Running on Empty?

Did cities and the County maintain Unreserved General Fund Balance levels consistent with GASB 34 recommendations over the time period from Fiscal Years 2007-2010, whether or not they had policies requiring that? 2. Did cities and the County comply with their own policies with respect to reserves during Fiscal Years 2007-2010, whether or not those policies complied with GASB 34 recommendations? Note: Significantly, the language of some policies specified quantitative levels of reserves to be maintained, but was not explicit in applying them to just the unreserved portion. This allows for the possibility of the County or cities including, in their “reserves”, funds that are legally restricted to their stated purpose and not available to support operations. As noted previously on , there has been sufficient ambiguity in reserve classification and reporting that GASB issued Statement 54 to attempt to improve clarity and make reporting more consistent. The results of this assessment are diagrammed in Attachment 2. Results are summarized as follows: 1. All cities and the County maintained levels of Unreserved General Fund Balance consistent with the GASB 34 recommended minimum of 5-15 percent of revenues or one to two months (8.3–16.6 percent) of expenditures during Fiscal Years 2007-2010, except Brisbane (2008 only) and Pacifica (2007 only).

All cities complied with their own policies during the Fiscal Years 2007-2010 These results suggest that GASB 34 levels are reasonable and achievable even in challenging economic environments. However, it should be noted that the CPA auditors interviewed stated that, in their opinion, the GASB 34 recommendations were low and, in this environment, UGFB levels twice those levels are appropriate for most cities. Governmental Accounting, Auditing, and Financial Reporting Using the GASB 34 Model, GFOA Publication by Stephen J. Gauthier, p51-52 13 Given this context, a quick and useful way to look at cities’ and the County’s current situation with respect to reserves follows in Table 2 below Table 2 Cities and County Levels of Current (2010 except where noted) UGFB As % of General Fund Revenues 0 -15% (upper end of 16 – 29% (between current 30% or higher (auditor current GASB 34 GASB recommendation suggested minimum for recommended range) and auditor suggested most cities in current range) environment) Belmont Brisbane (’09) Atherton Millbrae Burlingame Colma (’09) San Mateo Pacifica (’09) Daly City Redwood City East Palo Alto San Bruno Foster City South San Francisco Half Moon Bay San Mateo County Hillsborough Menlo Park Portola Valley San Carlos Woodside 3 total 7 total 11 total Smaller cities in terms of revenues and expenses tend to maintain higher levels of reserves. This is to be expected because larger cities generally have more diverse economies and revenue sources. Smaller cities are dependent on fewer sources for the bulk of their revenue and are therefore at greater risk in downturns. They therefore benefit from higher levels of Unreserved General Fund Balance as insulation. F. Retiree Pension and Health Care Payments This investigation of reserves and the extent of cost cutting to match revenues occurred during a period of heavy media attention to the impact the cost of retiree benefits were having on local government finances. This led the Grand Jury to examine whether or not cities and the County were fulfilling their annual payments to the systems covering these benefits. This is separate and distinct from the much larger issue of the relative financial soundness of these systems and future costs to the cities and County, which were beyond the scope of this investigation. The results of this assessment of annual payments to California Public Employees’ Retirement System (CalPERS) and the San Mateo County Employees’ Retirement Association (SamCERA) for pensions and of the health care portion of Other Post-Employment Benefits (OPEB) follow separately below. G. Retirement Pension Benefits (CalPERS and SamCERA) All 20 cities participate in CalPERS, for funding pension obligations. Actuarial calculations determine an amount each participating city must contribute annually, based on its labor contracts and commitments, its proportional share of the state pool, and actual earned and assumed earn rates on the fund’s assets over the next 30 years. San Mateo County has its own defined pension (and disability and death benefit) plan, (SamCERA). The County Employees’ Retirement Law of 1937 (the 1937 Act) established the basic obligations for employers and members to contribute to the pension trust fund. Statutes require participating employers to contribute the actuarially determined amounts necessary to fund the estimated benefits accruing to SamCERA members not otherwise funded by member contributions or investment earnings. All 20 cities and the County made their annual required contributions to CalPERS and SamCERA respectively between 2006 and 2010. They have met their obligations through the normal budgeting process while maintaining reserves at minimum GASB 34 recommended levels or higher. What cannot be determined from these examined reports is the magnitude of future annual pension costs, which will vary based on updated actuarial valuations, investment performance, the changing number of city employees participating in the various plans, and new labor agreements with changes in benefits negotiated over time. What is clear, and what has been reported widely, is that pension costs will rise significantly over time and that cities and the County are concerned about the impacts. They are taking steps, some more aggressively than others, to be able to manage those costs for the long term. Those who came out of the recession in positions of relative strength rather than weakness are better able to manage this next transition with reduced impact on services provided to its citizens. H. Other Post Employment Benefits (OPEB) - Health Care Until fairly recently, most cities paid for their retiree’s contracted health insurance benefits directly as expenses were incurred. The OPEB trust fund, which operates similarly to CalPERS for pensions, came into effect in 2008-9. Most cities joined this pool. As in the case of CalPERS for pensions, cities contribute to a pool and the trust invests the funds. The trust communicates to participating governments the actuarially determined annual payments needed for them to be fully funded. Unlike for pension financing, however, cities are not contractually required to make annual OPEB payments in full. Some participating cities have chosen to make their annual OPEB payments in full while others have made varying partial contributions. Failure to keep current on OPEB payments puts cities at risk that their accumulated obligation may eventually grow too large for them to be able to “make up” the difference without significantly impacting city services or jobs. Based on data available, current positions with regard to OPEB funding are summarized as follows and in Chart 5 below: Categories used are: • Made 100 percent of annual required contributions; no accrued liability. It is noteworthy that one city (San Carlos) and the County prepaid OPEB when joining the program and have current surpluses as a result. • Made greater than an average of 25% of annual required contributions 2009-10; has associated accrued liabilities • Made less than an average of 25% of annual required contribution 2009-10; has associated accrued liabilities • No retiree health care benefits or no data provided in Financial Reports 16 Chart 4 5 6 OPEB ARC Payment Status Made 100% of annual required contribution No accrued liability Belmont Half Moon Bay Made greater Hillsborough than 25% of No Benefits or Menlo Park annual required no data San Carlos contribution San Mateo County (2009 –2010) Burlingame Colma Daly City East Palo Alto Millbrae Pacifica Redwood City Portola Valley San Bruno Woodside San Mateo S. San Francisco (see Atherton Footnote 6) Brisbane Foster City (see Footnote 5) Made less than 25% of annual required contribution (2009 –2010) 5 Foster City has set aside $7 million, the full amount actuarially determined in 2009 as necessary to fully fund its OPEB obligation. Although managed separately, because the funds are not in an irrevocable trust, the liability must be reported as unfunded per GASB 45. South San Francisco has set aside $6.8 million towards its OPEB liability but it must be reported as unfunded for the same reason as noted for Foster City above. As in the case of pension benefits, the Grand Jury assessed the level at which cities and the County were making their annual required contributions. It did not attempt to assess the level or rate of growth of future annual payments and the impact those might have on city finances because of the variables involved, the limited time available, and the inability to challenge the assumptions made. These were beyond the scope of this investigation. I. Case for Caution Caution must be exercised in drawing firm conclusions about the fiscal health of a city or county in isolation, or in comparison with others, based on any limited set of data. This is especially true given that governments have some flexibility within GASB rules as to how they organize their finances and report their data. The best that can be done is to highlight potential issues for further investigation. Half Moon Bay served as an excellent example. Based on the data collected, Half Moon Bay was grouped into the category of cities whose reserves (UGFB) were flat or increased in the 2007-2010 period. The data shows an increase of 94%. It has a city policy currently requiring 30% of annual operating expenditures be held as reserves and it met that higher than minimum GASB 34 recommended standard each of those years. (The city policy was 20% of annual expenditures in 2007-2008). Its maximum Running Liquidity of 334 days was the second highest of all cities in the County. Its revenues exceeded its expenditures the last two years of the recession (not including internal transfers and one time proceeds or payments), and it made its contractually required CalPERS payments and is current on its OPEB retiree healthcare payments, with no net OPEB obligation as of June 30, 2010. Based on these indicators, one could conclude that Half Moon Bay was fiscally healthy. A recent news report7 highlighted a “fiscal crisis” and stated that the city could potentially run out of its reserves. While the Grand Jury avoided making any judgments about the fiscal soundness of any city or the County for the reasons mentioned previously, and limited its focus in this investigation primarily to the use of reserves, it looked further into Half Moon Bay’s public financial statements and sought additional clarification from a Half Moon Bay official to verify the correctness of the data used and further understand any limitations. In summary, Half Moon Bay issued Judgment Obligation Bonds to help cover the costs of a legal settlement. The proceeds from the bonds were received and subsequently disbursed in fiscal year 2009-2010 and properly reflected on the appropriate city financial statements. The full payment consisted of $15 million from the bond proceeds and $3 million from the General Fund8. The Adopted Annual Budget for 2010-2011 shows a projected deficit ($504,447) of revenues vs. expenditures, to be covered by its General Fund Balance. The result is that the city’s reserves would fall below its 30% of annual operating expenditures policy. A waiver permitting a one- year exception had been granted by City Council in anticipation of this need.9 The policy requires the City Manager to “prepare a plan for consideration by the City Council to implement 7 “Outsourcing Safety San Francisco Chronicle Editorial”, 4/5/11, pA13 8 Approved Half Moon Bay General Fund Budget Summary Comparison, pC2 9 Half Moon Bay City Council Resolution No. C-46-10 adopted 6/15/10 18 actions within a twelve-month period to rebuild the fund balance.”10 The City also identified key financial impacts in a Five Year Forecast document included as part of its budget, highlighting its specific challenges. In summary, the data collected by the Grand Jury was accurate as it related to a limited, defined set of data at a specific point in time. However, the data did not and could not tell the entire story. A more comprehensive examination of all relevant management discussions, financial statements, notes, budgets and forecasts, and changes in them over time, including data not yet published or audited, is needed to really understand the fiscal health of a city, which can change very quickly. This type of effort is beyond the capability of the average citizen and highlights the need for the cities and County to do the best they can to make as much information publicly available in as timely a fashion as possible, In this specific case, Half Moon Bay’s most recent CAFRs, Annual Approved Budgets, Reserve Policies, and Five Year Forecasts were available to the public on its website, enabling interested citizens capable of understanding it to properly educate themselves on the significant impact of a legal settlement, in this case, and of other major financial issues affecting the fiscal health of the city. Findings 1. The amount of financial information cities and the County make available on their respective public websites varies widely, ranging from a minimum of just the current year’s budget to the last ten years of both Comprehensive Annual Financial Reports (CAFRs) and Approved Annual Budgets.

Four cities (Brisbane, Colma, Pacifica, and Portola Valley) did not have 2010 CAFRs posted to their websites as of March 11, 2011, almost nine months after the close of the fiscal year.

All cities and the County had Unreserved General Fund Balances (reserves) consistent with GASB 34 recommended standards going into the recession, and have managed through the last three years in a way that maintained reserves on June 30,2010 that were still above those minimum levels.

All cities and the County maintained GASB 34 minimum recommended levels of reserves, whether or not they had city council approved policies requiring maintenance of defined levels of reserves.

Some city policies are written to apply to “reserves” and not explicitly to the unreserved component of them as recommended by GASB 34. This allows for inclusion of funds not available for discretionary spending. Half Moon Bay City Council Resolution No C-38-09, adopted 6/2/09 19 7. All cities complied with their own policies (where policies existed) from 2007-10 with respect to reserves, even in those few cases where those policies required higher levels than those recommended by GASB 34.

All cities complied with their own policies (where policies existed) from 2007-10 with respect to reserves, even in those few cases where those policies required higher levels than those recommended by GASB 34. Response: Concur with the finding.

Confusion as to how governments categorized and interpreted what portion of fund balance was available for discretionary spending led to development of a new GASB 54 standard, effective for all financial statements after June 30, 2011, which provides more structure and clarity around constraints placed on fund balances. San Mateo County implemented GASB 54 early, with the new terminology reflected in its FY 2010 CAFR. No cities in San Mateo County implemented early.

One city (Millbrae) had a Running Liquidity below 90 days.

All cities and the County are fully funding their Annual Required Contribution to CALPERS or SamCERA for retiree pension funding.

Ten participating cities12 are not making their full actuarially determined OPEB payments for retiree health care benefits, with three cities (Atherton, Brisbane, Foster City) having paid at less than an average of 25 percent for the last two years. Conclusions 1. There are significant differences in the amount of current and historical financial information governmental entities choose to make conveniently available to interested citizens.