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Home My WebLink About04.d. Receive update on Fiscal Year 2019-20 administrative overhead rate now that transition to CalPERS Healthcare has been completed, as requested by the Finance Committee at the January 28, 2019 meeting Page 1 of 3 Item 4.d. CENTRAL SAN October 22, 2019 TO: FINANCE COMMITTEE FROM: KEVIN MIZUNO, FINANCE MANAGER REVIEWED BY: PHILIP LEIBER, DIRECTOR OF FINANCE AND ADMINISTRATION ANN SASAKI, DEPUTY GENERAL MANAGER ROGER S. BAILEY, GENERAL MANAGER SUBJECT: RECEIVE UPDATE ON FISCAL YEAR 2019-20 ADMINISTRATIVE OVERHEAD RATE NOW THAT TRANSITION TO CALPERS HEALTHCARE HAS BEEN COMPLETED, AS REQUESTED BY THE FINANCE COMMITTEE AT THE JANUARY 28, 2019 MEETING ISSUE: REVISIT ADMINISTRATIVE OVERHEAD RATE? On January 31, 2019 the Board of Directors approved the 203% administrative overhead rate for the fiscal year(FY) ending June 30, 2020 (FY 2019-20). This rate represented a noteworthy decrease from the administrative overhead rate of 219% in the prior fiscal year. As outlined in the Position Paper recommending adoption of the FY 2019-20 rate, the largest contributors to the decline were (1) decreases attributable to retirement benefit costs and (2) administrative overhead expenses remaining relatively flat for the previous two years. Prior to adoption of the FY 2019-20 rate, the Finance Committee recommended Board approval of the 203% rate with the proviso that the rate be revisited in October or November to consider making an adjustment after completion of Central San's planned transition to CalPERS Healthcare effective July 1, 2019. In response to this recommendation, staff has conducted an internal analysis to assess the impact of estimated cost savings from the transition. As part of this analysis, staff reviewed the 2014 overhead cost study prepared by Matrix Consulting Group supporting the District's overhead rate calculation methodology. BACKGROUND REGARDING CALCULATION OF ADMINISTRATIVE OVERHEAD RATE In 2014, at the request of the Board, staff hired Matrix Consulting to review Central San's overhead rate calculation methodology for several purposes, including: compliance with regulations, consistency with best practices, ensuring the long-standing policy goal of full cost recovery, and consideration of the ease of application. The study found Central San's methodology to be in compliance with state and federal guidelines as well as consistent with the general approach used by other local jurisdictions. Furthermore, the study concluded that alternative methodologies would neither provide a better rate nor stabilize the volatility associated with the existing overhead rate. Supported by this 2014 study, the Board adopted a FY 2014-15 overhead rate utilizing a slightly different methodology that has continued to be employed through the latest FY 2019-20 adopted overhead rate. The slightly revised methodology included the following changes: 1. Using actual (not estimated or budgeted) benefit costs from the latest available audited financial October 22, 2019 Regular FINANCE Committee Meeting Agenda Packet- Page 164 of 168 Page 2 of 3 statements for the benefits component of the calculation; 2. Allocating the Other Post Employment Benefits (OPEB) contribution for active employees and retirees to their respective departments, and including only the administrative portion in the administrative component; 3. Continuing to treat retiree premiums as indirect, and include them in the administrative overhead component; and 4. Allocating any additional Unfunded Actuarial Accrued Liability(UAAL) payments to their respective departments and including only the administrative portion in the administrative overhead component. HEALTHCARE COST SAVINGS As contemplated in the adopted FY 2019-20 budget, Central San has begun to realize significant cost savings from the transition to CalPERS Healthcare effective July 1, 2019. In the FY 2019-20 budget, the savings were estimated at$5.807 million based on an actuarial opinion provided by Bartel Associates, LLC in January 2019 (which showed savings for active employees of$2.4 million, and for retirees of $3.407 million). Currently available information shows savings of about$5.46 million based on June (pre- transition)vs. July(post-transition) bills: June 2019 July 2019 Healthnet/Kaiser CalPERS Savings Premiums Premiums (Annualized) (Annualized) Actives $ 7,823,803 $5,723,363 $2,100,439 Retirees 4,067,976 2,288,157 1,779,819 Trust 1,582,800 - 1,582,800 Total $13,474,578 $8,011,520 $5,463,058 Full-year savings are still subject to some potential additional changes due to the fact that: • Health plan coverage levels (i.e. single, family, etc.) are not static and change throughout the plan year for legally qualifying events such as marriage, divorce, adoption/birth of a child, etc. • Calendar year 2020 rates were not available at the time the budget was prepared, and estimates were used for the January through June 2020 portion of the FY 2019-20 budget. This said, the savings estimates appear to be "on the order' of what was assumed in the budget. CONSIDERATIONS The primary concern about waiting for the availability of actual audited healthcare cost information appears to be the two-year lag in passing on the savings from the healthcare cost decline to customers paying the overhead rate. The audited actual results of savings realized from transitioning to CalPERS Healthcare will not be available until August/September 2020, and therefore will not be available until the overhead recovery rate for FY 2021-22 is calculated in January 2021. While this may seem a significant concern, there are advantages to maintaining the current approach: • Using rates based on historical actual information allows the District to eventually recover the full actual overhead costs over the medium term, ensuring that the various classes of users of Central San's services pay the fully allocated cost of the services they have used. Shifting the approach prematurely could result in under-recovery of costs from the classes of users paying fees that include the calculated overhead rate (such as the fee schedules applicable to developers and others maintained by Planning and Development), and over-recovery from customers paying the Sewer Service Charge (as revenues otherwise assessed and collected from other parties would have to be made up by higher SSC charges). There would be "winners" and "losers" in such a shift in approach. Accordingly, despite a time lag, the current approach is most consistent with the District's full-cost recovery goal from various customer classes. • Despite this time lag, continuing to use audited information and a three-year smoothing method is in line with best practices and may also help to mitigate volatility in overhead rates that could be October 22, 2019 Regular FINANCE Committee Meeting Agenda Packet- Page 165 of 168 Page 3 of 3 introduced by using estimates. • As referenced by Matrix Consulting's 2014 study , using actual audited benefit cost information allows Central San to meet the "objectivity" and "consistency" principles of the Government Accounting Standards Board (GASB) in determining overhead recovery rates. The use of estimates, and the need for subsequent"true-up" mechanisms is avoided. If the lower healthcare premium cost information were to be taken into account earlier than the schedule of the overhead calculation in January 2021 for effectiveness in FY 2021-22, the earliest realistic timeframe in which this could be done would be in the calculation submitted to the Board in January 2020 for FY 2020-21. Trying to do so earlier than that, and having the rates effective this year, would not appear to be viable, as updating the overhead rates would affect the fee schedules maintained by Planning and Development. Changing those fees for this year would require public outreach and notices, and re- adoption of fee schedules via ordinance. By the time this was completed, it would be close to the time for the normal annual rate updates. As to the impact on the administrative overhead rate that might be seen if the rate were to be modified early, staff calculated the impact as shown in the table below: FY 2019-20 FY 2019-20 Overhead Rate Overhead Using Actual Rate Using Costs updated (current Healthcare methodology) Costs Single-year rate 190% 167% Three-year smoothed 203% 196% rate The single-year rate drops from 190% to 167%. However, the methodology in use applies three-year smoothing, resulting in a 196% rate versus the current 203%. CONCLUSION Based on these considerations, staff does not recommend modifying the FY 2019-20 administrative overhead rate at this time, but does recommend allowing these savings to be reflected and flow through as actual audited information becomes available. This method is consistent with the Cost Study prepared by Matrix Consulting as well as previous Board direction. Strategic Plan Tie-In GOAL THREE: Be a Fiscally Sound and Effective Water Sector Utility Strategy 1 - Conduct long-range financial planning, Strategy 2- Manage costs October 22, 2019 Regular FINANCE Committee Meeting Agenda Packet- Page 166 of 168