AGENDA ITEM
TO: HONORABLE MAYOR
AND MEMBERS OF THE CITY COUNCIL
FROM: CARLO TOMAINO
CITY MANAGER
BY: SHARON DEL ROSARIO
FINANCE DIRECTOR
SIAMLU COX
DEPUTY FINANCE DIRECTOR
SUBJECT: title
SIGNAL HILL GENERAL FUND RESERVE POLICY
summary
Summary:
The City Council will consider adopting a General Fund Reserve Policy to formalize the City’s financial reserve targets and reserve criteria and pre-commit the City to prudent decisions about reserves. The City’s prudent fiscal practices have enabled the City to achieve and maintain a positive, long-term stable financial condition; the City’s current reserve funded status is approximately 92% of General Fund expenditures. During the budget adoption for the Fiscal Years (FY) 2024-2026, the City Council expressed an interest in revisiting the City’s reserve targets and establishing a formal General Fund Reserve Policy to ensure continued long-term fiscal stability. The proposed General Fund Reserve Policy would formalize the City’s management of reserve funds associated with both unplanned and planned activities to ensure funding availability on a long-term basis for both scenarios.
Strategic Plan Goal(s):
Goal No. 1 Financial Stability: Ensure the City’s long-term financial stability and resilience
Goal No. 2 Community Safety: Maintain community safety by supporting public safety services and increasing emergency preparedness.
Goal No. 3 Economic & Downtown Development: Improve the local economy, support local businesses, and create a vibrant downtown core.
Goal No. 4 Infrastructure: Maintain and improve the City’s physical infrastructure, water system, and recreational spaces.
Goal No. 5 High-Functioning Government: Strengthen internal communication, recruitment, retention, systems, and processes to increase the effectiveness and efficiency of City services.
recommendation
Recommendation:
Adopt a resolution, entitled:
A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF SIGNAL HILL, CALIFORNIA, ADOPTING A GENERAL FUND RESERVE POLICY FOR THE CITY OF SIGNAL HILL.
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Fiscal Impact:
There is no direct impact associated with the recommended action. Reserve designation recommendations will be considered during the final audited financial results for FY 2023-24 presentation of the Annual Comprehensive Financial Report (ACFR) and during the budget adoption process.
Background:
Governments are subject to unexpected financial changes, including natural catastrophes, recessions revenue source instability, and other exigent circumstances. Financial reserves (a “rainy day” fund) are essentially a form of self-insurance that governments use to buffer themselves against these risks. When assessing risk, one of the primary concerns is revenue source instability. The City’s main revenue source, which accounts for approximately 75% of the annual General Fund budget, comes from Sales Tax Revenue. The greater the instability of this revenue during an adverse economic event, the more stress it places on the City’s budget. This lack of revenue diversity increases the risk of a revenue shortfall during an economic slowdown.
To mitigate issues associated with economic forces outside the City’s control and to make prudent decisions related to foreseeing financial matters, such as capital projects, it is critical the City have sound financial policies in place. The City has been operating under budgeting and financial planning guidelines included in the annual adopted budget book (page 2 of Budget book) that includes the following reserve guidelines:
• The City shall maintain a combined General Fund reserve and Economic Uncertainties reserve equivalent to a minimum of six months operating expenses.
• The General Fund and Economic Uncertainties reserves shall only be used for cashflow purposes, loans to other funds, major citywide emergencies (e.g., earthquakes, floods, or fire), severe economic downturns, or loss of a major sales tax provider.
• When fiscally prudent, Special Reserve Funds should be established for identified, future major expenditures such as GASB 45 (Other post-employment benefits), PERS, Library, and Police Building. These Reserves should be clearly identified in the Annual Budget.
• Non-recurring resources will be used for non-recurring expenditures such as contributions to reserves, debt retirement, and/or capital projects.
Currently, the General Fund unassigned fund balance and economic uncertainties reserve balance exceeds the six months or 50% operating reserve target. The adopted budget estimates that the FY 2024-25 General Fund unassigned fund balance and Economic Uncertainties Reserve balance will total $32,142,530, representing 92% of the General Fund budgeted expenditures for FY 2024-25.
Analysis:
While the City’s reserve levels are healthy and above the target, the City Council requested that staff evaluate the current reserve guidelines to develop a formal General Fund Reserve Policy. Based on this request, staff prepared additional reserve parameters to address long-term financial stability and potential areas of financial exposure, such as aging infrastructure and rising cost of retiree benefits. Developing a strategy that optimizes the correct reserve balance level to manage risk and provide the City with the ability to advance community projects is critical.
As the City Council knows, the Government Finance Officer’s Association (GFOA) is a nationally recognized professional organization that provides guidance to its approximately 19,000 members across the United States. Therefore, when working to develop a proposed policy structure related to the City’s reserves, the GFOA provides a good starting point. The Government Finance Officers Association (GFOA) recommended the following summarized actions in a recent paper titled “Should We Rethink Reserves?” The paper includes the following elements: staff has attached the paper for the City Council’s general information and background (Attachment A):
1. Risk Based Reserve Analysis: How much is enough depending on risk levels?
2. Develop a Comprehensive Reserve Policy: Minimum and maximum amounts and ranges instead of single point policy.
3. Optimize the Combination of Commercial Insurance and Self-Insurance: Identify pricing efficiencies between holding funds and purchasing private insurance.
4. Optimize Investment Strategies: How much cash is necessary to keep liquid for unplanned, unavoidable expenditures versus long-term, less liquid investments?
5. Pool Risk: Understanding unrealized internal risk pooling opportunities
6. Understand Bond Ratings and Reserves: Measure higher reserves vs worth the cost to obtain higher bond rating.
Reserve Policy Structure
The purpose of this item is to provide the City Council an opportunity to consider a proposed Fund Balance Reserve Policy (Attachment B). To facilitate the City Council’s discussion, staff organized the balance of this report into two different types of reserves: Type I and Type II. In summary, Type 1 Reserves can be thought of as unplanned activities such as natural disasters and economic recessions; Type II Reserves are planned activities such as capital projects. The following sections provide definitions, examples, and discussion regarding each reserve type to inform the City Council’s understanding of the proposed policy options.
Type I Reserves:
The first type of reserve funds include five (5) reserve funds, created to prepare for future, unpredictable adverse events, such as recessions, which are the most prevalent source of financial instability for local governments. These reserves can play a crucial role in counteracting downturns in the economic cycles coupled with spending cuts and can provide a “soft landing” in the event of a disruptive event. The optimal risk management strategy considers a multi-faceted approach utilizing all available tools, such as reserves, private insurance, and city service levels when facing a severe event. Staff has highlighted five reserve funds that fall into this category type:
§ General Fund Unassigned Target Balance
§ Economic Uncertainties Reserve
§ CalPERS Reserve
§ Other Post Employment Benefit (OPEB) Reserve
§ Insurance Reserve
Type II Reserves:
Type II reserve funds function similarly to a savings account, set aside to cover future expenses that would not be affordable within a single year’s revenue budget. These reserves support multi-year financing strategies for large expenses, a capital asset outlay program is an example of such a cost. The Capital Improvement Project (CIP) Reserve is highlighted as an example in this staff report. The CIP Reserve funds future capital improvements projects that rely on the General Fund, with its allocation based on the five-year CIP schedule, covering a wide range of capital infrastructure projects. Staff emphasizes the importance of reviewing this reserve fund annually; this practice ensures the reserve is adequately funded to ensure long-term financial sustainability as well as to maintain and improve the City’s physical infrastructure.
The remaining infrastructure-related reserve funds have a narrower focus, typically allocated to a single specific type of infrastructure or maintenance costs with pre-determined funding estimates. The City Council established these reserves for specific purposes which may have a variable spending timeframe or scope that would not impact the General Fund, for example: the police radio/system reserve, the economic development, and similar reserves. Staff typically presents these reserves in the annual adopted budget as General Fund Balances Committed for Contingencies within the Summary of Changes in Fund Balance Statement.
Proposed General Fund Reserve Policy
The proposed General Fund Reserve Policy comprises Type I and Type II reserve funds. For each Reserve Category, staff has designated the following criteria (Attachment B):
Below is the list of reserve funds for consideration to establish thresholds and criteria separated by type:
Type I: Financial reserves (a “rainy day” fund) are essentially a form of self-insurance that governments use to buffer themselves against risks such as financial shocks, including natural catastrophes, recessions revenue source instability, and more:
1. Target Level: The City’s Target Reserve Level for the General Fund Unassigned Balance is established at a level of 30% to 40% of the General Fund Adopted Expenditures for the same year.
2. Minimum Threshold: The minimum threshold for the General Fund Unassigned Balance Reserve Fund is established as 30% of General Fund Adopted Expenditures for the same year.
3. Authority: The Finance Director may regularly review and recommend updates to the established Target Reserve Levels to the City Council to reflect changing economic conditions, risk factors, and financial goals.
4. Use: Access to this reserve shall be triggered by one or more of the following conditions:
• A reduction in revenue equal to or greater than 5% of projected revenues in a given fiscal year could trigger the potential use of these funds to support core City services
• A Resolution declaring a State of Local or National Emergency.
• Emergency Contract Services for the preservation of assets, or to protect public health.
• Any other catastrophic emergency such as, but not limited, to the repair or rebuilding of the City’s streets, hardscape, facilities, communication and technology systems, or other City-owned properties.
This committed reserve is held to mitigate annual revenue shortfalls due to a fluctuating economy, unforeseen natural disasters, or actions by the state/federal government that create a revenue shortfall. This reserve could be used to support core City services.
1. Target Level: The City’s Target Reserve Level for the General Fund Economic Uncertainties Reserve is established at a level of 20% to 35% of the General Fund Adopted Expenditures for the same year.
2. The Minimum Threshold: The minimum threshold for the Economic Uncertainties Reserve Fund is established as 20% of General Fund Adopted Expenditures for the same year.
3. Authority: The Finance Director may regularly review and recommend updates to the Reserve fund balance policy to the City Council to reflect changing economic conditions, risk factors, and financial goals.
4. Use: Access to this reserve shall be triggered by one or more of the following conditions:
• A reduction in revenue equal to or greater than 5% of projected revenues in a given fiscal year could trigger the potential use of these funds to support core city services to be used after the General Fund Unassigned Balance reserves are exhausted.
• A Resolution declaring a State of Local, or National Emergency.
• Emergency Contract Services for the preservation of assets, or to protect public health.
Based on the above to reserve requirements, the minimum threshold for both the General Fund unassigned fund balance and the Economic Uncertainties Reserve fund is established at 50% with an upper range of 75%. The CalPERS, OPEB and Insurance reserves could be considered a part of this total reserve target as these reserves are also established to mitigate economic uncertainty that may affect annual and long-term sustainability and are discussed in the following details.
The City has participated in the California Public Employees Retirement System since the 1940’s. The City established the PERS Reserve in FY 2003-2004 with an initial investment of $505,000. PERS dictates the rate increases which are the result of historical net gains or losses in PERS investments portfolio. This reserve is set aside to pay current year pension liability costs and/or pay down the longer-term pension liabilities presented in the ACFR for Governmental Activities. Pension costs are largely subject to economic cycles affecting CalPERS investment funds and CalPERS not meeting the stated discount rate.
1. Target Level: The reserve balance should be equal to 1% of the CalPERS total liability of the Governmental Activities presented in the most recent CalPERS valuation reports.
2. Minimum Threshold: The minimum threshold this Reserve Fund should be established at $1,500,000.
3. Authority: The Finance Director may regularly review and recommend updates to the Reserve fund balance policy to the City Council to reflect changing economic conditions, risk factors, and financial goals.
4. Use: To mitigate the cost associated with pensions including a potential additional discretionary payment to pay down the unfunded accrued liability (UAL) and for unanticipated increases to the annual pension costs from future actuarial assumptions and investment market volatility, or to make the City’s annual payments during times of economic uncertainty resulting in funding gaps.
5. Application: Considered as part of the total reserve target for the Economic Uncertainties Reserve and Unassigned Fund Balance levels as this reserve was established to mitigate economic uncertainty that may affect annual and long-term sustainability.
This reserve is set aside to pay down the other post-employment benefits (OPEB) liabilities or used towards current year retiree medical benefit costs.
1. Target Level: Approximately two years of annual retiree medical benefit costs.
2. The Minimum Threshold: The minimum threshold for this Reserve Fund should be established at $1,400,000
3. Authority: The Finance Director may regularly review and recommend updates to the Reserve fund balance policy to the City Council to reflect changing economic conditions, risk factors, and financial goals.
4. Use: To mitigate the cost associated with retiree medical benefits including making an additional discretionary payment to pay down the unfunded accrued liability (UAL) and for unanticipated increases to the annual retiree medical benefit costs from future actuarial assumptions and investment market volatility, or to make the City’s annual payments during times of economic uncertainty resulting in funding gaps.
5. Application: Considered as part of the total reserve target for the Economic Uncertainties Reserve and unassigned fund balance levels as the reserve was established to mitigate economic uncertainty that may affect annual and long-term sustainability.
The purpose of the Insurance Reserve Fund is to level the effect of the rising cost of general liability and worker’s compensation insurance and to provide funds to pay for any liability losses not covered by insurance.
1. Target Level: Approximately 50% of annual insurance costs to level the raising costs of insurance.
2. The Minimum Threshold: The minimum threshold for this Reserve Fund should be established at $500,000.
3. Authority: The Finance Director may regularly review and recommend updates to the Reserve fund balance policy to the City Council to reflect changing economic conditions, risk factors, and financial goals.
4. Use: To mitigate the cost associated with insurance liability coverage, liability or property losses not covered by insurance, or to make the City’s annual payments during times of economic uncertainty resulting in funding gaps.
5. Application: Considered as part of the total reserve target for the Economic Uncertainties Reserve and unassigned fund balance levels as the reserve was established to mitigate economic uncertainty that may affect annual and long-term sustainability.
Total Reserve Target
Staff recommends aggregating the five categories of Type I reserve funds. By including the CalPERS, OPEB, and Insurance reserves in the overall total reserve target, the current target percentage, based on the FY 2024-25 adopted budget, would result in a reserve level of 108% compared to the adopted expenditures budget. The addition of these three reserve funds at their minimum threshold would increase the target reserve by approximately 10%, or $3.4 million. Pooling reserves tied to the same risk scenarios allows the total reserve balance to be managed more cost-effectively, avoiding the opportunity costs of over-reserving based on acceptable risk levels. For the City Council’s reference, below is a table summarizing the individual target levels and the total reserves proposed based on the FY 2024-25 adopted budget:
While current reserve levels are healthy, economic forces such as inflation, increases in the costs of services, and personnel costs will gradually increase the City’s normal operation costs and reduce the overall percentage of these reserves compared to the adopted operating budget. Given expected fluctuations in the City’s reserve funds compared to future operating budgets, staff recommends adopting a Reserve Policy that provides for a range of reserve funding percentages.
Staff proposes a target range of 50% to 75% when considering only the General Fund Unassigned balance and the Economic Uncertainties Reserve, highlighted in blue above. Staff is also proposing the pooling of Type I reserves to reduce the cost of risk and allow for a total reserve balance with an optimal committed funding level. By including the minimum threshold for the CalPERS, OPEB and Insurance reserves, the lower end of the reserve funding range is 59.73%. The higher range, using the same minimum thresholds, for CalPERS, OPEB and Insurance, would increase to 84.73%. If the current balances for CalPERS, OPEB and Insurance reserves are applied, the funded percentage increases to 90%, assuming these reserves levels remain the same as in the FY 2024-25 adopted budget.
Type II: Saving account reserves to pay for future costs that would not be affordable within a single year’s revenue budget.
Capital Improvement Project Reserve (CIP) Fund
This Reserve is set aside for major improvement projects related to roadways, storm drains, parks, facilities, and rights-of-way. Subject to the annual budgeting process, the CIP reserve will be funded, to the extent possible, by allocating the following to the CIP fund:
1. Target Level: Annually, the City shall re-assess the target level based on the five-year capital improvement plan to ensure future projects that rely on funding from the CIP reserve are adequately funded.
2. The Minimum Threshold: The recommended target for this Reserve Fund should be approximately $2,000,000 with consideration of external economic conditions, and the next two years of budgeted capital improvements that utilize the CIP reserves as a funding source.
3. Authority: The Finance Director may regularly review and recommend updates to the Reserve fund balance policy to the City Council to reflect changing economic conditions, risk factors, and financial goals.
4. Use: Specific to Capital Improvement project funding.
All other Type II Reserves
All other Type II reserves should be reviewed annually to ensure adequate funds are available for annual and long-term planned expenditures. The specific target level should be tied to the identified program or project to commit the funds. Staff typically presents these reserves during the annual adopted budget process for City Council’s approval.
Presentation
All Reserves are presented as General Fund Balances Committed for Contingencies within the Summary of Changes in Fund Balance Statement.
Strategies for Accumulation
The Reserve Policy specifies the use of one-time surpluses and one-time revenue to be used towards building reserves if target levels are below the stated ranges to the extent such funds are not required for current expenditures, capital improvements, debt retirement and/or operating reserves. Such funds should be allocated on an annual priority basis that includes long-term strategic goals for capital projects, mandated infrastructure and system improvements, and large capital outlay and consider adding to applicable reserves. The Reserve Policy should also discourage the use of reserves for ongoing expenditures, as reserves are not considered an ongoing revenue source.
When reserves are utilized for their specific, intended purposes, or the levels fall below the policy levels as described, the City Council will approve a reserve replenishment plan to return the various reserves to their policy levels. This plan will seek to return the reserves to their policy levels within one (1) to five (5) years, per City Council direction. Staff recommends utilizing the Geneal Fund unassigned funds first to maintain and/or return the Committed reserves to the appropriate level.
Conclusion
Staff recommends the City Council consider adopting the proposed General Fund Reserve Policy and provide staff with further direction, as desired, relating to the recommended limits, reserve categories for target determinations, applications and use for reserves. Staff prepared a Resolution to effectuate the City Council’s adoption of the proposed Reserve Policy (Attachment C).
Attachments:
A. GFOA Article: Should We Rethink Reserves? Paper
B. Exhibit A - General Fund Balance Reserve Policy
C. Reserve Policy Resolution