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Attachment 4To: Honorable Mayor & Members of Los Gatos Town Council Submitted by: Terry Duryea Dated: Dec 13, 2018 As a member of the Town Council Finance Committee, I would like to share information related to the draft 2018 CAFR presented at the recent Finance Committee meeting to supplement any information Town Staff provides the Town Council The Finance Committee reviewed the CAFR at the December 10, 2018 meeting. There is a lot of good information buried in its 138 pages, but it is hard to find and interpret. There was significant discussion at the recent meeting to make the disclosures in the CAFR, particularly in the Management Discussion and Analysis, more informative and easier to understand. The Finance Committee did not approve the CAFR, but instead asked the Town Staff to makes changes as Staff felt appropriate based on the discussion at the Finance Committee meeting. The following information is from a presentation to the Finance Committee by Mr. Badawi, CPA, the Town’s Auditor. I provide below my personal observation based on the information provided. All numbers are in $1,000’s. Deferred Outflows and Inflows as recorded on the Town’s Statement of Net Position: Deferred Outflow of Pension/ OPEB Resources-see note Deferred Inflows of Pension/ OPEB Resources- see note Net (Inflow) Outflow 2016 $ 6,648 $10,245 ($3,797) 2017 $15,666 $5,778 $ 9,888 2018 $19,177 $3,924 $15,253 Note: a Deferred Outflow from the Town’s Statement of Net Position (balance sheet) will flow into the Town’s Statement of Activities over the next 3 to 5 years as an expense. A Deferred Inflow will flow into the Statement of Activities over the next 3 to 5 years as an expense reduction (or income) Observation: In the next 3 to 5 years the amount of money that will flow into the Town’s statement of activities, has shifted by $19,050 from $3,797 that was going to be an expense reduction to $15,253 that will be an increased expense. Unrestricted Net Position on the Town’s Statement of Net Position 2016 $12,744 2017 $15,134 2018 $ 170 Observation: If there are no other developments, events or changes in assumptions, the Deferred Outflow of $15,253 described above that will recorded as expenses over the next 3 to 5 years, will wipe out the Town’s $170 positive Unrestricted Net Position, causing it to become negative by $15,083 Net Cost of Service to Tax Revenue 2016 2017 2018 Cost of Net Service $20,846 $28,789 $28,803 Tax Revenue $25,521 $28,399 $28567 Surplus (Deficit) $ 4,675 ($ 390) ($ 236) Observation: In 2016 tax revenues covered the Town’s Cost of Net Services by $4,675 while in 2017 and 2018, the Town’s tax revenues did not cover the Cost of Net Service. This represents a deterioration of the Town’s ability to cover it Cost of Net Service with tax revenues. General Fund Expenditure Coverage—a measure of financial strength Per Mr. Badawi, CPA, this is defined as the ratio of General Fund Unrestricted Fund Balance to General Fund Total Expenditures and is measured by the number of months of coverage 2016 2017 2018 Unrestricted Fund Balance $29,574 $29,181 $30,428 Total Expenditures $36,166 $34,543 $37,104 Number of months 10 months 10 months 10 months GFOA recommendation 2 – 4 months Observation: The Town’s Unrestricted General Fund balance is well in excess of the CFOA recommendation. Is there a better use of these funds that will improve the sustainability of the Town’s quality of life? Town’s Unfunded Pension Liability and OPEB Liability June 2016—(2015 measurement date) June 2017—(2016 measurement date) June 2018--(2017 measurement date) Misc Pension Plan $23,209 $27,893 $30,788 Safety Pension Plan $10,200 $19,378 $22,415 Total UAL $33,409 $49,271 $53,203 See Note Note: This amount should be reduced by $1,206 to recognize the amount transferred to the Town’s Section 115 Pension Trust Fund OPEB $12,739 $13,337 $11,165 Total Unfunded Liability $46,148 $46,148 $64,368 Observation: The Town’s Pension UAL has increased $19,794 ($18,588 when you include the Section 115 Pension Trust Fund) over the last 3 years at the same time the Town’s has increased the pension contributions and the stock market has been very strong. I believe the Town is not doing enough to address this financial risk Observation: The Town’s has chosen to pay off the OPEB UAL at a faster rate than the Pension UAL even though the OBEB is incurring interest expense at 6.75% while the Pension Plan interest rate is higher at 7.15%. As a result the Town’s Pension UAL increased $19,794 ($18,588 with the Section 115 Pension Trust Fund) while the Town’s OPEB UAL has decreased $1,574. I believe the money used to pay down the OPEB unfunded liability should be redirected to pay down the Pension UAL Sensitivity of Pension Plan and OPEB Plan to interest rate assumptions The Pension Plan assumes a 7.15% interest rate, the OBEP Plan assumes a 6.75% interest rate. Note: Currently, CALPERS says it expects to earn approximately 6.2% a year over the next 10 years, well below the rate of return assumed in all of the Town’s pension information. A Pension Fund portfolio return of 1% less that the assumed 7.15% would increase the $53,203 UAL by $25,142 to a total of $78,346 for the combined Safety and Misc pensions. (Note: this does not include the $1,206 the Town has in the Section 115 Pension Trust Fund.) A OPEB Fund portfolio return of 1% less than the assumed 6.75% would increase the $11,165 UAL by $3,230. Observation: The return assumptions assumed in the computation of UALs understate significantly the potential obligation the Town is facing if the portfolios do not earn well above what CALPERS is currently forecasting over the next 10 years. If this happens, the obligations to fund the Town’s benefit plans will consume an even larger share of the Town’s operating budget than it is already forecast to consume. I believe the Town needs to do more to address the Pension UAL.