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HomeMy WebLinkAbout06. Approve updated administrative overhead percentage of 190% for Fiscal Year 2020-21 Page 1 of 14 Item 6. CENTRAL SAN BOARD OF DIRECTORS POSITION PAPER MEETING DATE: MARCH 5, 2020 SUBJECT: APPROVE UPDATED ADMINISTRATIVE OVERHEAD PERCENTAGE OF 190% FOR FISCAL YEAR 2020-21 USING BOARD APPROVED METHODOLOGY USING ACTUAL COSTS AND THREE-YEAR SMOOTHING, OR CONSIDER ALTERNATIVE RATES INCORPORATING ONE YEAR OF PRO-FORMA ESTIMATED SAVINGS ARISING FROM THE TRANSITION TO CALPERS HEALTHCARE, WITH OR WITHOUT SMOOTHING SUBMITTED BY: INITIATING DEPARTMENT: KEVIN MIZUNO, FINANACE MANAGER ADMINISTRATION-FINANCE REVIEWED BY: PHILIP LEIBER, DIRECTOR OF FINANCE AND ADMINISTRATION ANN SASAKI, DEPUTY GENERAL MANAGER Roger S. Bailey General Manager ISSUE Board approval is needed to revise the annually updated administrative overhead percentage in order to recover the full cost of the indirect support services provided by Central San. This overhead rate is used for several purposes including billing outside agencies, calculating certain customer rates and charges, and for internal use in charging overhead to capital projects. BACKGROUND Pursuant to long-standing Board policy direction, the purpose of calculating administrative overhead, employee benefits, and non-work hours rates has been for Central San to recover the full cost, including indirect costs, of the services it provides to various users. I n an effort to set the rate early enough to be used for calculating rates and charges and the negotiation of the Clean Water Program contract, staff brings the annual updated percentage to the Board every January. Due to some complexities encountered involving the consideration of alternative courses of action, the proposal of the FY 2020-21 March 5, 2020 Regular Board Meeting Agenda Packet- Page 21 of 106 Page 2 of 14 administrative overhead rate is being brought to the Board later than usual. The administrative overhead rate is comprised of three subcomponents capturing the following: 1. Administrative overhead consists of all administrative indirect costs for Central San that are incurred for a common purpose benefiting more than one task. This rate includes Administration Department staff salaries and retirement costs, the administrative portion of Other Post-Employment Benefits (OPEB)trust contributions for active and retired employees, and any additional Unfunded Actuarial Accrued Liability (UAAL) payments allocated to administration. 2. Employee benefits consist of costs associated with retirement pension payments, medical premiums, deferred compensation contribution in lieu of social security, and other similar benefits expressed as a percent of salaries. 3. Non-work hours consist of the value of compensated leave (i.e. vacation, sick leave, administrative leave, birthday holiday) and earned overtime expressed as a percentage of annual work hours. Change in Methodology Adopted in 2014 During 2013, staff, in conjunction with Matrix Consulting Group (Matrix), reviewed the methodology used by Central San and analyzed other allowable methods used to calculate overhead. Matrix issued its report in March 2014, which stated that the methodology that Central San previously used was compliant with State and Federal guidelines, and was generally consistent with other agencies and jurisdictions, so there was no immediate need for change. It was suggested by several Board Members that staff conduct further analysis as to Central San's methodology for calculating the administrative overhead percentage prior to presenting the matter for consideration for Fiscal Year (FY) 2014-15. Consequently, staff, with the help of Matrix, had proposed and recommended a slightly different methodology for calculating the administrative overhead percentage for FY 2014-15 and beyond. The four main items addressed by staff and the consultant included the treatment of the following: 1. Use of audited or budgeted benefit amounts for the employee benefits component 2. OPEB contributions for active employees and retires 3. Retiree premiums 4. Additional UAAL payments On April 3, 2014, following its review of the report issued by Matrix, the Board approved the following: 1. A change/clarification in methodology for calculating Central San's administrative overhead percentage, commencing FY 2014-15 as follows: • Use audited cost of benefits for the benefits component of the calculation • Allocate the OPEB contribution for active employees and retirees to their respective departments, and include only the administrative portion in the administrative component • Continue to treat retiree health insurance premiums as indirect, and include them in the administrative overhead component • Allocate any additional UAAL payments to their respective departments, and include only the administrative portion in the administrative overhead component 2. A single administrative overhead percentage is to be used for billing outside agencies, calculating the annual Environmental and Development Rates and Charges, and for internal use in charging to capital projects (administrative and non-work hours percentages used); and 3. A three-year smoothing methodology going forward to adjust for volatility in the rate, using FY 2014- March 5, 2020 Regular Board Meeting Agenda Packet- Page 22 of 106 Page 3 of 14 15 as the base year. The rate for FY 2015-16 would be based on two years and it would not be until FY 2016-17 that an actual three-year smoothing would be able to be utilized. Proposed Rate for FY 2020-21 The proposed administrative overhead recovery rate for FY 2020-21 has been calculated in accordance with the methodology approved by the Board as outlined previously. The proposed rate (three-year smoothed)for FY 2020-21 is 190%, reflecting a noteworthy decline of 13% from the prior year's approved rate of 203%. As outlined in Attachment 1, the 12% decrease in the un-smoothed administrative overhead rate from FY 2019-20 to FY 2020-21 from 190% to 178% is attributable to the following factors: 1. Employee Benefits Rate Component— One third of this decrease is caused by a slight decrease in employee benefits costs (numerator), while the denominator of the equation, salaries, increased. The slight reduction in benefit costs overall was primarily driven by a reduction in the required employer retirement contributions made to CCCERA towards the UAAL. The increase in salaries, the denominator, is attributed to the labor agreements specifying cost of living adjustments and other salary adjustments (i.e. longevity, step increases for eligible employees, etc.). 2. Administrative Overhead Rate Component—Two thirds of this decrease attributable to significant decreases in indirect overhead costs (numerator), while the salaries increased overall (denominator). Noteworthy decreases in indirect costs were evident for several variables including: indirect salaries &wages, benefits charged through payroll, and net self-insurance costs. The increase in salaries, the denominator, is attributable to prevailing labor agreements specifying cost of living adjustments and other salary adjustments (i.e. longevity, step increases for eligible employees, etc.). Refer to the attached FY 2020-21 Administrative Overhead Summary(Attachment 1)for additional highlights of the proposed FY 2020-21 rate compared to the rates adopted by the Board for the previous two fiscal years. ALTERNATIVES/CONSIDERATIONS Following the Board's approval of the FY2019-20 administrative overhead rate, Finance Committee members expressed interest in revisiting the FY 2019-20 administrative overhead rate to potentially incorporate the budgetary savings (estimated at$5.46 million) realized from Central San's transition to CaIPERS Healthcare effective July 1, 2019. Such savings are not included in the methodology which relies on actual audited costs and three-year smoothing, as the savings had not yet occurred in the period upon which that calculation relies (three-year period from FY 2016-17 to FY 2018-19). Upon revisiting this concept on October 22, 2019, the Committee members agreed with the staff recommendation to refrain from revising the rate already in place for FY 2019-20. Instead, the Committee recommended staff provide an alternative rate that incorporated the estimated budgetary savings for the Board to consider in its annual review of the administrative overhead rate for FY 2020-21. Accordingly, as an alternative to adopting the FY 2020-21 administrative overhead rate being proposed, staff has calculated revised rates (smoothed and un-smoothed) incorporating the estimated savings from the transition to CaIPERS Healthcare summarized in Attachment 2. Alternative 1 One alternative approach is to calculate the overhead rate by applying the estimated FY 2019-20 healthcare savings onto actual audited results for FY 2018-19 and continuing to use three-year smoothing. As outlined in Attachment 2, this results in a revised overhead rate of 186%. March 5, 2020 Regular Board Meeting Agenda Packet- Page 23 of 106 Page 4 of 14 Alternative 2 A second alternative approach is to calculate the overhead rate by applying the estimated FY 2019-20 healthcare savings into actual audited results for FY 2018-19 and using the single-year un-smoothed rate. As outlined in Attachment 2, this results in a significantly reduced overhead rate of 168%. Alternative 3 A third alternative would be to adopt the FY 2020-21 overhead rate (190%) being proposed by staff using the Board-approved method, and further direct staff to use the single-year un-smoothed rate calculated based on FY 2019-20 costs in the calculation of next year's overhead rate for FY 2021-22. The single year un-smoothed rate for FY 2021-22 would be based on audited actual figures and incorporate real savings from Central San's transition to CalPERS Healthcare in FY 2019-20. Thereafter, in FY 2022-23 the overhead rate could be smoothed over a two-year period, and in FY 2023-24 be smoothed over a three-year period, which is the approach currently in place and reflective of best practices. This approach would result in the lowest possible overhead rate under the model in FY 2021-22 and would be in line with best practices to only use audited information. Additional Considerations While there are understandable motivations in trying to incorporate estimated savings into the administrative overhead rate earlier than normal, staff does not currently recommend Alternatives 1 or 2 as they deviate from the current Board-approved methodology which relies on audited information only. Following the approved methodology, the soonest the CalPERS savings would be available for use in the administrative overhead rate calculation would be for FY 2021-22, which is expected to be proposed to the Board in January 2021, once audit of FY 2019-20 financial statements has been completed. Given this time lag, the Board may choose to reconsider its previous policy direction and direct staff to change the calculation methodology to allow for un-audited estimates in extraordinary circumstances. However, staff maintains it is beneficial to maintain the current approach for the following reasons: 1. 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 introduced by using estimates for FY 2020-21 and in future years. 2. 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. While the estimate of projected savings arising from the transition to CalPERS Healthcare is expected to be reliable, it is still an estimate, which deviates from Matrix's recommendations. 3. The overhead rate calculation worksheet is quite complex resulting in some risk when making significant changes to the methodology such as inserting estimated cost savings into years they did not actually occur. For instance, several of the worksheet inputs are developed based on longstanding instructions and by running specific accounting reports and deviating from this methodology creates an element of uncertainty. As noted previously, the worksheet and methodology were last reviewed by an independent qualified consultant in 2014 and it may be prudent to have any changes to the model be reviewed once again by an independent specialist before moving forward. March 5, 2020 Regular Board Meeting Agenda Packet- Page 24 of 106 Page 5 of 14 FINANCIAL IMPACTS The administrative overhead percentage is calculated annually for the purpose of recovering administrative overhead and employee benefit costs when charging to capital projects as well as for recovering full costs for services provided to other agencies, companies or developers, and for customer billings involving labor costs. Reductions in revenue from these sources would require use of reserves to offset the difference. Estimated Impact to Running Expense Fund and Sewer Construction Fund Exhibit A in Attachment 3 provides a summary of the estimated reductions to Central San revenues for the recommended action as well as the two alternative actions proposed using FY 2019-20 budgeted figures as a baseline. The estimated fiscal impacts assume the following types of revenues are impacted by changes to the administrative overhead rate: permit fees, application fees, septic tank dumping, inspection charges, storm water program fees, annual City of Concord bill, and household hazardous waste partner reimbursements. Estimated I mpacts to Annual City of Concord Bill for Wastewater Treatment Services At the January 2020 Finance Committee meeting, Committee Members specifically expressed interest in the fiscal impact to the City of Concord, Central San's largest individual customer, if either Alternatives 1 or 2 were adopted by the Board. I n assessing the impact of reductions to the overhead rate on the annual bill to the City of Concord for its share of wastewater treatment costs, staff is confident reductions to the rate proposed in Alternatives 1 or 2 would not have a direct or material impact on the O&M component of the annual bill. The O&M portion of the annual bill to the City of Concord is not impacted as it is based on its share of actual costs for the year and the overhead rate does not have any direct or material impacts on the calculation. In contrast, the capital portion of the annual bill to the City of Concord is impacted by reductions to the overhead rate, though to a relatively limited extent. Exhibit B in Attachment 3 provides a summary of the estimated reductions to the total Concord Bill for the recommended action as well as the two alternative actions proposed using FY 2019-20 budgeted figures as a baseline. As summarized in the attachment, using FY 2019-20 budgeted revenues from the City of Concord annual bill as a baseline, opting for the Staff Recommendation, Alternative 1 or Alternative 2 results in estimated revenue reductions of $47,000, $60,400 and $134,300 respectively. Attachment 3 also summarizes the proportion of the Concord bill that each of these reductions represents. COMMITTEE RECOMMENDATION The Finance Committee reviewed this matter at meetings held October 22, 2019 and January 28, 2020. At the October meeting, the Committee requested two options for the FY 2020-21 administrative overhead rate, one using current methodology, and another including early capture of the estimated savings from the transition to CaIPERS Healthcare. At the January meeting, the Committee requested further information on anticipated lost revenues should one of the two alternative administrative overhead rates be adopted rather than the rate recommended by staff. Due to timing issues and Committee Member availability, this matter was brought directly to the Board without a Committee recommendation. RECOMMENDED BOARD ACTION Approve the use of the administrative overhead percentage of 190% for Fiscal Year 2020-21. March 5, 2020 Regular Board Meeting Agenda Packet- Page 25 of 106 Page 6 of 14 ATTACHMENTS: 1. Administrative Overhead Rate Calculation Summary for FY 2020-21 2. Administrative Overhead Summary for FY 2020-21 (Alternatives 1 and 2) 3. Overhead Rate 4. FY2020-21 OH Rate Presentation March 5, 2020 Regular Board Meeting Agenda Packet- Page 26 of 106 Page 7 of 14 ATTACHMENT 1 Central Contra Costa Sanitary District Administrative Overhead Rate Calculation Summary for FY 2020-21 (Staff Recommendation) Calculated using 2018-2019 Audited Financial Statements Current Year 3 Year Calculation Last Year's Two Years Ago Smoothed Unsmoothed Unsmoothed Unsmoothed Year 2020-2021 2020-2021 2019-2020 2018-2019 Employee Benefits 75.72% 71.24% 75.30% 80.63% Administrative Overhead 95.87% 88.62% 96.71% 102.29% Non-work Hours 18.11% 18.09% 18.18% 18.06% 189.71% 177.95% 190.20% 200.98% Smoothed Rate W 190% * 203% 219% Years in Smooth Rate 3 yr 3 yr 0 3 yr Ir Comparison of Rate Before Smoothing 2020-2021 2019-2020 Decrease Employee Benefits 71% 75% 4% Administrative Overhead 89% 97% -8% Non-work Hours 18% 18% 0% Total 178% 190% -12% Summary of Increases(Decreases) Employee Benefits: Total adjusted benefits(numerator)decreased by 0.7%,and total salaries(denominator)increased by 4.9%,causing -4% the overall decrease FY 2018-19 FY 2017-18 Difference Benefits(numerator) $27.2 $27.4 ($0.2) Salaries(denominator) 38.2 36.4 1.8 Admin Overhead: Total adjusted indirect costs(numerator)decreased by 4.1%,and total direct salaries(denominator)increased by 4.7%,causing the overall decrease -8% FY 2018-19 FY 2017-18 Difference Indirect costs(numerator) $27.8 $29.0 ($1.2) Direct salaries(denominator) 31.4 30.0 1.4 March 5, 2020 Regular Board Meeting Agenda Packet- Page 27 of 106 Page 8 of 14 ATTACHMENT Central Contra Costa Sanitary District Administrative Overhead Summary for FY 2020-21 (Alternatives 1 &2) Calculated using 2018-2019 Audited Financial Statements with Adjustments for CaIPERS Healthcare Cost Current Year 3 Year Calculation Last Year's Two Years Ago Smoothed Unsmoothed Unsmoothed Unsmoothed Year 2020-2021 2020-2021 2019-2020 2018-2019 Employee Benefits 74.36% 67.15% 75.30% 80.63% Administrative Overhead 93.93% 82.78% 96.71% 102.29% Non-work Hours 18.11% 18.09% 18.18% 18.06% 186.40% 168.01% 190.20% 200.98% Smoothed Rate 186% 203% 219 Years in Smooth Rate lPOw 3 yr 3 yr 3 yr Comparison of Rate Before Smoothing 2020-2021 2019-2020 Decrease Employee Benefits 67% 75% -8% Administrative Overhead 83% 97% -14% Non-work Hours 18% 18% 0% Total 168% 190% -22% Summary of Increases(Decreases) Employee Benefits: Total adjusted benefits(numerator)decreased by 6.2%,and total salaries(denominator)increased by 4.9%,causing -8% the overall decrease FY 2018-19 FY 2017-18 Difference Benefits(numerator) $25.7 $27.4 ($1.7) Salaries(denominator) 38.2 36.4 1.8 Admin Overhead: Total adjusted indirect costs(numerator)decreased by 10.3%,and total direct salaries(denominator)increased by 4.7%,causing the overall decrease -14% FY 2018-19 FY 2017-18 Difference Indirect costs(numerator) $26.0 $29.0 ($3.0) Direct salaries(denominator) 31.4 30.0 1.4 March 5, 2020 Regular Board Meeting Agenda Packet- Page 28 of 106 Central Contra Costa Sanitary District Attachment 3 FY 2020-21 Overhead Rate Fiscal Impacts Tables Exhibit A Estimated Fiscal Impact of Proposed Alternatives to Total Revenues of Running Expense and Sewer Construction Funds Using FY 2019-20 Total Budgeted Revenues as a Baseline Estimated Revenue Decrease from Estimated Revenue Decrease from FY 2019-20 Budgeted ($) FY 2019-20 Budgeted (%) Running Expense Sewer Construction Running Expense Sewer Construction Action Overhead Rate Fund Fund Fund Fund Staff Recommendation 190% ($218,400) ($72,600) -0.25% -0.11% Alternative 1 186% ($285,400) ($93,900) -0.33% -0.14% Alternative 2 168% $588,800 $203,300 -0.67% -0.31% Exhibit B Estimated Fiscal Impact of Proposed Alternatives to the City of Concord Bill Using FY 2019-20 Budgeted Revenues from City of Concord as a Baseline Administrative Overhead Rate Sub- Reduction to Action Component Reduction to Bill ($) Concord Bill (%) Staff Recommendation 96% ($47,000) -0.18% Alternative 1 94% ($60,400) -0.23% Alternative 2 93% $134,300 -0.51% March 5, 2020 Regular Board Meeting Agenda Packet- Page 29 of 106 FY 2020 =21 ADMINISTRATIVE OVERHEAD RATE Phil Leiber, Director of Finance and r Administration and Kevin Mizuno, Finance Manager f r ' March 5, 2020 1 BACKGROUND Administrative overhead rate adopted annually by Board in early part of calendar year Key part of implementing full cost recovery policy Used for updating rates and charges and negotiation of the Clean Water Program contract • Comprised of three sub-component rates : Benefit Rate Administrative Overhead Rate Non-Work Hours Rate tiy L CENTFiAGONTF cJsa DOWNWARD TREND OF OVERHEAD RATE 250% 240% — 230% 220% +� 210% ca v 200% ^ t L p 190% 180% 170% 160% 150% 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 Fiscal Year --*--3 Year Smoothed Rate —4--Single Year Rate 3 CENTFiAGONTFa cJs�a x i RECOMMENDED ACTION Adopt FY 2020-21 administrative overhead rate of 190% Calculated using Board-approved and independently reviewed (Matrix) methodology Smoothed over three year period using audited actual financial results reported in CAFRs Uses information from the following audited fiscal years: 2016- 17, 2017- 18 and 2018- 19 - . 4 CENTFiAGONTF cJsa ALTERNATIVES Apply projected FY 2019-20 savings from transition to CalPERS healthcare earlier than normal Status quo method would apply results from this transition in calculation of FY 2021 -22 rate (January 2021 ) using audited results from FY 2019-20 (current year) Applying estimated savings into FY 2018-19 audited actual results in the following alternative administrative overhead rates: 186% (3 year smoothing) 168% (single year un-smoothed) lie Adopt proposed FY 2020-21 overhead rate but direct staff to use single year un-smoothed rate in calculation of next year's (FY 2021 -22) overhead rate, once audited information becomes available. = y 5 �_ WHY RECOMMENDED ACTION IS PREFERRED OVER PROPOSED ALTERNATIVES 1 & 2 Using audited actuals and smoothing techniques is in-line with best practices Using estimates in-lieu of actual results deviates from Government Accounting Standards Board "objectivity" and "consistency" principles Manual adjustments and utilization of estimates increases risk given complexity of administrative overhead rate calculation model �ey 6.I�IC �.-w.. • .moi— '.' I COMPARISON OF OVERHEAD RATE COMPONENTS 250% 203% 200% 190 186% 168% 150% 100% 50% 0% Prior Year Rate(2019-20) Proposed Rate(2020-21) Alternative 1 Rate(2020-21) Alternative 2 Rate(2020-21) ■Employee Benefits ■Administrative Overhead Non-Work Hours 7 ..EN;RAL C9xrat ;. �unr, ')TIMATED Fiqr- AL IMPACTS Estimated Fiscal Impact of Proposed Alternatives to Total Revenues of Running Expense and Sewer Construction Funds Using FY 2019-20 Total Budgeted Revenues as a Baseline Estimated Revenue Decrease from Estimated Revenue Decrease from FY 2019-20 Budgeted $ FY 2019-20 Budgeted Running Expense Sewer Construction Running Expense Sewer Construction Action Overhead Rate Fund Fund Fund Fund Staff Recommendation 190% ($218,400) ($72,600) -0.25% -0.11% Alternative 1 186% ($285,400) ($93,900) -0.33% -0.14% Alternative 2 168% $588,800 $203,300 -0.67% -0.31% Estimated Fiscal Impact of Proposed Alternatives to the City of Concord Bill Using FY 2019-20 Budgeted Revenues from City of Concord as a Baseline Administrative Overhead Rate Sub- Reduction to Action Component Reduction to Bill ($) Concord Bill Staff Recommendation 96% ($47,000) -0.18% Alternative 1 94% ($60,400) -0.23% Alternative 2 93% $134,300 -0.51% 8 CEN79ACUNTF CM - i DISCUSSION IN • 'mFwpuwA, f. 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