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Home My WebLink About06. Approve updated administrative overhead and benefits rate of 164% for FY 2023-24 Page 1 of 4 Item 6. CENTRAL SAN BOARD OF DIRECTORS POSITION PAPER MEETING DATE: MARCH 2, 2023 SUBJECT: APPROVE UPDATED ADMINISTRATIVE OVERHEAD AND BENEFITS RATE OF 164% FOR FISCAL YEAR (FY) 2023-24 SUBMITTED BY: INITIATING DEPARTMENT: CHRISTOPHER THOMAS, ACCOUNTING ADMINISTRATION-FINANCE SUPERVISOR KEVIN MIZUNO, FINANCE MANAGER REVIEWED BY: PHILIP LEIBER, DIRECTOR OF FINANCE AND ADMINISTRATION Roger S. Bailey General Manager ISSUE Board approval is needed to adopt the updated administrative overhead and benefits rate for the fiscal year ending J une 30, 2024 (FY 2023-24). This rate is used for several purposes, including billing outside agencies, calculating certain customer rates and charges, and internal use in billing labor costs to capital projects. BACKGROUND 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. This has been consistent with long-standing Board policy on cost recovery. Staff strives to bring the annual updated percentage to the Board early every calendar year, in 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. The administrative overhead and benefits rate is comprised of three sub-components 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 including all Executive Governance and Administration Department costs, and certain support costs of the Engineering & Technical Services and Operations departments. March 2, 2023 Regular Board Meeting Agenda Packet- Page 60 of 313 Page 2 of 4 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. Calculation Methodology The current administrative overhead and benefits rate calculation methodology was approved by the Board on April 3, 2014, and first employed in FY 2014-15. The calculation is supported by a study issued by Matrix Consulting Group, an independent consulting firm specializing in developing overhead rates for governmental agencies in conformance with prevailing laws and best practices. I n summary, the methodology currently used is based on the independent consultant's study and incorporates the following previously Board approved principles: 1. Standardizes the methodology for calculating the rate by: • Using the actual cost of benefits as reported in the independently audited financial statement for the benefits component of the calculation rather than budgeted estimates, • Allocates other post-employment benefits (OPEB)trust contributions in excess of pay-as-you- go costs for active employees and retirees to their respective organization units (i.e. departments and divisions), leaving only the administrative portion in the administrative component, • Continuing to treat retiree health and other premiums as indirect, and include them in the administrative overhead component of the rate, and • Allocating any additional Unfunded Actuarial Accrued Liability(UAAL) payments to their respective organization units, and including only the administrative portion in the administrative overhead component of the rate. 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 to adjust for volatility in the rate, initially using FY 2014-15 as the base year(with the rate for FY 2015-16 using two years of data, and from FY 2016-17 forward fully using three-year smoothing). Proposed Rate for FY 2023-24 The proposed administrative overhead recovery rate for FY 2023-24 has been calculated in accordance with the methodology approved by the Board as outlined. The proposed rate (three-year smoothed)for FY 2023-24 is 164%, reflecting a decline of 5% from the approved FY 2022-23 rate of 169%. This is the result of the overall decline in annual rates over the past several years, declining annually in six of the past seven years. While the three-year smoothed rate is declining, there was also a 4.5% decrease in the un- smoothed one-year rate from the prior fiscal year from 167.1% (FY 2022-23)to 162.6% (FY 2023-24) which is attributable to the following factors: 1. Employee Benefits Rate Component-This component decreased by 1.5% from the prior year, largely attributable to the increase in employee benefits costs (numerator) being outpaced by the increase in employee salaries (denominator). The minimal increase in the benefit cost rate was primarily driven by a slight increase in benefit premium rates overall in FY 2021-22. The increase in salaries (denominator) is attributed to the labor agreements specifying cost of living adjustments and other salary adjustments (i.e., longevity, step increases, etc.). March 2, 2023 Regular Board Meeting Agenda Packet- Page 61 of 313 Page 3 of 4 2. Administrative Overhead Rate Component- This component decreased by 3.3% from the prior year, largely due to the proportional increase in indirect overhead costs (numerator) being slightly outpaced by the increase in direct salaries costs (denominator). While relatively minimal, increases in indirect costs were most evident in the following areas: overall increases indirect salaries and wages attributable to the labor agreements specifying cost of living adjustments and other salary adjustments (i.e., longevity, step increases, etc.) as well as an increase in non-labor support costs in certain functions. The increase in direct salaries (denominator) is attributable to prevailing labor agreements and other salary adjustments mentioned previously. ALTERNATIVES/CONSIDERATIONS The methodology used for this year's calculation employed the same methodology approved by the Board in 2014, which employs three-year smoothing as well as the use of audited actual numbers as opposed to using budgeted or projected figures. Alternatives that could be employed include eliminating three-year smoothing, or using budgeted or projected figures instead of actuals. These are not recommended as it could significantly impact comparability of the rate with prior years and not be in line with rate calculation best practices. Following the payoff of Central San's pension UAAL in June 2021 facilitated by the issuance of the 2021 Certificates of Participation (2021 COPs), effective FY 2021-22 Central San was not required to make a large pension UAAL contribution to its pension administrator(CCCERA). In lieu of this pension UAAL contribution, Central San paid $11.3 million in debt service on the 2021 COPs. The Board could choose to exclude the FY 2021-22 debt service from this year's administrative overhead and benefits rate calculation. This is not recommended as it is the opinion of staff that the pension UAAL was essentially swapped for lower debt service on the 2021 COPs and exclusion of the debt service would result in Central San potentially under-recovering costs associated with its pension expense. Despite the application of three-year smoothing, given the magnitude of the change, it is projected removing the 2021 COPs would significantly reduce the FY 2023-24 rate, lowering it by 9% to a new revised rate of 155%. Lastly, the 2014 Board approved rate calculation methodology assumed that the component of OPEB costs associated with retiree health benefits was entirely an indirect cost, and that additional contributions to the trust account beyond that should be spread between both direct and indirect costs as appropriate. Effective FY 2021-22, Central San revised the methodology by which OPEB costs were budgeted to improve transparency and the usefulness of financial reporting. This was achieved in two ways: (1) by budgeting the actuarially determine contribution (ADC) instead of assumed retiree benefits paid and (2) splitting the OPEB costs between its normal cost and UAAL components. Considering the change in budgeting methodology, which disregards the "cash flow" component of retiree benefit premiums payments, it may be timely to change the way OPEB costs are handled in the annual administrative overhead and benefits rate calculation so that OPEB costs are fully allocated between direct and indirect components. Doing so would impact comparability with prior years to some extent, however the application of three-year smoothing would significantly diminish any spikes in the first year of implementation. This change would reduce the FY 2023-24 rate as proposed by 1% to a revised rate of 163%. FINANCIAL IMPACTS The administrative overhead and benefits rate is calculated annually for the purpose of recovering administrative overhead and employee benefit costs when charging to capital projects and developing fees for the full recovery of costs incurred for services provided to customers, including residents, other agencies, businesses, and developers/contractors. March 2, 2023 Regular Board Meeting Agenda Packet- Page 62 of 313 Page 4 of 4 COMMITTEE RECOMMENDATION The proposed three-year smoothed administrative overhead percentage of 164% for FY 2023-24 was reviewed by the Finance Committee on February 21, 2023 and recommended approval. RECOMMENDED BOARD ACTION Approve the use of the administrative overhead and benefits rate of 164% for Fiscal Year 2023-24. Strategic Plan Tie-In GOAL FOUR: Governance and Fiscal Responsibility Strategy 3- Maintain financial stability and sustainability March 2, 2023 Regular Board Meeting Agenda Packet- Page 63 of 313