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08.01 Proposed Financial Reserve Policy �('i,�� �'Se�� ��C' Ser'' e- City of Orange Finance Department Memo To: Rick Otto, City Manager From: Will Kolbow, Finance Director Date: April 19, 2018 Subject: Reserve Policy Draft Financial reserve policies are a cornerstone of proper fiscal management. They allow for the mitigation of current and future risks, assist in setting budget targets, and help with long-term financial planning. The Finance Department has prepared a reserve policy draft for your review. Our objective is to bring a draft to one of our upcoming budget study sessions for City Council discussion and to ultimately have the City Council consider adoption, by Resolution, of the reserve policy alongside the budget in June. Background The only formal reserve policy that the City currently has is the General Fund Catastrophic Reserve. This was established in May 1996 and at a level of 25%of General Fund expenditures. This reserve was established by a vote of the City Council (not by Resolution). The City has not met its reserve target in the General Fund in quite some time. There was no formal action defined as to what steps the City should take should the reserve drop below its target. In February 2009, the Governmental Accounting Standards Board established its Statement No. 54 (GASB 54), which defines how fund balances should be reported and what standards must be met to establish various levels of reserves. The fund balance classifications include nonspendable (non- cash items), restricted (outside restrictions such as enabling legislation — Gas Tax for example), committed (amounts designated by the highest decision making authority by Resolution or Ordinance), assigned (intended use, but not necessarily formal action), and unassigned (all other fund balance that does not meet the criteria of other classifications). While it could be argued that the General Fund Catastrophic Reserve could fall under the "assigned" category, it has histarically been defined as "unassigned" in the City's financial statements. Discussion In October 2016, staff first presented the idea of a comprehensive reserve policy to the City Council. Subsequently, staff study reserve policies of other cities in the context of how those various cities operate. We also did some analysis on the City's fiscal health, as seen in attached documents. We then put together a set of reserves which we felt made sense for the City based on its operations and presented these ideas at the budget study session on May 2, 2017. The City Council provided feedback on some of the reserves presented, including the catastrophic reserve, capital reserve, and equipment replacement reserve. City of Orange Finance Department Based on the City Council feedback, we have put together the attached policy draft. Below is a summary of the proposed reserves and minimum balances. We have removed targeted fund levels since that could change as the City Council's priorities shift. This allows for flexibility for the City Council to set the targeted fund balance in any given fiscal year. Reserve T e Brief Descri tion Minimum Level GENERAL FUND GROUP General Fund Contingency Addresses unforeseen occurrences and 16.6% of annual Reserve* emergencies,including local economic downturns, General Fund Federal and/or State actions affecting local expenditures revenues, catastro hic events or acts of God General Fund Report outstanding purchase order and contractual None Encumbrances commitments at the end of the fiscal year. For financial re ortin u oses onl . General Fund Carryover Report appropriations approved to be carried over None Appropriations to the following fiscal year. For financial reporting oses onl . Building Records Revenues and expenditures related to the None Management Fee Fund* maintenance and management of building records. For budgetary purposes only —reported as part of the General Fund in financial statements. Business Investment Fund* Track payments related to certain tax sharing None agreements and to set aside funds to attract new businesses to the City in the future. For budgetary purposes only — reported as part of the General Fund in financial statements. Capital Projects Fund* Accounts for capital projects that are funded by the Annual average General Fund. of the adopted five-year CIP budgeted expenditures, or 50% of highest sin le ear INTERNAL SERVICE FUNDS Vehicle Replacement Acquisition and replacement of all vehicles and Annual average Fund* equipment of the prior three years' actual vehicle and equipment ex enditures Major Building Source of funding for major building None Improvements Fund* improvements funded by transfers from the Ca ital Projects Fund. City of Orange Finance Department Reserve T e Brief Descri tion Minimum Level Workers' Compensation Self- Funding for the City's workers' compensation 150% of the Insurance Fund insurance program, which includes limited annual average self-insurance of the prior three years' actual workers' compensation claims aid General Liability Self- Funding for the City's general liability 150% of the Insurance Fund insurance program, which includes limited annual average self-insurance of the prior three years' actual general liability claims aid PERS Set Aside Reserve* Provide contingency funds for the City's None pension plan with Ca1PERS. This reserve is maintained within the Employee Accrued Liabilit Fund Computer& Technology Acquisition and replacement of the City's Annual average Replacement Fund* information technology infrastructure and of the prior three related equipment. years' information technology capital ex enditures *CITY COUNCIL Sum of the funds indicated with an asterisk(*) 40% of annual DISCRETIONARY plus unassigned General Fund balance. This General Fund RESERVE will ensure adequate liquidity for emergencies expenditures and imbalances and cash flow. ENTERPRISE FUNDS Water Operating Reserve Contingency reserve within the Water Fund in 25% of a.nnual the event of unexpected increases in expenses, Water Fund shortfalls in revenue, and catastrophic events. operating ex enditures Sanitation Operating Reserve Contingency reserve within the Sanitation 25% of annual Fund in the event of unexpected increases in Sanitation Fund expenses, shortfalls in revenue, and operating catastro hic events. ex enditures Sanitation Capital Fund A separate fund to account for revenues from None the sanitation infrastructure fee and related ca ital ex enditures. CC: Katrin Bandhauer, Assistant Finance Director Robert Moya, Budget Officer Enclosures: Draft of Reserve Policy Analysis of FY 19 proposed fund balance vs. Reserve Policy EXHIBIT ��A" FINANCIAL RESERVE POLICY PURPOSE The purpose of this policy is to establish adequate reserves for the City to continue to meet its financial obligations in the event of economic uncertainty, catastrophes, or other unforeseen circumstances. This policy will be reviewed annually during the preparation of the City's budget and recommended changes will be presented to the City Council for consideration with the adoption of the budget. BACKGROUND It is essential for governments to maintain adequa;te levels of fund balance to mitigate current and future risks (e.g. revenue shortfalls and unanticipated expenditures) and to support long-term financial plans.This policy e�tablishes the reserve levels for various City funds. The policy covers the General Fund Group (which includ�:s the General Fund, Building Records Management Fee Fund, B�siness Investment Fund, and Capital Projects Fund), Internal Service Funds (which includes �ehicle �nd Equipment M�intenance and Replacement Funds, General I���.bility and Wor�ers �ompensation Funds,` Employee Accrued Liability Fund, and Cornpute�Maintenance atzd Replacement Funds), the Water Fund, and the Sanitation Fund. �'car ptt�po��es of this po�icy, the General Fund Group includes the Business Investment F`tax�.d, and Capital Proj�cts Fund, since the resources maintained in these fu�ads originated frorn the General Fund. The General Fund Group also includes the Building k��cords Management Fe�Fund, since this fund is included with the General Fund for�nancial repprting purpo�es. Unless otherwise specified, appropriations from fund balance w�ll,continue to be made as they are under both existing policies and the Orange Municipal Code. For t�E Generat Fu�q.�Group,�und balances are considered to be unrestricted and available for u�at the discretican of the Ci��,Council,unless the fund balances have been designated as no�-sp�ndable or rest�eted,. Un�l�r GASB Statement 54 - Fund Balance Reporting and Governr�e�tal Fund Type Definitions, unrestricted fund balances may be categorized as committed, assigned and unassigned. To be categorized as Com�eitted, amounts can be used only for the specific purposes determined by the highes� ��vel of decision-making authority (i.e. the City Council). The City Council has the au�hority to establish a fund balance commitment, through the action of a resolution or an ordinance, and must use the same action to modify or rescind that commitment. To be categorized as Assigned, amounts are identified to reflect the City's intended use of those resources. Such intent is to be established by the City Council; however, the City Council may designate that authority to another body or official. All special revenue funds, will be classified as assigned, unless they qualify as restricted or committed. All General Fund fund balance resources that cannot be properly classified into the non- spendable, restricted, committed or assigned category will be categorized as Unassigned. GENERAL FUND GROUP The City Council may Commit or Assign unrestricted fund balances in the General Fund, Building Record Management Fee Fund, Business Investment Fund, and Capital Projects Fund for two primary purposes: (1) to ensure the continued orderly operation of City government, while maintaining the stability of tax and fee structures in the event of unforeseen occurrences or emergencies outside of the City's control; and (2) to allow for the setting aside of funds for particular purposes that will be spent in future years. General Fund Contin�encv Reserve Definition & Purpose: To address unforeseen occurrences or emergencies. Unforeseen occurrences or emergencies may include uncertaintie� 'related to local economic downturns, State and/or Federal actions affecting loGa� �'�venues, uninsured losses, errors in actuarial liability estimates, and other financial risks outs�c�e the control of the City. The City Council commits these balances for Contin�;encies in the fin:ancial records and on the annual audited financial statements. Fund Balance Classi ication: Committed Minimum Reserve Level: 16.6% (i.e. 60 days) of annt��1 General Fund expend�tures. Reguired Action for Use: At the tim�e o�, and concurrent with, the annual budget adoption (i.e. within the budget approval resolution);: � simple majority City Council approval is required. For all other#ames, a 4/5 approval of City Council by Resolution is required. Re-establishing �rrinimum balance: If the balanc� falls belpw the minimum reserve level, the City Manager s�all be required to forrnulate a plan to restore the balance to the minimum amount required within a 2-year perit>d. General Fund E�r�mbranGes Definition & Purpose: 'i'o report autstanding and purchase arder commitments at the end of the fiscal year. The Gity Council assigns these balances as Encumbrances in the financial records and on the annual audited financial statements. This reserve is for financial state�n�nt reporti�g purposes only and will be allocated to expenditure appropriations as applicable in the subsequent year. Fund Balance Classi acation: Assigned Minimum Reserve Level: None. Required Action e or Use: The City Council defers authority to staff to determine the amount of outstanding contract and purchase order commitments at the end of every fiscal year. Re-establishinQ minimum balance: Not applicable. General Fund Unencumbered Carrvover Appropriations Definition & Purpose: To establish an assignment of fund balance for continuing appropriations, as approved along with the budget. The City Council will determine this amount along with the adoption of the subsequent year's budget and assign these balances as Carryover Appropriations in the financial records and on the annual audited financial statements. This reserve is for financial statement reporting purposes only and will be allocated to expenditure appropriations as applicable in the subsequent year. Fund Balance Classification: Assigned Minimum Reserve Level: None. Required Action� or Use: Not applicable. Re-establishing minimum balance: Not applicable. Building Records Mana�ement Fee Fund'Balance Definition & Purpose: This fund is maintained as a separa#e fund for budgetary purposes to record revenues and expenditures related to the maintenance and management of building records. The City Court�il assigns this fi�nd balance as Building Records Management in the financial records and t���ie annual�udited financial statements within the General Fund. Fund Balance Class%,�tcatifln: Assigned Minimum Reserve Level: None. Reguired,s4�t�Qn for Use: Appropriation by City�ouncil. Re-establishin�minrrrtum balanee: Not applicable. Business�nvestment Fund Balance Pur,�ose: This fund is main#ained as a separate fund for budgetary purposes to track payments related t� certain tax sharing agreements, and to set aside funds to attract new businesses to the City in the future. The primary funding source for the Business Investment Fund is tran�f�rs from the General Fund. The City Council assigns this fund balance as Business Investment in the financial records and on the annual audited financial statements within the General Fund. Fund Balance Classi�cation: Assigned Minimum Reserve Level: None—set annually by City Council upon budget adoption. Rec�uired Action for Use: Appropriation by City Council. Re-establishing minimum balance: Not applicable. Canital Proiects Fund Balance Definition & Purpose: This fund is maintained as a separate fund for budgetary and financial reporting purposes for capital projects that are funded by the General Fund. The primary funding source for the Capital Projects Fund is transfers from the General Fund. The City Council assigns this fund balance as Capital Improvements in the financial records and on the annual audited financial statements. Fund Balance Classification: Assigned Minimum Reserve Level: The annual average of the five-year Capital Improvement Plan budgeted expenditures, or 50% of single highest year in the� five-year CIP, whichever is higher. This will be calculated on an annual basis as p�rt of the budget preparation and adoption. Required Action for Use: The City Council ap�ropriates funds from the fund balance in conjunction with the adoption of the annual budget. At other times, fund balance may be appropriated by City Council under existing'policies. Re-establishing minimum balance: As directed by the,C�ty Council during the budget process. INTERNAL SERVICE FUNDS Internal service funds are used to efficiently allocat�costs of vaxious internal functions to the City's individu�.l dep�rtments and' fun�s. These services include equipment maintenance and replacement, self-insurance funds, ernployee accrued liabilities, and information technalogy maint�nance and '�eplacement. Internal service funds utilize proprietary accounting. As such, the classifications of fund balance described above do not apply to �he internal service fun�s. Reserve levels will be determined on a current resoure� basis (c�at�'ent ass�ts less current liabilities) and established from a strictly budgetary perspective. Vehicle Renlacement Fu�d Definition &F��,pose: To pro�vide a source of funding for the acquisition and replacement of all rolling stock and equip�ent, including vehicles, heavy machinery and equipment, and trailers. The fur�dz`ng s�urce for this fund is charges to user departments. Fund Balance Classification: Not applicable Minimum Reserve Level: The annual average of the prior three years' of actual vehicle and equipment expenditures Reguired Action for Use: Appropriation by City Council. Re-establishing minimum balance: As directed by the City Council during the budget process. Maior Building Improvements Fund De�nition & Purpose: To provide a source of funding for major building improvements. The primary funding source for the Major Building Improvements Fund is transfers from the Capital Projects Fund. Fund Balance Classification: Not applicable Minimum Reserve Level: None. Required Action for Use: Appropriation by City CounciL Re-establishinQ minimum balance: Not applicable. Workers' Compensation Self-Insurance Fund Definition &Purpose: To provide funding ft�r the City's warkers' cc��n�ensation insurance program, which includes limited self-insurance, Fund Balance Classification: Nat applicable Minimum Reserve Level: One hundred fifty percent (15U%o) of the annual average of the prior three years' of actual workers' compensatic�n claims paid. Required Action for Use: Appropriation by,City Ct�uncii. ' Re-establishin� minrnzum balanee: If the b��ance falls below the minimum reserve level, the City Manager sh�ll be required to formulate a plan to restore the balance to the minimum arnvunt requirec�within a 2-year periad. General.Liabilitv Self-�nsurance Fund Definition c� Purpose: To provide funding for the City's general liability insurance program, whieh includes limited self-insurance. Fund Balance Classificatian:Not applicable Minimum Reserve Level: One hundred fifty percent (150%) of the annual average of the prior three years' of actual general liability claims paid. Rec�uired Action for Use: Appropriation by City Council. Re-establishing minimum balance: If the balance falls below the minimum reserve level, the City Manager shall be required to formulate a plan to restore the balance to the minimum required amount within a 2-year period. PERS Set Aside Reserve Definition & Purpose: To provide contingency funds for the City's pension plans with Ca1PERS. This reserve is maintained within the Employee Accrued Liability Fund. Fund Balance Classifcation: Not applicable Minimum Reserve Level: None—set annually by City Council upon budget adoption. Required Action for Use: Appropriation by City Council. Re-establishing minimum balance: Not applicable. Computer and Technolo�v Replacement Fund De�nition &Purpose: To provide a source c�f funding for the acquisition and replacement of the City's information technology infrastructure and related equipment. Fund Balance Classification: Not applicable Minimum Reserve Level: The annual average of the prior three years' of actual computer and technology capital expenditures. Rec�uired Action for Use.' Appropriation by City Councii; Re-establishing minirnum balance: As directed by the City Council during the budget process. CITY COUNCII.DISCRETIONARY�SERVE In ord�t to ensure adequate liquidity for emergencies and imbalances in cash flow, the combined �und balances c�f the General Fund Contingency Reserve, Building Records Management Fee Fund, Business Investment Fund, Capital Projects Fund, Vehicle Replacement Fund, Major $uilding Improvements Fund, PERS Set Aside Reserve, Computer and Teclinology R�placement Fund, and unassigned General Fund balance, collectively known as the City Council Discretionary Reserve, shall be maintained at a minimum level of 40%t�f General Fund expenditures. ENTERPRISE FUNDS Enterprise funds are maintained for funds whose primary source of revenue is charges for services. The City maintains enterprise funds for two functions: Water and Sanitation. The California Constitution restricts revenues generated by the user charges to be used only for the purposes for which the fees are collected. Enterprise funds utilize proprietary accounting. As such, the classifications of fund balance described above do not apply to the enterprise funds. Reserve levels will be determined on a current resource basis(current assets less current liabilities) and established from a strictly budgetary perspective. Water Fund Onerating Reserve Definition & Purpose: To provide a contingency reserve for the Water Fund in the event of unexpected increases in expenses, shortfalls in revenue, or catastrophic events. Fund Balance Classi ication: Not applicable Minimum Reserve Level: Twenty-five percent (25%) of budgeted operating expenses. Rec�uired Action for Use: Appropriation by City Council. Re-establishing minimum balance: If the balance falls below the minimum reserve level, the City Manager shall be required to formulate a pla� to restore the balance to the minimum required amount within a 2-year period. ' Sanitation Fund Oqerating Reserve ' Definition & Purpose: To provide a conting�n�y reserve for the Sanitation Fund in the event of unexpected increases in expenses, shortfalls in revenue, or catastraphic events. Fund Balance Classification: Not applicable Minimum Reserve Level: Twenty-five perce�t(25%) of budgeted operating expenses. Required Action for tlse.• Appropriation by City Council, Re-establishi��minirrzum balartee: If the bal�nce falls below the minimum reserve level, the City Manager shall be re�u�red to formulate a plan to restore the balance to the minimum rec�uired amount wit�in a 2-year periad. Sanitation Capital Fund De�nition & Purpose: 'This fund is maintained separately for budgetary purposes to account for the sanitation infr�.structure fee. The revenue generated from this charge is to be used for capital improvements to the City's sewer infrastructure. It is combined with the Sanitation Fund for fina.ncial reporting purposes. Fund Balance Classificertion: Not applicable Minimum Reserve Level: None. Reguired Action or Use: Appropriation by City Council. Re-establishin�minimum balance: Not applicable. City of Orange Proposed FY19 Fund Balances vs. Proposed Reserve Policy Reserve Minimum Level Minimum Balance Proiected Balance General Fund Contingency Reserve* 16.6%of annual General Fund expenditures 18,564,510 20,067,960 Unreserved General Fund Balance* None - 3,797,668 General Fund Encumbrances None - - General Fund Carryover Appropriations None Building Records Management Fee Fund* None - 537,392 Business Investment Fund* None - 1,704,380 Capital Projects Fund* Higher of annual average of the adopted five-year CIP budgeted expenditures or 50%of single highest year 235,000 9,113,707 Vehicle Maintenance Fund* None - (18,166) Vehicle Replacement Fund* Annual average of the prior three years'actual vehicle and equipment expenditures 3,552,223 2,866,348 Major Building Improvements Fund* None - 58,927 Accrued Liability Fund* None - (27,512) PERS Set Aside Reserve* None - 6,243,000 Computer&Technology Maintenance None Fund* - 35,291 Computer&Technology Replacement Annual average of the prior three Fund* years' information technology capital expenditures 957,741 474,274 *CITY COUNCIL DISCRETIONARY RESERVE 40%of annual General Fund expenditures 44,733,759 44,853,269 Workers'Compensation Self-Insurance 150%of the annual average of the Fund prior three years'actual workers' compensation claims paid 3,120,911 7,036,803 General Liability Self-Insurance Fund 150%of the annual average of the prior three years'actual general liability claims paid 735,944 1,077,533 Water Operating Reserve 25%of annual Water Fund operating expenditures 8,000,612 5,519,018 Sanitation Operating Reserve 25%of annual Sanitation Fund operating expenditures 1,173,239 1,444,433 Sanitation Capital Fund None - 1,867,885