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HomeMy WebLinkAbout04.c. Review Draft Position Paper and approve updated Administrative Overhead and Benefits Rate of 156 percent for Fiscal Year (FY) 2025-26Page 1 of 10 Item 4.c. BOARD OF DIRECTORS POSITION PAPER DRAFT MEETING DATE: JANUARY21, 2025 SUBJECT: REVIEW DRAFT POSITION PAPER AND APPROVE UPDATED ADMINISTRATIVE OVERHEAD AND BENEFITS RATE OF 156 PERCENT FOR FISCAL YEAR (FY) 2025-26 SUBMITTED BY: INITIATING DEPARTMENT: BRENNAN ROGERS, ACCOUNTING ADMINISTRATION -FINANCE SUPERVISOR KEVIN MIZUNO, FINANCE MANAGER REVIEWED BY: PHILIP LEIBER, DEPUTYGENERAL MANAGER -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 June 30, 2026 (FY 2025-26). 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. 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 percentage of salaries. January 21, 2025 Regular FINANCE Committee Meeting Agenda Packet - Page 104 of 118 Page 2 of 10 3. Non -work hours consist of the value of compensated leave (i.e. vacation, sick leave, administrative leave, birthday leave), and earned overtime expressed as a percentage of annual work hours. Calculation Methodologv 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. In summary, the methodology currently used is based on the independent consultant's study and incorporates the following previously Board approved principles: 1. 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; 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). One noteworthy element of calculation methodology, as supported by the third -party Matrix report, entails allocating OPEB and pension UAAL costs, including additional discretional trust contributions, between their respective departments. In doing so this ensured that the full amount of those costs was not defaulted administrative overhead but rather broken up between departments and thus allocated between direct and indirect components. This methodology has consistently been applied in the calculation of the annual benefits and administrative overhead rate and remains intact for the FY 2025-26. Another noteworthy calculation element is how the 2021 certificates of participation (COPs) debt service is handled. Commencing with the FY 2021-22 budget, Central San's pension UAAL was effectively eliminated, with pension UAAL costs essentially being replaced with debt service on the 2021 COPs. In all annual benefit and administrative overhead rate calculations following this debt issuance, the 2021 COPs debt service was treated as a "replacement" rather than "elimination" of pension UAAL. Accordingly, in the annual rate calculation debt service on the 2021 COPs is allocated between departments, like how the pension UAAL normally is. This year, the rate calculation incorporates one deviation from prior rate calculations to better reflect Central San's modified approach to budgeting for OPEB costs in place since the adoption of its FY2021- 22 budget. This modification acknowledged that OPEB costs should be budgeted and reported in a manner consistent to the pension plan, with the annual expenses broken down between normal and UAAL cost components. Additionally, it acknowledges that the annual budgeted cost to Central San should not be the amount paid to retirees, but rather the actuarially determined contribution (ADC) required to be made to the trust (either to pension or OPEB), plus additional discretionary trust contributions if applicable. This year, a closer examination of the rate methodology, as supported by the Matrix report, treated the entire cost of retiree OPEB benefits paid (i.e., health premiums, Medicare reimbursements, etc.) as administrative overhead. It is the opinion of staff that this treatment is no longer appropriate following the recent change in mythology for budgeting and costing of OPEB. Accordingly, commencing with this year's rate calculation (for FY 2025-26), OPEB costs are being allocated between the normal and UAAL cost components of the ADC and further allocated between departments based on current headcount. Therefore, the only component of OPEB costs considered administrative overhead is the indirection component attributable to support functions. January 21, 2025 Regular FINANCE Committee Meeting Agenda Packet - Page 105 of 118 Page 3of10 Proposed Rate for FY 2025-26 The proposed administrative overhead recovery rate for FY 2025-26 has been calculated in accordance with the previous methodology approved by the Board, apart from how OPEB costs are allocated (as described previously). The proposed rate (three-year smoothed) for FY 2025-26 is 156 percent, reflecting a decline of 7 percent from the approved FY 2024-25 rate of 163 percent. This is the result of the overall decline in single year annual rates over the past several years, declining annually in nine of the past ten years. While the three-year smoothed rate is declining, there was also an 11.4 percent decrease in the un-smoothed one-year rate from the prior fiscal year from 158.0 percent (FY 2024-25) to 146.6 percent (FY 2025-26) which is attributable to the following factors: Employee Benefits Rate Component- This component decreased by 6.6 percent from the prior year, largely attributable to decreasing debt service payments on the 2021 COPS, which were issued to pay off the existing pension UAAL, decreasing employee benefits (numerator) by 5 percent. Additionally, a 6 percent increase in salaries (denominator) was driven by cost of living adjustments and other salary adjustments (i.e., longevity, step increases, etc.) and increases to the district wide full-time permanent employee headcount. 2. Administrative Overhead Rate Component - This component decreased by 5.1 percent from the prior year, due to a 3 percent decrease in indirect overhead costs (numerator), and a 4 percent increase in direct salaries costs (denominator). The decrease in indirect costs were predominantly the result of lower OPEB ADCs partially offset by increases in 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. The attached presentation (Attachment 1) provides additional highlights of the proposed FY 2025-26 rate compared to the rates adopted by the Board in prior years. ALTERNATIVES/CONSIDERATIONS The methodology used for this year's calculation employs three-year smoothing as well as the use of audited actual numbers as opposed to using budgeted or projected figures consistent with prior years. Alternatives that could be employed include eliminating three-year smoothing or using budgeted or projected figures instead of actuals. These alternatives are not recommended as doing so would significantly impact comparability of the rate with prior years and would cause the rate to not be in line with best practices. There had been some discussion in past years of these modifications, as it would have resulted in a faster decrease overall downward trend in the administrative overhead rate from certain cost reductions like the transition to CalPERS as a health insurance provider in 2019. However, as the most significant of those cost reductions have been fully recognized in the three-year smoothed results, there is even less of a rationale for such changes now. Accordingly, maintenance of the same approach to calculation of the administrative overhead rate as in past years is recommended. Additionally, in the Board's consideration of the FY 2023-24 rate, an alternative was presented to exclude the 2021 COPs debt service, which would significantly decrease the rate. This alternative was not selected at that time, and is not being recommended currently, as the debt service associated with the 2021 COPs is essentially a swap for the prior pension UAAL expenses (albeit at a significantly lower interest rate) and excluding it would reduce full cost recovery, which is a primary objective of the rate. Lastly, as described previously, this year's rate calculation fully allocated the ADC cost of OPEB between departments rather than defaulting the full amount to the administrative overhead sub -component. The Board may prefer to keep the calculation consistent with prior years and the third -party Matrix report, which would result in a slight increase to the currently proposed rate from 156 percent to 157 percent. This is not January 21, 2025 Regular FINANCE Committee Meeting Agenda Packet - Page 106 of 118 Page 4 of 10 recommended as new method for handling OPEB costs in the rate calculation is in better alignment with how OPE B costs are now accounted and budgeted for commencing with the FY 2021-22 budget. 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. COMMITTEE RECOMMENDATION The Finance Committee reviewed this matter at its meeting on January 21, 2025, and recommended RECOMMENDED BOARD ACTION Approve the use of the administrative overhead and benefits rate of 156 percent for Fiscal Year 2025-26. Strategic Plan Tie -In GOAL FOUR: Governance and Fiscal Responsibility Strategy 1 - Promote and uphold ethical behavior, openness, and accessibility, Strategy 3 - Maintain financial stability and sustainability ATTACHMENTS: 1. Presentation (FY 2025-26 Rate) January 21, 2025 Regular FINANCE Committee Meeting Agenda Packet - Page 107 of 118 Page 5 of 10 Attachment 1 January 21, 2025 Regular FINANCE Committee Meeting Agenda Packet - Page 108 of 118 Page 6 of 10 Issue Board approval necessary to update administrative overhead and benefits rate to recover full cost of indirect support services Rate used for various purposes:''''�� f Billing outside agencies r Calculating certain customer rates and charges Capital project labor charges Labor charges for grants without program - specific rates/limits V 3 Background Methodology Calculation conducted in-house Methodology largely supported by a study issued by an independent consulting firm (Matrix Consulting Group) in conformance with prevailing laws and best practices Utilizes audited actual year-end figures, not budget or projections Employs 3-year smoothing Rate comprised of 3 sub -components 4 January 21, 2025 Regular FINANCE Committee Meeting Agenda Packet - Page 109 of 118 2 Page 7 of 10 Backaround Rate Components Employee Benefits consists of costs associated with direct employee benefits Non -work hours consists of the value of compensated leave and earned overtime expressed as a percentage of annual work hours Administrative overhead consists of all administrative indirect costs incurred for a common purpose benefiting more than one task 5 Backaround Proposed Rate Single year FY 2025-26 unsmoothed rate is 146.6% 3-year smoothed rate proposed for adoption is 155.7% Consistent with prior years, largest component is administrative overhead, reducing by 4.0% Reduction in benefits rate component by 2.9 Overall, 3-year smoothed rate decreasing by 6.9% I II' Administrative Overhead & Benefits Rate FY 2025-26 Administrative Overhead & Benefits Rate Sub -Components ■ Employee Benefits Administrative Overhead Non -Work Hours January 21, 2025 Regular FINANCE Committee Meeting Agenda Packet - Page 110 of 118 3 Page 8 of 10 Background Historical Trends Historical Trend of Smoothed versus Single Year Rates 250.0% 240.0% 220.0% / 210.0% 200.0% 190.0% 180.0% 170.0% 160.0% I Sao% 140.0% 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25 2025-26 Fiscal Year �3 Year Smoothed Raze Single Year Rate 7 Background Historical Trends Historical Trend of Rate Components (Unsmoothed SingleYear) 250.0% 200.0% — — .p 150.0% E b Qr and � O 100.0% — d m 0.0% 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25 2025-26 Fiscal Year • Employee Benefits ■Administrative Overhead Non -Work Hours I January 21, 2025 Regular FINANCE Committee Meeting Agenda Packet - Page 111 of 118 4 Page 9 of 10 Alternatives & Considerations Alternative courses of action the Board may consider include the following: Budgeted or projected cost instead of actuals A single year rate versus smoothed Excluding the 2021 Certificates of Participation (COPS) debt service OPEB costs treated as indirect admin (excluding additional trust contributions) �.. First three alternatives considered previously by Board and were not adopted in consideration of comparability, best practices, and full cost recovery Last alternative not recommended as it is inconsistent with how OPEB is currently accounted for and budgeted 10 January 21, 2025 Regular FINANCE Committee Meeting Agenda Packet - Page 112 of 118 Page 10 of 10 Questions & Discussion 11 January 21, 2025 Regular FINANCE Committee Meeting Agenda Packet - Page 113 of 118