of the long term liability. The target cash reserve shall be the median difference between the minimum and maximum figures. Each department will make contributions to the Compensated Absences Fund through its operating budget as a specified percentage of salary. The Finance Director will review and recommend adjustments to the percentage of salary required during the annual budget development process. This percentage will be set so as to maintain the reserve within the parameters established above. 5. Post Retirement Funding Policies: a. Pension Funding: (i) California Public Employees Retirement System (CalPERS): The City's principal Defined Benefit Pension program is provided through 13 9-23 F-2 contract with Ca1PERS. The City's contributions to the plan include an actuarially determined employer contribution that fluctuates each year based on an annual actuarial plan valuation. This variable rate employer contribution includes the normal cost of providing the contracted benefits plus or minus an amortization of plan changes and net actuarial gains and losses since the last valuation period. It is the City's policy to make contributions to the plan equaling at least one hundred percent (100%) of the actuarially required contribution (annual pension cost). Because the City pays the entire actuarially required contribution each year, by definition, its net pension obligation at the end of each year is $0. Any unfunded actuarial liability (UAL) is amortized and paid in accordance with the actuary's funding recommendations. The City will strive to maintain its UAL within a range that is considered acceptable to actuarial standards. The City Council shall consider increasing the annual Ca1PERS contribution should the UAL status fall below acceptable actuarial standards. (u) Laborer's International Union of North America (LIUNA): The Gb provides funds to support a supplemental pension plan for some employee associations through contract with LIUNA. This is funded at a fixed percentage of total compensation on a pay-as-you-go basis. The City is not contractually required to guarantee the level of the ultimate LIUNA benefit to retirees, nor does it do so. Therefore the City's liability for this program is full funded each year. b. Other Post Employment Benefits (OPEB Funding): Background. The City's OPEB funding obligations consists of two retiree medical plans. New Plan. Effective January 2006, the City and its employee associations agreed to major changes to the Post Employment Healthcare Plan. New employees and all current employees participate in a program that requires certain defined employee and employer contributions while the employee is in active service. However, once the contributions have been made to the employee's account, the City has transferred a substantial portion of the funding risk to the employee. Old Plan. Eligible employees who retired prior to the "New Plan" and 14 9-24 F-2 certain active employees were eligible to continue to receive post- retirement medical benefits (a defined benefit plan). The cost was divided among the City, current employees and retirees. In the past, this program was largely funded on a pay-as-you-go basis, so there was a significant unfunded liability. Recognizing this problem, the City began contributing to this obligation in 2001. In 2008, these assets were placed in a pre -funding trust. The City's intention is to amortize the remaining unfunded liability within 20 years. Policy & Practice. New Plan. Consistent with agreements between the City and Employee Associations, the new defined contribution plan will be one hundred percent (100%) funded, on an ongoing basis, as part of the annual budget process. Funds to cover this expenditure will be contained within the salary section of each department's annual operating budget. Old Plan. The City's policy is to pre fund the explicit (cash subsidy) portion of the Actuarial Accrued Liability (AAL) of the remnants of the old plan over a 20 -year amortization period, or less. This amount will be based on the Annual Required Contribution (ARC) determined by a biennial actuarial review; subject to review and analysis by the City. The City will strive to maintain a funded status that will be within a range that is considered acceptable to actuarial standards. The City Council shall consider increasing the annual OPEB contribution should the funded status fall below acceptable actuarial standards. Adopted - January 24, 1994 Amended - April 10, 1995 Amended - April 27, 1998 Amended - March 14, 2000 Amended - May 8, 2001 Amended - April 23, 2002 Amended - April 13, 2004 Amended - September 15, 2008 Amended- November 12, 2008 Amended - May 24, 2011 Amended - September 27, 2011 Amended - May 14, 2013 15 Formatted 9-25 Amended- June 10, 2014 Amended - May 12, 2015 Amended - September 25, 2018 F-2 16 Formatted: Indent Left: 0" 9-26 Attachment B Resolution No. 2018-72 authorizing revisions to Council Policy F-2 (Clean Version) 9-27 RESOLUTION NO, 2018-72 A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF NEWPORT BEACH, CALIFORNIA, AMENDING CITY COUNCIL RESERVE POLICY F-2 WHEREAS, the City Council of the City of Newport Beach ("City") has a long and established history of being good guardians and stewards of the public's money; WHEREAS, appropriations, expenditures and other budgetary matters are a primary concern of the City Council; WHEREAS, the City Council has adopted various policies regarding financial matters; WHEREAS, the City Council has adopted City Council Reserve Policy F-2 for the administration of "Reserves," which are defined within the policy as fund balances in governmental funds and net working capital in proprietary funds; WHEREAS, on December 12, 1994, the City Council adopted Resolution No. 94- 110 establishing the Finance Committee, whose duties and responsibilities have been amended throughout the years to further protect and safe guard the public's money; WHEREAS, the existing Finance Committee is charged with a variety of tasks, including, but not limited to: reviewing and monitoring events and issues which may affect the financial status of the City; and making recommendations to the City Council regarding amendments to financial and budgetary policies; and WHEREAS, the Finance Committee has recommended an amendment to City Council Reserve Policy F-2 that excludes the additional discretionary payments to the City's unfunded pension liability from the annual Contingency Reserve calculation. NOW, THEREFORE, the City Council of the City of Newport Beach resolves as follows: Section 1: The City Council hereby amends City Council Reserve Policy F-2 as described in Attachment 'A" which is attached hereto and incorporated herein by reference. Section 2: The City Council hereby repeals all prior versions of City Council Reserve Policy F-2 that are in conflict with this resolution. Section 3: If any section, subsection, sentence, clause or phrase of this resolution is for any reason held to be invalid or unconstitutional, such decision shall not affect the validity or constitutionality of the remaining portions of this resolution. The City 9-28 Resolution 2018 - Page 2 of 2 Council hereby declares that it would have passed this resolution and each section, subsection, sentence, clause or phrase hereof, irrespective of the fact that any one or more sections, subsections, sentences, clauses or phrases be declared invalid or unconstitutional. Section 4: The recitals provided in this resolution are true and correct and are incorporated into the substantive portion of this resolution. Section 5: The City Council find the adoption of this resolution and the amendment of City Council Reserve Policy F-2 is not subject to the California Environmental Quality Act ("CEQA") pursuant to Sections 15060(c)(2) (the activity will not result in a direct or reasonably foreseeable indirect physical change in the environment) and 15060(c)(3) (the activity is not a project as defined in Section 15378) of the CEQA Guidelines, California Code of Regulations, Title 14, Chapter 3, because it has no potential for resulting in physical change to the environment, directly or indirectly. Section 6: This resolution shall take effect immediately upon its adoption by the City Council, and the City Clerk shall certify the vote adopting this resolution. ADOPTED this 25th day of September, 2018. Marshall "Duffy" Duffield Mayor ATTEST: Leilani I. Brown, City Clerk APPR V AS TO FORM: Aaron . arp City Attorney Attachment A: Amended City Council Reserve Policy F-2 001 RESERVE POLICY PURPOSE F-2 To establish City Council policy for the administration of Reserves defined as fund balances in governmental funds and net working capital in proprietary funds. BACKGROUND Prudent financial management dictates that some portion of the funds available to the City be reserved for future use. As a general budget principle concerning the use of reserves, the City Council decides whether to appropriate funds from Reserve accounts. Even though a project or other expenditure qualifies as a proper use of Reserves, the Council may decide that it is more beneficial to use current year operating revenues or bond proceeds instead, thereby retaining the Reserve funds for future use. Reserve funds will not be spent for any function other than the specific purpose of the Reserve account from which they are drawn without specific direction in the annual budget; or by a separate City Council action. Information regarding Annual Budget Adoption and Administration is contained in City Council Policy F-3. GOVERNMENTAL FUNDS AND FUND BALANCE DEFINED Governmental Funds including the General Fund, Special Revenue Funds, Capital Projects Funds, Debt Service Funds and Permanent Funds have a short- term or current flow of financial resources, measurement focus and basis of accounting and therefore, exclude long-term assets and long-term liabilities. The term Fund Balance, used to describe the resources that accumulate in these funds, is the difference between the fund assets and fund liabilities of these funds. Fund Balance is similar to the measure of net working capital that is used in private sector accounting. By definition, both Fund Balance and Net Working Capital exclude long-term assets and long-term liabilities. PROPRIETARY FUNDS AND NET WORKING CAPITAL DEFINED Proprietary Funds including Enterprise Funds and Internal Service Funds have a long- term or economic resources measurement focus and basis of accounting 1 9-30 F-2 and therefore, include long-term assets and liabilities. This basis of accounting is very similar to that used in private sector. However, instead of Retained Earnings, the term Net Assets is used to describe the difference between fund assets and fund liabilities. Since Net Assets include both long-term assets and liabilities, the most comparable measure of proprietary fund financial resources to governmental Fund Balance is Net Working Capital, which is the difference between current assets and current liabilities. Net Working Capital, like Fund Balance, excludes long-term assets and long-term liabilities. GOVERNMENTAL FUND RESERVES (FUND BALANCE) For Governmental Funds, the Governmental Accounting Standards Board ("GASB") Statement No. 54 defines five specific classifications of fund balance. The five classifications are intended to identify whether the specific components of fund balance are available for appropriation and are therefore "Spendable." The classifications also are intended to identify the extent to which fund balance is constrained by special restrictions, if any. Applicable only to governmental funds, the five classifications of fund balance are as follows: CLASSIFICATIONS NATURE OF RESTRICTION Non -spendable Restricted Committed Assigned Unassigned Cannot be readily converted to cash Externally imposed restrictions City Council imposed commitment City Manager assigned purpose/ intent Residual balance not otherwise restricted A. Non -spendable fund balance: That portion of fund balance that includes amounts that are either (a) not in a spendable form, or (b) legally or contractually required to be maintained intact. Examples of Non -spendable fund balance include: 1. Reserve for Inventories: The value of inventories purchased by the City but not yet issued to the operating Departments is reflected in this account. 2 9-31 F-2 2. Reserve for Long Term Receivables and Advances: This Reserve is used toidentify and segregate that portion of the City's financial assets which are not due to be received for an extended period, so are not available for appropriation during the budget year. 3. Reserve for Prepaid Assets: This reserve represents resources that have been paid to another entity in advance of the accounting period in which the resource is deducted from fund balance. A common example is an insurance premium, which is typically payable in advance of the coverage period. Although prepaid assets have yet to be deducted from fund balance, they are no longer available for appropriation. 4. Reserve for Permanent Endowment - Bay Dredging: The endowment specifiesthat the principal amount will not be depleted and represents the asset amounts to be held in the Bay Dredging Fund. 5. Reserve for Permanent Endowment - Ackerman Fund: The ffdymet specifies that the principal amount will not be depleted and represents the asset amount to be held in the Ackerman Fund. B. Restricted fund balance: The portion of fund balance that reflects constraints placed on the use of resources (other than non -spendable items) that are either (a) externally imposed by creditors, grantors, contributors, or laws or regulations of other governments; or (b) imposed by law through constitutional provisions or enabling legislation. Examples of restricted fund balance are: 1. Reserve for Debt Service: Funds are placed in this Reserve at the time debt is issued. The provisions governing the Reserve, if established, are in the Bond Indenture and the Reserve itself is typically controlled by the Trustee. 2. Affordable Housing: A principal provision of the Newport Beach Housing Element requires developers to provide housing units for lower income households, the number of which is to be negotiated for each development project. In lieu of constructing affordable housing, developers have paid into this reserve which is used at the City Council's discretion to provide alternate methods for the delivery of affordable housing for lower income households. 3 9-32 F-2 3. Park In Lieu: Per NBMC 19.52 and California Government Code Section 664777 (The 1975 "Quimby Act"), a dedication of land or payment of fees for park or recreational purposes in conjunction with residential development is required. The fees collected can only be used for specific park or recreation purposes as outlined in NBMC 19.52.030 and 19.52.070. 4. Upper Newport Bay Restoration Reserve: This reserve is the repository for funds mandated by S13573, as well as special fees charged to permit holders as an alternative to meeting certain specified mitigation criteria. In addition to the mitigation fees, ten percent (10%) of Beacon Bay lease revenue is placed in this Reserve. Funds in the Reserve are restricted for Upper Newport Bay restoration projects. 5. Permanent Endowment for Bay Dredging: The endowment also specifies that the interest earnings on the principal amount can only be used for dredging projects in the Newport Bay. 6. Permanent Endowment for Ackerman Fund: The endowment also specifies that the interest earnings on the principal amount can only be used for scholarships provided by the City and high-tech library equipment. 7. Oceanfront Encroachment Reserve: In the early 1990's, it was discovered by survey that improvements to several ocean front parcels were encroaching onto the public beach. The encroachment was relatively minor. The negotiated solution was for the property owners to pay a permit fee each year to the City. Revenue thus generated may only be used for ocean front restoration projects and incidental costs of improvements and maintenance to enhance public access and use of ocean beaches as approved by the City Council. This Reserve is the repository for those funds. City Council Policy L- 12 contains additional background and details about the encroachment issue The external restriction on this balance is imposed by the Local Coastal Plan (LCP). C. Committed fund balance: That portion of a fund balance that includes amounts that can only be used for specific purposes pursuant to constraints imposed by formal action by the government's highest level of decision making authority, and remain binding unless removed in the same manner. The City considers a resolution to constitute a formal action for the purposes of establishing committed fund balance. The action to constrain resources 91 9-33 F-2 must occur within the fiscal reporting period; however the amount can be determined subsequently. City Council imposed Commitments are as follows: 1. Facilities Financial Planning (FFP) Fund: In conjunction with the Cit)A Facilities Financial Plan, a sinking fund has been established to amortize the cost of critical City facilities such as, but not limited to, the Civic Center, Police Department buildings, Fire Stations, Library Branches and other Facility Improvement Projects. The Facilities Financial Planning Program establishes a level charge to the General Fund that will perpetually replenish the cash flows necessary to finance the construction of critical City facilities. This plan will be updated annually as part of the budget process, or as conditions change. The City shall strive to maintain fund balance in the Facilities Financial Planning Reserve at a level equal to or greater than the maximum annual debt service on existing obligations. The eligible uses of this reserve include the cash funding of public facility improvements or the servicing of related debt. 2. Off Street Parking: Per NBMC 12.44.025 the City Council may direct revenues into the off-street parking facilities fund for purposes of the acquisition, development and improvement of off street parking facilities, and for any expenditures necessary or convenient to accomplish such purposes. 3. In Lieu Parking: Per NBMC 12.44.125 the City requires commercial businesses to provide adequate off-street parking or where this is not possible, businesses are afforded the opportunity to pay an annual fee and use parking spaces in a municipal lot, providing such a lot is located within specified proximity to the business. These funds can only be used to provide additional parking. 4. Neighborhood Enhancement - A: Funds previously accumulated to Neighborhood Enhancement Area "A" pursuant to a prior version of NBMC 12.44.027 shall continue to be used only for the purpose of enhancing and supplementing services to the West Newport area. Both the nature of the supplemental services and the definition of the area served are set forth in NBMC 12.44.027. W 9-34 F-2 5. Neighborhood Enhancement - B: Funds previously accumulated to Neighborhood Enhancement Area "B" pursuant to a prior version of NBMC 12.44.027 shall continue to be used only for the purpose of enhancing and supplementing services in the Balboa Peninsula. Both the nature of the supplemental services and the definition of the area served are set forth in NBMC 12.44.027. 6. Cable Franchise: Pursuant to the provisions of the Newport Beach Municipal Code, Title 5, Business Licenses & Regulations, Chapter 5.44, in return for the use of the City's streets and public ways for the purpose of installing, operating, maintaining, or reconstructing a cable system to provide cable service, fees are collected by the City from cable providers. Those fees are to be used by the City for support of Public, Education, and Government access programming only. 7. Oil and Gas Reserve: The annual $40,000 which is being set aside from the oil and gas field production revenues is to be used to fund abandoned wells and facilities as they go out of service. 8. Capital Reappropriation: This reserve represents an administrative procedure that recognizes a portion of fund balance is not readily available to fund new endeavors because it has been reappropriated through the budget adoption process or amendment process. D. Assigned fund balance: That portion of a fund balance that includes amounts that are constrained by the City's intent to be used for specific purposes but that are not restricted or committed. This policy hereby delegates the authority to the City Manager or designee to modify or create new assignments of fund balance. Constraints imposed on the use of assigned amounts may be changed by the City Manager or his designee. Appropriations of balances are subject to Council Policy F-3 concerning budget adoption and administration. E. Unassigned fund balance: 1. Contingency Reserve: The Contingency Reserve shall have a target balance of twenty five percent (25%) of General Fund "Operating Budget" as originally adopted. Operating Budget for this purpose shall include current expenditure appropriations and shall exclude Capital Improvement Projects, Transfers Out, and additional discretionary payments to the City's unfunded pension liability. Appropriation and/ 6 9-35 F-2 or access to these funds are generally reserved for emergency or unforeseen situations but may be accessed by Council by simple budget appropriation. Examples may include but are not limited to the following: a. A catastrophic loss of critical infrastructure. b. A State or Federally declared state of emergency. e. Any settlement arising from a claim or judgment. d. Deviation from budgeted revenue projections. e. Any action by another government that eliminates or shifts revenues from the City. f. Inability of the City to meet its debt service obligations in any given year. g. Other circumstances deemed necessary by City Council to meet the claims and obligations of the City. Should the Contingency Reserve be used, the City Manager shall present a plan to City Council to replenish the reserve within five years. 2. Residual Fund Balance: The residual portion of available fund balance that is not otherwise restricted, committed or assigned and is above and beyond the Contingency Reserve target reserve balance. PROPRIETARY FUND RESERVES (NETWORKING CAPITAL) In the case of Proprietary Funds (Enterprise and Internal Service Funds), Generally Accepted Accounting Principles ("GAAP") does not permit the reporting of reserves on the face of City financial statements. However, this does not preclude the City from setting policies to accumulate financial resources for prudent financial management of its proprietary fund operations. Since proprietary funds may include both long-term capital assets and long-term liabilities, the most comparable measure of liquid financial resources that is similar to fund balance in proprietary funds is net working capital which is the difference between current assets and current liabilities. For all further references to reserves in Proprietary Funds, Net Working Capital is the intended meaning. 7 9-36 F-2 A. Water Enterprise Fund 1. Stabilization and Contingency Reserve: This Reserve is used to provide sufficient funds to support seasonal variations in cash flows and in more extreme conditions, to maintain operations for a reasonable period of time so the City may reorganize in an orderly manner or effectuate a rate increase to offset sustained cost increases. The intent of the Reserve is to provide funds to offset cost increases that are projected to be short-lived, thereby partially eliminating the volatility in annual rate adjustments. It is not intended to offset ongoing, long-term pricing structure changes. The target level of this reserve is fifty percent (50%) of the annual operating budget. This reserve level is intended to provide a reorganization period of 6 months with zero income or 24 months at a twenty-five percent (25%) loss rate. The City Council must approve the use of these funds, based on City Manager recommendation. Funds collected in excess of the Stabilization reserve target would be available to offset future rate adjustments, while extended reserve shortfalls would be recovered from future rate increases. Should catastrophic losses to the infrastructure system occur, the Stabilization and Contingency Reserve may be called upon to avoid disruption to water distribution. 2. Infrastructure Replacement Funding Policy: This funding policy is intended to be a temporary repository for cash flows associated with the funding of infrastructure replacement projects provided by the Water Master Plan. The contribution rate is intended to level -amortize the cost of infrastructure replacement projects over a long period. The annual funding rate of the Water Master Plan is targeted at an amount that, when combined with prior or future year contributions, is sufficient to provide for the eventual replacement of assets as scheduled in the plan. This contribution policy is based on the funding requirements of the most current Water Master Plan. There are no minimum or maximum balances contemplated by this funding policy. However, the contributions level should be reviewed periodically or as major updates to the Water Master Plan occur. Annual funding is contingent on many factors and may ultimately involve a combined strategy of cash funding and debt issuance with the intent to normalize the burden on Water customer rates. B. Wastewater Enterprise Fund 1. Stabilization and Contingency Reserve: This Reserve is used to provide 8 9-37 F-2 sufficient funds to support seasonal variations in cash flows and in more extreme conditions, to maintain operations for a reasonable period of time so the City may reorganize in an orderly manner or effectuate a rate increase to offset sustained cost increases. The intent of the Reserve is to provide funds to offset cost increases that are projected to be short-lived, thereby partially eliminating the volatility in annual rate adjustments. It is not intended to offset ongoing, long-term pricing structure changes. The target level of this reserve is fifty percent (50%) of the annual operating budget. This reserve level is intended to provide a reorganization period of 6 months with zero income or 24 months at a twenty-five percent (25 %) loss rate. The City Council must approve use of these funds, based on City Manager recommendation. Funds collected in excess of the Stabilization reserve target would be available to offset future rate adjustments, while extended reserve shortfalls would be recovered from future rate increases. Should catastrophic losses to the infrastructure system occur, the Stabilization and Contingency Reserve may be called upon to avoid disruption to wastewater service. 2. Infrastructure Replacement Funding Policy: This funding policy is intended to be a temporary repository for cash flows associated with the funding of infrastructure replacement projects provided by the Wastewater Master Plan. The contribution rate is intended to level - amortize the cost of infrastructure replacement projects over a long period of time. The annual funding rate of the Wastewater Master Plan is targeted at an amount that, when combined with prior or future year contributions, is sufficient to provide for the eventual replacement of assets as scheduled in the plan. This contribution policy should be updated periodically based on the most current Wastewater Master Plan. There are no minimum or maximum balances contemplated by this funding policy. However, the contributions level should be reviewed periodically or as major updates to the Wastewater Master Plan occur. Annual funding is contingent on many factors and may ultimately involve a combined strategy of cash funding and debt issuance with the intent to normalize the burden on Wastewater customer rates. C. Internal Service Funds Background. Internal Service Funds are used to centrally manage and account for specific 9 Em F-2 program activity in a centralized cost center. Their revenue generally comes from internal charges to departmental operating budgets rather than external revenue sources. They have several functions. --They work well in normalizing departmental budgeting for programs that have life -cycles greater than one year; thereby facilitating level budgeting for expenditures that will, by their nature, be erratic from year to year. This also facilitates easier identification of long term trends. --They act as a strategic savings plan for long-term assets and liabilities. --From an analytical standpoint, they enable appropriate distribution of city- wide costs to individual departments, thereby more readily establishing true costs of various operations. Since departmental charges to the internal service fund duplicate the ultimate expenditure from the internal service fund, they are eliminated when consolidating entity -wide totals. The measurement criteria, cash flow patterns, funding horizon and acceptable funding levels are unique to each program being funded. Policy regarding target balance and/ or contribution policy, gain/loss amortization assumption, source data, and governance for each of the City's Internal Service Funds is set forth as follows: 1. For all Internal Service Funds: The Finance Director may transfer part or all of any unencumbered fund balance between the Internal Service Funds provided that the withdrawal of funds from the transferred fund would not cause insufficient reserve levels or insufficient resources to carry out its intended purpose. This action is appropriate when the decline in cash balance in any fund is precipitated by an off -trend non-recurring event. The Finance Director will make such recommendations as part of the annual budget adoption or through separate Council action. 2. Equipment Maintenance Fund and Equipment Replacement Fund: The Equipment Maintenance and Replacement Funds receive operating money from the Departments to provide equipment maintenance and to fund the regular replacement of major pieces of equipment (mostly vehicles) at their economic obsolescence. a. Equipment Maintenance Fund: The Equipment Maintenance Fund acts solely as a cost allocation center (vs. a pre -funding center) and is funded 10 9-39 F-2 on a pay- as -you -go basis by departmental maintenance charges by vehicle type and usage requirement. Because of this limited function, the target year-end balance is zero. Contribution rates (departmental charges) are set to include the direct costs associated with maintaining the City vehicle fleet, including fleet maintenance employee salary and benefits, operating expenses and maintenance related capital outlay. Administrative overhead and maintenance facility improvements and replacement costs are to be provided outside of this cost unit. Governance is achieved through annual management adjustment of contribution rates on the basis of maintenance cost by vehicle and distribution of costs based on fleet use by department. b. Equipment Replacement Fund: Operating Departments are charged annual amounts sufficient to accumulate funds for the replacement of vehicles, communications equipment, parking equipment and other equipment replacement determined appropriate by the Finance Director. The City Manager recommends annual rate adjustments as part of the budget preparation process. These adjustments are based on pricing, future replacement schedules and other variables. The age and needs of the equipment inventory vary from year to year. Therefore the year-end fund balance will fluctuate in direct correlation to accumulated depreciation. In general, it will increase in the years preceding the scheduled replacement of relatively large percentage of the equipment, on a dollar value basis. However, rising equipment costs, dissimilar future needs, replacing equipment faster than their expected life or maintaining equipment longer than their expected life all contribute to variation from the projected schedule. Target funding levels shall be determined by the Finance Director after considering the age, expected life and cash flow anticipated by the replacement equipment being funded. If departmental replacement charges for equipment prove to be excessive or insufficient with regard to this target funding level, new rates established during the next budget cycle will be adjusted with a view toward bringing the balance back to the target level over a three-year period. 3. Insurance Reserve Funds: The Insurance Reserve funds account for the activities of general liability and workers' compensation claims. 11 M F-2 Background. The City employs an actuary to estimate the liabilities associated with the general liability and workers compensation activities. The costs typically associated with these programs include: claims administration, legal defense, insurance premiums, self insured retention and the establishment of appropriate loss reserves including "incurred -but -not reported" (IBNR) claims. Ina prescribed measurement methodology, the Actuary estimates the liabilities in conformity with Generally Accepted Accounting Principles (GAAP). The Actuary refers to this measurement level in his report as the "Expected Level." However, because actuarial estimates are subject to significant uncertainties, actuaries typically recommend that a target funding level be set at an amount in excess of expected liability as a margin to cover contingencies. A typical target funding level would be set to obtain a specified confidence level (the percent chance that resources set-aside will be sufficient to cover existing claims). Full funding of the Actuary's "Target Funding Level" establishes a seventy- five percent (75%) confidence there will be sufficient resources (including projected interest) to pay the full amount of existing claims without future contributions. Funding at the "Expected Level" produces a confidence level of only fifty percent to sixty-five percent (50%-65% ). Therefore, the target funding of insurance reserves should exceed the "Expected Level" to account for adverse estimate deviation. Policy & Practice. The City should target funding of its risk management obligations at not less than the Expected Level, described above; and not more than an amount sufficient to establish a seventy-five percent (75%) Confidence Level. Actuarial losses should be recovered over a rolling 3 -year basis while actuarial gains should be amortized over a rolling 5 -year basis. As part of the operating budget, each department will be charged a rate equal to its proportionate share of the total "revenue" required to fund the Insurance Reserve Fund at this level. To lessen the impact of short-term annual rate change fluctuation, City management may implement one-time fund transfers (rather than department rate increases) when funding shortfalls appear to be due to 12 9-41 F-2 unusually sharp and non-recurring factors. Excess reserves in other areas may be transferred to the internal service fund in these instances but such transfers should not exceed the funding necessary to reach a seventy-five (75%) confidence level interval. 4. Compensated Absences Fund: Background. The primary purpose of flex leave, vacation leave and sick leave is to provide compensated time off as appropriate and approved. However, under certain circumstances, typically at separation from service, some employees have the option of receiving cash -out payments for some accumulated leave balances. The Compensated Absences Fund is utilized primarily as a budget smoothing technique for any such leave bank liquidations. The primary purpose of the Compensated Absences Fund is to maintain a balance sufficient to facilitate this smoothing. Policy and Practice. The contribution rate will be set to cover estimated annual cash flows based on a three-year trailing average. The minimum cash reserve should not fall below that three-year average. The maximum cash reserve should not exceed fifty percent (50%) of the long term liability. The target cash reserve shall be the median difference between the minimum and maximum figures. Each department will make contributions to the Compensated Absences Fund through its operating budget as a specified percentage of salary. The Finance Director will review and recommend adjustments to the percentage of salary required during the annual budget development process. This percentage will be set so as to maintain the reserve within the parameters established above. 5. Post Retirement Funding Policies: a. Pension Funding: (i) California Public Employees Retirement System (CalPERS): The City's principal Defined Benefit Pension program is provided through 13 9-42 F-2 contract with CaIPERS. The City's contributions to the plan include an actuarially determined employer contribution that fluctuates each year based on an annual actuarial plan valuation. This variable rate employer contribution includes the normal cost of providing the contracted benefits plus or minus an amortization of plan changes and net actuarial gains and losses since the last valuation period. It is the City's policy to make contributions to the plan equaling at least one hundred percent (100%) of the actuarially required contribution (annual pension cost). Because the City pays the entire actuarially required contribution each year, by definition, its net pension obligation at the end of each year is $0. Any unfunded actuarial liability (UAL) is amortized and paid in accordance with the actuary's funding recommendations. The City will strive to maintain its UAL within a range that is considered acceptable to actuarial standards. The City Council shall consider increasing the annual CalPERS contribution should the UAL status fall below acceptable actuarial standards. (ii) Laborer's International Union of North America (LIUNA): The Gly provides funds to support a supplemental pension plan for some employee associations through contract with LIUNA. This is funded at a fixed percentage of total compensation on a pay-as-you-go basis. The City is not contractually required to guarantee the level of the ultimate LIUNA benefit to retirees, nor does it do so. Therefore the City's liability for this program is full funded each year. b. Other Post Employment Benefits (OPEB Funding): Background. The City's OPEB funding obligations consists of two retiree medical plans. New Plan. Effective January 2006, the City and its employee associations agreed to major changes to the Post Employment Healthcare Plan. New employees and all current employees participate in a program that requires certain defined employee and employer contributions while the employee is in active service. However, once the contributions have been made to the employee's account, the City has transferred a substantial portion of the funding risk to the employee. Old Plan. Eligible employees who retired prior to the "New Plan" and 14 F-2 certain active employees were eligible to continue to receive post- retirement medical benefits (a defined benefit plan). The cost was divided among the City, current employees and retirees. In the past, this program was largely funded on a pay-as-you-go basis, so there was a significant unfunded liability. Recognizing this problem, the City began contributing to this obligation in 2001. In 2008, these assets were placed in a pre -funding trust. The City's intention is to amortize the remaining unfunded liability within 20 years. Policy & Practice. New Plan. Consistent with agreements between the City and Employee Associations, the new defined contribution plan will be one hundred percent (100%) funded, on an ongoing basis, as part of the annual budget process. Funds to cover this expenditure will be contained within the salary section of each department's annual operating budget. Old Plan. The City's policy is to pre fund the explicit (cash subsidy) portion of the Actuarial Accrued Liability (AAL) of the remnants of the old plan over a 20 -year amortization period, or less. This amount will be based on the Annual Required Contribution (ARC) determined by a biennial actuarial review; subject to review and analysis by the City. The City will strive to maintain a funded status that will be within a range that is considered acceptable to actuarial standards. The City Council shall consider increasing the annual OPEB contribution should the funded status fall below acceptable actuarial standards. Adopted - January 24,1994 Amended - April 10, 1995 Amended - April 27,1998 Amended - March 14, 2000 Amended - May 8, 2001 Amended - April 23, 2002 Amended - April 13, 2004 Amended - September 15, 2008 Amended- November 12, 2008 Amended - May 24, 2011 Amended - September 27, 2011 Amended - May 14, 2013 Amended- June 10, 2014 Amended - May 12, 2015 Amended - September 25, 2018 15