Back in June, gloating over a projected $30.8 million balance in the General Fund as of the end of this fiscal year, Council instructed staff to come up with a list of recommendations about how to “allocate” – i.e., spend – the “excess” cash.
Over the summer, staff did as requested, and Interim City Manager Liz Warmerdam and Finance Director Elena Adair will present the list to Council Tuesday.
We’ll discuss a few of the specific proposals in a minute, but let’s start with the bottom line:
If Council adopts all of staff’s proposals, the “available” General Fund balance – more colloquially known as the “reserves” – will fall to $6.56 million by June 30, 2020. This is far less than either the $17.0 million “available balance” shown in the forecast presented to Council last June or the $18.2 million “available balance” that the so-called 20% “reserve policy” would mandate.
Here’s how we get the $6.56 million figure:
“Available balance” as of June 30, 2016 $30,800,000
Less: Additional spending items recommended by staff ($4,497,000)
Less: Amount proposed by staff for PERS and OPEB funds ($6,043,000)
Less: Annual operating deficits projected by staff ($13,700,000)
“Available balance” as of June 30, 2020 $6,560,000
(A more detailed version of this calculation is available by clicking on the link below. Be advised: You won’t find the $6.56 million figure in the staff report itself. Indeed, you’ll see an item in which staff purports to recommend increasing the “reserves.” But the staff report takes the City’s financial condition only through the end of the next fiscal year. We’ve used the five-year forecast prepared by staff and presented to Council last June to extend the analysis for another four years. Even if Council accepts the staff recommendation for increasing the “reserves” in the short run, these funds already are included in the $30.8 million balance we’ve used as a starting point.)
We suspect that only a handful of our readers will find our conclusion disturbing. It is, after all, based on staff projections of revenue and expenses, and, as we all know, the City’s finance personnel are known for erring on the conservative side. (BTW, the next time you hear someone denounce City Treasurer Kevin Kennedy or City Auditor Kevin Kearney for prophesying back in 2012 that the apocalypse was upon us, remember that Messrs. Kennedy and Kearney were reacting to a forecast prepared by staff.)
Vice Mayor Frank Matarrese, for one, has publicly stated that he is sure that the City will receive greater revenues than staff is predicting. Accordingly, if he and his colleagues manage to hire a new city manager who is able to hold the line on expenses – is Ann Marie Gallant available? – the future will be flush with operating surpluses. So, yeah, maybe the numbers computed using the staff reports come out to $6.56 million, but “everyone knows” things will never get that bad.
But optimism, especially bleary-eyed optimism, isn’t in the Merry-Go-Round’s DNA. If faith is the assurance of things hoped for, count us among the skeptics. And if things don’t happen as hoped for, there is a price to be paid. Suppose Council adopts all of staff’s proposals. If revenues turn out to be lower or operating expenses higher during the next four years than they were projected to be, the cash on hand that can be used to make up the shortfall will have been reduced by two-thirds. Moreover, unless Council begins balancing the budget starting in Fiscal Year 2020-21, the General Fund “reserves” may disappear altogether.
Okay, you’ve been warned. So now let’s look at a few of the individual items recommended in the staff report. We’ll start with the additional spending proposals.
The first thing we noticed is that, of the eight items identified by Council during the budget discussions as possible areas for additional spending – what Mayor Trish Spencer and Ms. Warmerdam called the “parking lot” – only five made the final list. The other three – demolishing vacant apartment buildings at Alameda Point, contributing toward the cost of renovating the Carnegie Library, and providing health benefits for part-time employees – bit the dust.
At the same time, “[u]pon further review and after analysis by each City Department,” four new items found their way onto the spending schedule. The most notable was – hang onto your hats – additional funding for the new, state-of-the-art Emergency Operations Center and fire station no. 3.
Yes, that’s right. Back in May, Council authorized a contract in the amount of $7,960,608 for construction of the new EOC and fire station (which former City Manager John Russo had represented, just three years ago, would cost $4.5 million). Because the former and present Councils approved borrowing money to pay for the project, the new edifices would end up setting the City back around $14.5 million.
Well, once the work began, it turned out there was just one little problem. In late July, the staff report discloses, the contractor
performed additional hazardous materials testing on the site to confirm that the soil could be disposed in a regular landfill. Unfortunately, those results came back showing higher levels of lead than originally identified. AECOM performed additional testing that has confirmed high levels of lead. The lead appears to follow the old railroad line through the site and may have come from lead based paint that was used on railroad cars.
These results apparently came as a surprise to the Public Works Department, since the City had performed a “base line hazardous materials survey” of the Beltline property in 2006-8, which showed a “limited amount” of hazardous materials, and then another survey specifically of the EOC/fire station site in 2012, which produced “findings within acceptable limits.” We’re sure Public Works Director Bob Haun is prepared to explain to Council why these prior surveys missed the lead. We hope someone asks him.
In any event, as a result of the discovery of lead-contaminated soil, the general contractor was “unable to work” on the site between mid-July and mid-August, which led to a delay claim against the City that now totals $39,959. In addition, in August the Public Works Department issued a $305,698 no-bid contract for removal of the hazardous soil, only to learn, as a result of yet more “additional testing” – costing another $18,000 – that “an entire volume of soil had to be disposed of as hazardous,” adding $93,000 to the tab. Again, we’re sure Mr. Haun can explain why his department didn’t get it right the first time.
These expenses depleted the contingency built into the original contract price. Since “it is likely there will be additional unforeseen conditions that will require a contingency,” staff now wants Council to appropriate $457,000 from the General Fund to “replenish” the contingency. This will bring the total cost of the EOC/fire station to around $15 million, but don’t expect Council to pull the plug on the project now. For our part, we’re going to keep the books open in case some other “unforeseen conditions” befall the job. And maybe Council ought to consider hiring a professional construction manager to assist Mr. Haun.
The other new item on staff’s list that caught our eye involves Estuary Park, an eight-acre site located on the West End that will contain athletic fields and a community park. When the project was announced a year ago, staff stated that the cost to build Phase One – the athletic fields – would be $3.35 million. The necessary financing would come from Measure WW funds, grants, and private donations. Nothing was said about tapping the General Fund available balance/reserves.
Apparently, things have not gone as planned. The cost estimate has risen to $4.1 million. And, despite what we’re sure was a valiant effort by Recreation and Parks Director Amy Wooldridge, only $3.1 million has been raised to date. One of the grants requires that construction begin by next January – less than four months from now. So staff is asking Council to make up the $1 million shortfall by appropriating $500,000 from the Recreation Fund – the separate account into which user fees go – and another $500,000 from the General Fund.
Again, it will be hard for Council to say, No. (“What? You voted against the parks?”) But, in the future, it might be wiser to lock down the necessary funding before announcing that a new park (or any other project) will be built without touching the General Fund. Ms. Wooldridge may be a magician – but she ain’t Houdini.
Both the EOC/fire station and, to a lesser extent, Estuary Park can be seen as examples of a “Let’s decide to build it and we’ll figure out how to pay for it later” mentality that we, at least, find troubling. Once Council has determined to erect a grandiose EOC and fire station or to put up a new park, the projects take on a life of their own. If the total cost can’t be covered by taxes and fees – and staff can’t find somebody else to stick with the tab – the needed cash has got to come out of the General Fund available balance/reserves. And if that means reducing or eliminating the amount set aside for a“rainy day,” well, it never rains in northern California, does it? Any rumors you hear about El Niño are just Republican propaganda.
Now we’ll turn to the staff proposals for pensions and OPEB. Under the former, Council would “allocate” $3.043 million of the available balance/reserves to a “PERS smoothing fund.” Under the latter, Council would “allocate” an additional $3.0 million to an “OPEB trust” to “continue funding OPEB obligations for existing retirees.”
The staff report describing the two proposals contains only three paragraphs, but Ms. Adair was kind enough – over the weekend, no less – to furnish supplemental information in response to our questions. A lot of the details, it seems, remain to be worked out. So we can’t be exactly sure how these two funds will work – or how much good they will do.
The impetus for creating a “PERS smoothing fund” is clear. Back in April 2013, CalPERS changed its “amortization and smoothing” policy for accounting for investment gains and losses. These changes resulted in increases in employer contribution rates beginning in fiscal year 2015-16. For the Alameda public safety employee pension plan, the rate will go from 46% in FY 2015-16 to 56.2% in FY 2019-20. As a result, the amount of the contribution required to be made by the City will rise from $9.7 million in FY 2015-16 to $12.8 million in FY 2019-20. (Similar, but smaller, increases in rates and amounts apply to the miscellaneous employee pension plan).
It is less clear how the PERS smoothing fund is intended to help with this additional expense. “At this point,” Ms. Adair told us, “the City will reserve the funds and apply them to the future PERS employer rate increases to smooth the impact. It is still to be determined on whether the City will set up a Pension Trust (similar to the OPEB Trust).”
This is a decision that makes a material difference. To “reserve” the funds requires no more than a bookkeeping entry changing a portion of the General Fund balance from “available” to a more restrictive category. But this (or a future) Council can simply reverse the entry if it decides later to spend the money on something else. By contrast, if the funds actually are deposited in an irrevocable trust, Council loses a significant degree of control over them. Assuming that the Council members themselves are the trustees, they can decide when to spend the money – but not what to spend it for. Only disbursements for the specified trust purposes would be permitted.
Which then raises the issue: What should those specified trust purposes be? There would seem to be two choices. One is to use the trust simply to provide an additional source of funds to meet the City’s annual obligations to CalPERs. For example, if the required employer contribution is $12 million, all of which ordinarily would be paid out of current General Fund revenue, the City could take $1 million from the pension trust, which would reduce the amount charged to the General Fund to $11 million. The other is to use the trust to supplement, rather than to pay a portion of, the annual employer contribution. In our example, the City would send CalPERS not only the required $12 million (from the General Fund) but another $1 million (from the pension trust).
Again, the choice makes a material difference. The first option – paying a portion of the annual required employer contribution from the trust – does not affect the City’s overall financial condition, since the amount “saved” by paying less out of the General Fund will be offset precisely by the amount withdrawn from the pension trust. Moreover, this alternative does not reduce the City’s unfunded pension liability, since the City is paying only the amount it already is calculated to owe based on CalPERS’ amortization formula.
Worst of all, the move poses a political risk: If, instead of paying the $12 million out of current General Fund revenue, the City takes $11 million from the General Fund and gets the rest from the pension trust, General Fund operating expenses will appear lower, the results of operations better, and the ending balance higher. The politicians might very well be tempted to see the $1 million variance between budgeted and actual operating results as creating a $1 million “surplus” available for them to spend. If so, who knows what worthy project they will decide to bestow the newly found money on?
The second option – supplementing the annual required employer contribution – should make a difference in the City’s unfunded pension liability, since the City is paying more than the amount it is calculated to owe, and, presumably, the extra funds would be applied – in some fashion – against the total outstanding debt. It would take an actuary to figure out just how much of a reduction in unfunded liability would result. (We suspect it’s not quite as simple as computing the effect of pre-paying a mortgage). But even if the City gets credit for the full $3.043 million in “extra” contributions, it won’t make much of a dent in the $121.2 million unfunded liability for the public safety employee pension plan or the $50.1 million unfunded liability for the miscellaneous employee pension plan.
Staff’s proposal for a new OPEB trust raises its own set of questions.
Again, the impetus for creating a trust benefiting existing retirees is clear. According to the latest actuarial report, the City’s unfunded OPEB liability as of January 1, 2013 was $91.2 million, consisting of $53 million owed to “active” employees who will retire in the future and $48.1 million owed to current retirees. The OPEB trust established by Council in April was intended to pay – eventually – a portion of the cost of providing retiree health benefits to the former group (more precisely, the subset of that group who retire after January 1, 2019). The current proposal is directed at the latter.
According to Ms. Adair, the new trust will piggyback on the recently established one. “Staff is working on setting up a separate account within one Trust to segregate the pooled of money,” she told us. And since the trust structure will be used, this (or a future) Council won’t be able to get its hands on the funds for other purposes. “[O]nce funds are in the Trust,” Ms. Adair stated, “the City can only use it for OPEB costs.”
Which leaves the issue of when and under what circumstances disbursements will be made from the new trust (or sub-trust). According to Ms. Adair, “The mechanics of how the payment process will work is still to be determined.”
The disbursement options for the OPEB trust are different from those for a pension trust. Unlike the City’s annual employer contribution to CalPERS, its annual OPEB payment does not include any amount intended to amortize future liabilities; it all goes to pay the current year’s health insurance premiums. In theory, the new OPEB trust could be used to reduce the unfunded liability. But, according to the latest actuarial report, the amount needed in FY 2013-14 alone to amortize the accrued OPEB debt was $4.8 million – and the new trust will be capitalized with only $3 million.
Alternatively, the new OPEB trust could be used to provide funds to pick up part of the annual tab that otherwise would be paid out of the General Fund. (For example, if annual health insurance premiums amounted to $2.65 million, as they did in FY 2013-14, the City could take $500,000 out of the trust and $2.15 million from the General Fund). But this move would have the same effect as the similar one for a pension trust: It would not improve the City’s overall financial condition or reduce the unfunded OPEB liability, and it might tempt the politicians to take an overly rosy view of the General Fund operating results and spend accordingly.
These are some of the questions we see raised by staff’s proposals for a PERS smoothing fund and a new OPEB trust. We’d have to imagine that financial experts – dare we suggest Messrs. Kennedy and Kearney, knowing full well that protecting the City’s financial wellbeing is not one of their Charter duties? – would have other, and probably better, ones. And, of course, it would be nice to have an actuarial report laying out the financial consequences of the various alternatives.
Nevertheless, we commend Ms. Warmerdam and Ms. Adair for responding so promptly to Council’s requests for pension and OPEB proposals. We just hope that someone on Council will want to see those ideas fleshed out a little bit more before moving forward. We’re more than willing to give the politicians credit for tackling the pension and OPEB problems – when and if we’re sure that they’ve brought down the ball carrier, not just a practice dummy.
September 15, 2015 staff report: 2015-09-15 staff report re additional spending
June 2, 2015 staff presentation: 2015-06-02 staff presentation – Budget Adoption
Analysis of “available balance”: Additional spending analysis
EOC/fire station no. 3 construction contract: 2015-05-19 staff report re FS3 construction contract