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APPROPRIATION COMMITTEE REPORT TO THE NOVEMBER 2012 STM Please note that this proposed Fund, the purpose of which includes the use of funds for debt service, is distinct from the "Debt Service Stabilization Fund" (DSSF) created in 2009. The funds from the DSSF can be appropriated only for mitigating debt service resulting from the project that was initiated in 1998 to perform renovation work at Lexington High School and the Diamond and Clarke Middle Schools. The Committee recommends approval of this request (8 -0). Article 4: Appropriate to Post Funds Funding Committee Employment Insurance Liability Requested Source Recommendation Fund $500,000 GF Approve (8 -0) BacklZround The Town of Lexington is required by State law to provide health benefits to retired employees that are comparable to those provided for active employees. Much of the cost of retiree health insurance is borne by Medicare, but the Town must provide supplementary coverage and coverage for retired employees not on Medicare. Since the Town is obligated to provide this benefit on an ongoing basis, the cost that will be incurred over the lifetimes of the current and future retirees represents a liability. The actuarial value of this liability must be included in the Town's financial statements and is in the hundreds of millions of dollars. In FY2013 the Town is paying upwards of $6,000,000, on a pay -as- you -go basis, for current year retiree health benefits costs. While these payments retire a portion of the existing liability, the liability grows as employees continue to work, earning additional health insurance benefits during retirement. The general escalation of health care costs makes it almost certain that the net effect, particularly over time intervals of many years, will be an increase in the actuarial value of the liability. While the Town has a legal obligation to provide health benefits to present retirees, it has no legal obligation to pre -fund any future liability, i.e., to set aside funds that would cover the costs of the future obligations. Nevertheless, in 2002 the State legislature passed a special act that allowed the Town to create the Post Employment Insurance Liability (PEIL) Fund for this purpose. In each of the last five years (FYs 2009 - 2013), Town Meeting has approved an appropriation into the Fund. In FYs 2009, 2010, and 2011 the appropriation was in excess of $400,000 and involved a portion of Free Cash that approximated the previous year's reimbursement from the federal government for the prescription drug coverage the Town provides to retirees in lieu of Medicare Part D coverage. These federal reimbursements go into the General Fund and become part of the following year's Free Cash balance. In FY2012, the appropriation was rounded up to $500,000. This practice was continued at the Annual Town Meeting this past spring when $500,000 of FY2013 revenue was appropriated into the Fund. The balance in the PEIL Fund is now about $2,500,000. There are at least four points in favor of funding the liability. First, any monies in the PEIL Fund provide assurance that the Town will be able to satisfy some portion of its future liability. Bond rating agencies look favorably upon this, although it is unclear how large an amount or, if in fact, any amount is necessary to maintain the Town's AAA bond rating. Second, the Town's growing liability is comparable to borrowing; funding the future liabilities by putting aside reserves, rather than "borrowing," is an important move towards a truly balanced budget and future fiscal strength. Third, the balance in the PEIL Fund is invested and earns income, which could serve as a partial hedge against future increases in health insurance costs and inflation. In general, the Town may only invest funds in very low risk vehicles, such as certificates of deposit, but there are notable exceptions to this restriction, including stabilization funds, the Retirement Fund, and the PEIL Fund. The balances in the latter two funds may be invested in mutual funds or equities, and hence, these funds are appropriate places to accumulate large balances that will be held for many years. Fourth, the PEIL