Fund balance policy minutes 12/17

The following is the Dec 17 Budget Committee meeting minutes (unedited). I know it's long... this portion of the meeting took two hours. Nonetheless, I'll probably blog about this in the next few days, so to avoid anything being taken out of context... here it is in its entirety:

MINUTES OF THE CHESHIRE TOWN COUNCIL BUDGET COMMITTEE AND JOINT SPECIAL COUNCIL MEETING HELD ON MONDAY, DECEMBER 17, 2007, AT 7:30 P.M. IN ROOM 207, TOWN HALL, CHESHIRE CT 06410

Present
Michael Ecke, Budget Committee Chairman; Matthew Hall, Council Chairman; Elizabeth Esty and Thomas Ruocco, Budget Committee Members; Matthew Altieri, Laura DeCaprio, James Sima, Timothy Slocum, Timothy White.
Staff: Michael A. Milone, Town Manager; Patti Lynn Ryan, Finance Director; James Jaskot, Deputy Finance Director.
Guest: Special Counsel Attorney John K. Knott; Matthew Spoerndle, V.P. People’s United Bank, Town Financial Advisor.

1. CALL TO ORDER.
Mr. Ecke called the meeting to order at 7:38 p.m.

2. PLEDGE OF ALLEGIANCE
The group Pledged Allegiance to the Flag.

3. DISCUSSION RE: FUND BALANCE POLICY
Town Manager Milone informed the Council that some of the information regarding the fund balance policy has been seen before, and some is new information. He explained that in the last few years, the town has been fortunate to have healthy surpluses, and as a result there is a fund balance which is higher than ever before. The fund balance is the difference between the town’s assets and liabilities, and is the accumulation of surpluses over time, which sits in a fund balance account/equity, rainy day fund or reserve account. Through good fiscal practices and luck, there is a healthy fund balance. Staff wanted to discuss with the Council implementation of one of the best practices recommended by the financial profession…that is to have a fund balance policy. This policy would have written guidelines which provide guidance on how fund balance is to be used, how it would be spent, and how to determine a reasonable amount to be maintained in this fund balance account. The town is using a percentage of the overall operating expenses, and the fund balance should be “X” percent of the expenses. It is a changing dollar amount as the budget grows, but the percentage stays relatively the same.

With the town being a position to have a healthy fund balance, Mr. Milone said that one of the goals he has tried to maintain is to implement best practices wherever possible. The staff came to the Council in April talking about formalizing a fund balance policy, so the Council could explain how surpluses would be used in a planned way.

Ms. Ryan and Mr. Jaskot took a model fund balance policy and modified it so it met the particular needs of the Town of Cheshire. At the three previous Budget Committee meetings there was discussion about a reasonable policy for debate, and with a few minor changes, the draft policy is before the Council for review and discussion.

Mr. Milone discussed the key points in the draft policy.

#1, it is recommended that the Town maintain 8% of the operating budget set aside in a fund balance account.

#2, if the Town is lucky to have money in excess of this 8%, it can be used to establish reserves for a future budget. Four areas of importance are funding reserves, which would offset major increases in future expenses. The town has established a debt service reserve, heart and hypertension reserve, and in establishing these reserves, one of the rationales is avoidance of future debt, reduction of debt service, and using any money above 8% for direct mill rate relief.

Traditionally, the Town has always used money from fund balance as revenue in the next year’s budget; this year the Council took $550,000 from the fund balance to be used as revenue. This is direct mill rate relief. The fund balance has also been used for debt service reserve, heart and hypertension, which also reduces the mill rate, by reducing the expenditure side of the budget.

Items 3, 4 and 5 are general information and recommendations for the fund balance policy. They talk about a fiscal emergency situation. Mr. Milone advised that in 2003 the State was threatening to take $1.4 million revenue away from the Town five months into the fiscal year. That is a fiscal emergency. Item #4 speaks to that situation where an emergency appropriation must be made by the Council, or facing the loss of significant revenue in a fiscal year, the reserve could be used. Item #4 is a reactionary situation; item #2 is a proactive situation planning for the future.

In developing the draft policy, Mr. Milone said it was done following industry standards and practices, and also medians were looked at for other communities in the State, and what is recommended by professional organizations.

Ms. Ryan reviewed the draft policy, stating that the staff is recommending the Town maintain a minimum percent, but the recommended goal is one or two months of the ensuing year’s operating expenditures. The 8% minimum is about $250,000 shy of one month’s expenditures; and the goal is to have one month of expenditures in the fund balance account.

Page 2 – National GFOA recommended practice works with GASBE (accounting standards which the Town is bound by). The recommended GFOA practice is a minimum fund balance of no less than 5% to 15% of operating expenditures. Ms. Ryan read an excerpt from page 2 into the record, and advised that these are the guidelines for the Town of Cheshire. When the upgrade was given to the Town by the rating agencies, the fund balance was at 8%, and it is hoped the balance will not drop below the 8% minimum recommendation. She said that one month of expenditures should be put away for emergency situations, and at this time the Town does not quite have that amount set aside.

Mr. Spoerndle pointed out that it is recommended for a town to have a formal policy on fund balance.

Fund Balance Survey page 4 – Ms. Ryan noted that 10 towns responded with information on their fund balance policy, and there is a range of percentages, goals, and information on policies in place.

Page 5 – MFRA – Moody’s Investors Service Survey of all Aa rated towns in Connecticut. Ms. Ryan cited the unreserved, undesignated operating funds balance as percentage of revenues for Aa rated towns, the median was 9%.

Page 6 – MFRA – every rated town in Connecticut is listed, and the median percentage is 9.2% for fund balance reserve.

Page 7 – outlines the Town of Cheshire use of fund balance analysis, 1997 to 2007; the surplus generated; the appropriation out of the surplus; and transfers to other funds. Over the last 10 years there has been $13.4 million in total year end surpluses; fund balance appropriations of $5.5 million for property tax relief. As the Town got to the end of a good year, money was appropriated to offset the mill rate, totaling $5.5 million.

In the analysis, Mr. Jaskot noted that the transfers cited were out of surplus for funding reserve accounts.

Mr. Milone said that this shows that when there is a healthy fund balance, the Council has been more aggressive in re-directing the fund balance into reserve accounts to protect against future large increases in heart and hypertension, debt service, etc. He mentioned that the FY 2007 un-audited surplus will be about $2.3 million. At the time the Council appropriated the transfers to the reserve accounts, it was projected that the surplus would be $1.1 million.

Page 8 – Town of Cheshire Year End Surplus Analysis 2007 – the surplus is expected to be $2.3 million; this is 9.65 % of actual year end expenditures or 9.4% of actual year end revenues; this leaves $8.4 million undesignated and unreserved at year end.

On the 2nd page of the GFOA document, Mr. Altieri said that, to him, this means the staff is talking about $2.3 million and other reserve accounts which must be funded as well, i.e. the WPCA having a certain amount of reserve funds which should be more than 1 or 2 months. His concern is that in talking about fund balance policy there should be discussion about all the accounts, not just municipal accounts.

This is a good point and Ms. Ryan said that you do have to look at all the funds, and the information presented is a snapshot of the general fund, and does not include the long term liabilities in the general fund, which are in the financial statements. Cheshire has $79 million in outstanding principal debt; $3.5 million estimated liability in heart and hypertension claims; a commitment through the five year capital budget plan of $6.8 million; and the pension liability for the next year is $788,000 for the contribution. Cheshire has an NPO outstanding, but Ms. Ryan is not concerned about this because the pension plans are well funded. There are some sizable long term liabilities out here. Cheshire has the VEBA, with a possible minimum impact of $10 million. There is a lot out there not seen visually, and we do not have one month expenditures in reserve.

Mr. Milone explained that everything runs through the general fund; the general fund supports the pension fund, debt service reserve fund, capital projects fund, etc. and they are all fed from the money from the general fund. But they appear in the financial statements as separate, stand alone things, that continue to get support, and they all have significant liabilities.

Ms. Ryan stated that the heart and hypertension estimated liability is $3.4 million, and this is based on projects, trends, settlements, compensation, based through year end 2007. The cash reserve in this fund is $575,000, and the recommendation is to continue to pre-fund this account while claims are being managed.

These are liabilities to the town, and Mr. Milone explained the benefits of the heart and hypertension for the police and fire departments, which is separate from workers compensation, and there is no coverage if it is a heart and hypertension claim. Cheshire tries to protect itself by funding a reserve account. The legislature is trying to extend this benefit to include a cancer provision, even if not job related. The risk is great, and premiums would be unbelievable, so there is no insurance coverage.

Given all the long term obligations, Mrs. Esty asked if there is guidance as part of the GFOA recommendation; or is there any thought about how the town goes about considering these long term obligations; what the appropriate amounts are to be set aside for them. In the lean years nothing would be set aside, and there are concerns about looking at the guidelines. The Town needs to get a handle on the time period for the long term debt, and how much should be set aside for this debt for which there is no insurance. There should be calculations on the long term debt which will play into what the reserves should be.

Mrs. Esty also commented on the major costs for the WPCA, its infrastructure, and the entire town’s infrastructure based on the age of the buildings.
According to Mr. Milone, the hope is to agree on a fund balance policy, then with the final audit report, the exact levels of liability in various other funds can be seen. There can then be a determination of how to take the balance over 8% and allocate that amount of money, and establish guidelines on allocation of this year’s surplus. The final audit numbers will be available in a few weeks.

In FY 2009-10, the debt service is expected to increase by $600,000 more than it is today; in FY 2009-10 there will be a property revaluation. These two things will be significant and impact on what it costs to run the Town. The staff is trying to work with the Council to prevent spikes in the mill rate and budget.

If we are going to maintain an 8% fund balance, Mr. Slocum asked about a lean year or fat year, and the cost of maintaining the 8% being higher in a lean year and impacting the taxpayers. He asked how this 8% target will be maintained each year.

Mr. Milone replied that the suggestion is two things – if there is a 9.4% fund balance now, 8% sits as protection for the town; 1.4% is redirected into various reserve accounts to protect against future swings, heart and hypertension, debt service, mill rate increase. We are talking about preserving the 8% and re-directing anything over 8% the way the Council decides.

On page 7 of the report, Mr. Milone pointed out that the more money appropriated from fund balance the bigger the hole in the subsequent year. Without another $1 million to replenish this account, it must be made up on the back of the taxpayer, and there is a balancing act on the taxpayers. We are starting at a reasonable point, and trying to preserve it, and this is the time to redirect some of the money to reserve accounts.

Mr. Slocum asked what the cost benefit analysis is for the taxpayer and the cost to them to have this one month of operating expenditures set aside.

This cannot be characterized as a cost, and Mr. Milone said the surplus is due to increase in State aid, consistently higher tax collection rate. There must be a concern about a possible recession. Mr. Milone pointed out that this fund balance does not lend itself to a cost benefit analysis, because the start is a false premise that there is a cost involved. There is no cost; there is a revenue investment that sits there that is being debated as to its use. The Town needs some protection; there has not been a recession in many years; when there was a recession the tax collection was 2% less than budgeted; and the fear is that this could happen again. There could be a down swing. 75% of the budget comes from tax collection, and with a recession or bad real estate market, ¾ of what the Town relies on could be impacted.

In 2003, just 5 months after the fiscal year started, the State pulled $1.4 million in revenue from Cheshire. This was made up by cutting costs, going into the CNR fund; and it took 5 years to get back today to where the CNR was 5 years ago. As a result, there was $1.4 million foregone which could have been used to pay for capital projects for cash. The projects were let go, or borrowing was done with interest to pay for them.

Mr. Milone commented on the fact that Cheshire has not had a budget referendum since 1993, and if there was a referendum, tax bills cannot go out until late July, with cash coming to the Town in August. There are debt payments due in August. With a referendum there would be a cash shortfall of $6 million to $8 million. $30 million in tax revenue comes into the town in July, and if a referendum is forced, this money does not come in until mid or late August. The town would have to go out and borrow short term to find the cash for this shortfall.

Additionally, WPCA decided not to send out the sewer use bills until February 2008 pending a revaluation of the sewer use charge; this is $2 million in revenue that is being foregone. The WPCA will be supported by the money in this reserve account. For every $1 million in this reserve account, it is about $40,000 in investment income as well. There are many major benefits in having a reserve which do not appear on the surface every day. Mr. Milone noted that the Town has been prudent, has had the fall back, and the reserve has helped with bumps in the budget road.

Mr. Ecke asked if anyone does a cost benefit analysis, and he is not sure how this would be approached.

Mr. Spoerndle stated that a cost benefit analysis of the surplus and reserves relative to cost savings cannot be done. The town is saving money in a fiscally responsible way, generating interest, and as a benefit to that there is a reward of a higher credit rating, reduction in borrowing costs with a low interest rate. Mr. Spoerndle stated that he has never heard of this type of analysis before, and does not believe it can be done.

Regarding insurance, Mr. Ecke asked if municipalities purchase insurance when issuing bonds.

Mr. Spoerndle explained that bond insurers will charge a lower rate for He also commented on the fact that it is the underwriter’s discretion whether or not there is insurance put on the bonds, and the cost of the insurance is cheap. It is rare to see an issuer buy insurance on their own. When a bond is sold with Aaa there is a lower rate because of the better credit. In this environment the underlying rating is still very important. In the current environment the insurance providers are getting hammered by the sub-prime, because they insure mortgages and invest many assets in these mortgage backed securities. There is defaulting and they are taking millions in write-offs. There is so much exposure. The underlying rating is always important.
Mr. Ruocco commented on the idea of a cost benefit analysis, from the taxpayer’s standpoint asking about the 8% fund balance, and the town wanting to get a better credit rating for lower interest on borrowing. The taxpayer may ask how much is saved each year on interest rate reduction. If it is $50,000 in borrowing costs, the people are taxed $8 million, and Mr. Ruocco asked how much taxes per household there is to get the fund balance to 8% versus paying the extra cost in interest. He asked how much a taxpayer pays to get the better credit rating, but if there is significant savings on interest, then it must be proven to the taxpayer. On the day to day borrowing, he is not sure it is cost effective, and people are asked to pay more taxes than savings in interest.

Mr.Ecke said it is hard to estimate in April when the budget is done; there is risk to the budget in getting it so close to perfect for what the Town will get in tax revenues.

According to Mr. Spoerndle if the primary goal in having a fund balance level was solely to get a good credit rating and thus save on borrowing costs, then that is a good question.

It was made clear by Mr. Milone that one of the benefits of a good credit rating is getting lower borrowing on debt. But, that is one of 15 reasons…the primary reason is to maintain a reserve so the town can deal with things that cannot be predicted. In 1992 the collection rate was 2% less than projected; in 2003, the State reduced aid by $1.4 million; the town had to carry the WPCA for two months cash, $2 million. For every million taken out of the reserve account, take $40,000 to $50,000 out of interest income account on the revenue side. Because the Town has a healthy fund balance, it can go into the bond market every two years because there is cash to support the capital projects. Traditionally, the Town was in the bond market every December; the borrowing costs were higher; and there is payment of more in debt.

Mr. Milone said he must dispel the argument that it is all about the credit rating. There are industry standards; those are the best practices; and the municipal industry is saying one to two months worth of reserves. The credit rating is one of many reasons for a fund balance, but it is to support the operation of Town government for any of numerous, unforeseen things that could happen, and to help mitigate against larger increases that will occur with property revaluation, $600,000 debt increase, and the heart and hypertension fund ballooning beyond anything that could be predicted. Having a reserve account is a good fiscal practice.

It was stated by Mrs. Esty that better interest rates is not the sole reason for the fund balance. We all have savings accounts for unexpected expenses, not to get a better credit rating. It is not right to think that the fund balance is on top of what we are taxing people. The Council must talk about what is the right amount in the reserve, not what is the right interest, or what are we getting on savings on differential credit amounts. The big picture is what the level should be for this community, with rising utility costs, rising uncertainty at both the state and federal level of support. The credit rating is far down on the list.

In the spring time, Mr. Altieri said that Mr. Spoerndle stated there are many benefits, and businesses wanting to relocate to Cheshire look at the fund balance and fiscal health of the town. He cannot look at the fund balance as just the bond rating, and when explaining this to people they do get it. There are more important things beyond the bond rating.

Mr. Sima asked about clarification on the $3.4 million heart and hypertension in the future for this obligation. He asked if this is part of the surplus to be maintained, or once it is funded, it is out of the picture. He also asked about the 8% or 10% fund balance, and the cost to the Town.

If the budget increases by 2%, Mr. Milone said the fund balance goes up by 2% of the value of the fund balance, no 8%.

Regarding the 3 year payback for money taken out of the fund, Mr. Sima asked about a lean year, and the debt is funded for 3 years, it could be difficult, and this could be looked at further.

Mr. Milone cited a scenario of a household annual cost of $10,000 in 1990, with $500 in reserve. Today it costs $25,000 to run the household…do you still want to keep $500 in that reserve…is it adequate. That is what we are talking about with the fund balance account. The fund balance must grow to deal with the exigencies that have been talked about…a budget referendum with the town $6 to $8 million cash poor; a lower tax collection rate; and these are the things that we are trying to protect against. Without the fund balance growing, there is running the risk of having an inadequate supply or reserve relative to the expenditure exposure.

Mr. Milone said that the fund balance is a protection, and the policy can be revised at any time based on the situation being faced by the Town.

With regard to heart and hypertension, Mr. Sima asked about funding them now.

In response, Mr. Milone said that they have been funded, but there is still a liability, and the Town is trying to pre-fund with money put aside so there are no high peaks in claims.

Ms. Ryan stated that heart and hypertension reserve is a separate fund, outside of the general fund. The rainy day account is in the general fund. The 8% is used as a floor and we want to take the additional funds, recommend that the Council put money away for the long term liabilities, one of which is heart and hypertension. If all claims were due today, the Town is looking at $3.4 million in claims as of June 30, 2007. The Town has $575,000 in this reserve fund; the Council has been putting money away for this liability for several years. The Council has also provided property tax relief, and funded some of these liabilities out of the year end surplus. There are four reserve funds, outside of the general fund, and any surplus will be put into these reserve funds.

Mr. Sima commented on the heart and hypertension reserve fund being a surplus with a designated use.

Mr. Milone said this fund is protecting the Town against spikes in claims. Before there was a fund, Mr. Milone advised that payment was made out of the general fund.

The Council reviewed the draft fund balance policy.

Under #4, Ms. Ryan noted that it said…within a three year period.” Having a goal in mind shows commitment.

Mr. Ecke said that the Council could come up with a plan, but not outline the time period.

Mr. Ruocco noted that at the September 17th meeting, “within a three year period” was deleted.

This was confirmed and the draft policy will be so amended.

Mr. Altieri discussed #4 and fiscal emergency, and sees a fiscal emergency as being problematic, and one person’s emergency can be different from someone else.

Mr. Ecke stated this should be left open to interpretation for future Budget Committees to determine a fiscal emergency. $1.4 million taken away by the State in 2003 would be considered a fiscal emergency.

Ms. Ryan informed the Council that the policy was modeled after another fund balance policy.

#1 – 8% target fund balance. There is no maximum stated, and Mr. Ruocco said he would want a range, i.e. 8% to 9% or 7.5% to 8.5%.

If the fund balance is above 8%, Mr. Ecke said it would be funded as noted in #2.

Mr. Ruocco said the 8% puts pressure on the taxpayers, and he wants a maximum amount in the fund balance.

Mr. Ecke said he could go with 8% to 9%.
There is a big range, and Mrs. Esty said the 8% to 9% could be funded for now. WPCA is advised to have 180 days of operating expenses in reserve. The Council wants to keep taxes down, but there is an obligation to do long term planning, with reserves and the surplus. People want to be protected from bad things happening such as aging infrastructure issues, and without a fund balance this could kill a budget. Mrs. Esty said that the Council will have an option to review this fund balance policy annually.

Mr. Slocum asked about 8% being the standard for a fund balance.

There are industry guidelines, and Mr. Milone said that if best practices change, he would go to the Council, and he hopes there would be rationale to determine what is best.

According to Ms. Ryan the rationale is one to two months of operating expenses in reserve. The ceiling for Aa communities is 9.8%, with no town going over 10%. One month of Cheshire’s operating expenses is 8.33% of the operating expenses. The question is do we want one month of reserve or 8.33%.

Mr. Altieri could support 8% to 9%, with most towns with Aa rating at 9%.

In Connecticut there is talk about property tax relief, and Mr. Sima said that the legislature looks at towns being healthy with 8% reserve in the fund balance. He believes the State will not give the town property tax relief. Arbitrators could vote against Cheshire because it is a wealthy town with a fund reserve. He is concerned the State will raid the town’s surplus. He asked if this should be on the minds of our legislators in the future at the State level.

Mr. Ecke said it would be a sad state of affairs if the Town were punished for being fiscally prudent and having a good reserve.

It could happen, and Mrs. Esty said if the State did this, there would be an outcry to the State. She said the Council should do the right thing for our community. Looking at the real estate market, the Town raised its assumptions on tax collection last year, and this year they may have to be lowered looking at the number of houses on the market and reduction in prices.

Mr. Milone said that the State will balance their budget on the back of the communities because it does not have a fiscal conscience. Every municipal grant and PILOT program is funded well below the statutory limit. Cheshire is funded at 79% rather than 100% for PILOT programs.

Mr. Sima asked whether it is prudent to stay on the lower side or higher side of the one to two months of operating expenditures.

The Town of Cheshire is in great financial shape, and Ms. Ryan said that the VEBA trust is funded beyond accounting standards. The staff is fiscally responsible, and the Town has controlled its own destiny because of the fund balance. The State raided Cheshire with a $2 million reduction State aid after the budget was already adopted. The Town did have the ability to set money aside and control its own destiny. With the fund balance, we continue to protect the mill rate and the citizens.

Regarding arbitration, Mr. Altieri stated that the State can only look at 5%, and Cheshire would have to bring its fund balance to this level for good binding arbitration. This is a chance the Town does not want to take. It is difficult to see the town going from 8% to 5% for better binding arbitration. All communities are faced with the problem of binding arbitration, and Mr. Altieri would not support a reduction in the fund balance for this reason.

#2 – Mr. Ruocco asked about adding wording about the end of the fiscal year when there is more money left over or there is a shortfall. He wants to consider a taxpayer reserve fund to tap into if there is a dramatic increase in the real estate values after revaluation. This could come under “d” Direct mill rate relief.

Mrs. Esty said that the Council could consider looking at the revaluation was a separate reserve, and more will be known in the next 6 months on how WPCA approaches their situation. It may be that WPCA should have a separate reserve; and there should be determination on whether there should be another line item for other reserves.

Mr. Ruocco wants a specific accounting transaction applied to a separate reserve account for taxpayers.

In reviewing all that has been stated, Mr. Milone said that these are all issues for another day. The goal is to adopt the policy and then decide on how to allocate the funds.

In #2, it was recommended it read, line 5, “will be studied in conjunction with the annual audit report”…

This will force revisiting this policy every year, with decisions made on how to allocate or redirect funds.

Mrs. Esty recommended that the last line of #2 read…”general fund balance may be allocated to accomplish the following goals:”

In #2, Mr. Ruocco suggested adding a tax rebate as a goal.

Mr. Ecke said this was discussed and determined to be unreasonable.

Ms. Ryan made the recommendation to increase the $550,000 contribution to $850,000 and reduce the mill rage to the taxpayers in the next year’s budget.

#3 – Mr. Ruocco suggested line 4 read…”may be made upon a specific vote of the Town Council.”

There was a discussion about the 8% as one month’s reserve.

Mr. Ecke stated that the changes can be incorporated into the policy; they will be e-mailed to everyone for review and discussion at the January 8, 2008 Council meeting. The fund balance policy will be on the Council agenda and a public hearing is not required.

(Mr. White entered the meeting)