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Home My WebLink About2019-05-15 Summit Packet - Released Board of Selectmen, School Committee,Appropriation Committee, Capital Expenditures C o mmitte e May 15, 2019 7:00 PM Cafeteria, Hadley Public Services Building, 201 Bedford Street AGENDA ITEMS FOR INDIVIDUAL CONSIDERATION 1. Discussion- Finance Policies • Current Fiscal P o lic ie s • Personal Property Tax Discussion • Other Post-Employment Benefits (OPEB)2014 Policy Review • Proposition 2 1/2 - Discussion on the level of taxation-utilizing the maximum under Proposition 2 1/2 vs. growing excess levy capacity • Capital Expenditure Policy ADJOURN 1. Anticipated Adjournment The next regularly scheduled meeting of the Board of Selectmen will be held on Monday, May 20, 2019 at 7:00 p.m. in the Selectmen's Meeting Room, Town Office Building, 1625 Massachusetts Avenue. Hearing Assistance Devices Available on Request Leiqedil"a All agenda time and the order of items are approximate and subject to change. Recorded by LexMedia AGENDA ITEM SUMMARY LEXINGTON BOARD OF SELECTMEN MEETING AGENDA ITEM TITLE: Discussion- Finance Policies PRESENTER: ITEM NUMBER: Jim Malloy, Town Manager I.1 Sub Item: • Current Fiscal Policies • Personal Property Tax Discussion • Other Post-Employment Benefits (OPEB) 2014 Policy Review • Proposition 2 1/2 - Discussion on the level of taxation utilizing the maximum under Proposition 2 1/2 vs. growing excess levy capacity • Capital Expenditure Policy SUMMARY: This Summit is intended to be a kick off and preliminary discussion regarding the above topics. The Town has had a general framework on developing the budget, but this has not been a written policy or guideline to guide management in developing the budget. The anticipated outcome is to generate a more formalized process to ensure expectations are being met and to reduce conflict. The current policies as we understand them are attached. There was discussion during the last budget cycle related to whether a change in policy on utilization of personal property new growth and the depreciation of personal property and the impact this has on other property classes. The current OPEB policy was generated prior to the changes in the newer GASB statements. This portion of the discussion will relate to where the Town is with it's current policy and whether there is a need to update the existing policy. The next portion of the discussion will relate to the capital planning process and establishing a priority based system that will allow the Town to address the highest rated capital projects in a planned manner and within the prescribed budget constraints for capital projects. SUGGESTED MOTION: FOLLOW-UP: DATE AND APPROXIMATE TIME ON AGENDA: 5/15/2019 ATTACHMENTS: Description Type F) OPE13 2014 Cbver Vlleryx) IVII.- F) Ad floc 2006 ("Awer ern(..) F) Personal Property Cbver,VIlerryo F) Rresentation C..k.)v e r VII e nio F) Clurrent Policies Cbver VIlerno AGENDA ITEM SUMM LEXINGTON DATE: PRESENTER: ITEM NUMBER: March 109 2014. Carl F.Valente L 7 Rob Addelsori SUBJECT: OPEB Working Group Recommendation EXECUTIVE SUMMARY: The Town Manager's OPEB Working group has reviewed the most recent OPEB.Actuarial Study and has made the attached recommendation regarding the future funding of OPEB benefits. FINANCIAL IMPACT: NA RECOMMENDATION 1 SUGGESTED MOTION: Move to endorse the funding policy recommended by the Town Manager's OPEB Working. Group. STAFF FOLLOW-UP: ARY 1 TMO and Finance Prepared by cfv .R r Board of Selectmen DRAFT POLICY for FUNDING OTHER POST EMPLOYMENT BENEFITS (OPEB) March 10,2014 Background: The Town of Lexington,pursuant to the Massachusetts General Laws, is required to provide its active employees upon their retirement with certain post- employment benefits (health and dental insurance) known as OPEB (Other Post Employment Benefits). The liability that results from.the provision of these benefits is estimated using actuarial methods and revised every two years. Assuming a 7.75%discount rate,the Unfunded Actuarially Accrued Liability -the present value of the.future post retirement benefits for all currently retired employees and active employees eligible for those benefits - is $87,194,853 based upon a supplementary schedule provided in the Actuarial Valuation as of 6/30/13. While the estimate of this liability can vary based on changes in statutory requirements, benefit levels provided to employees and revised actuarial assumptions such as mortality, medical inflation rates, and the discount rate, the Board of Selectmen believe that the magnitude of this liability is unlikely to change materially. Full financing of the Town's liability is represented by the Annual Required Contribution (ARC), an annual payment that is the sum of two components. The first- component is an amortized payment that is actuarially determined to retire the Unfunded Actuarially Accrued Liability over a fixed number of years. The second component of the ARC is the Normal Cost, which represents an actuarially determined annual contribution that will fund the Town's share of future retiree benefits earned by active employees in the current fiscal year. At the assumed discount rate of 7.75% and an amortization period of 26 years, the ARC is $9,142,199 comprised of a Normal Cost of $1,711,000 and an Amortization of Unfunded Actuarially Accrued Liability of $7,43 1,000. Given the competing demands on limited revenue,the Town has limited flexibility to fund its Unfunded Actuarial Accrued Liability other than by continuing its pay-as-you- go funding approach. This pay-as-you-go amount in FY 14 was approximately $5,900,000 and covers only the annual health insurance premiums for current retirees. The Town does have the ability to fund some portion of the Normal Cost. By doing so the Town will build assets in a trust fund---enabled by a 2002 of-the Legislature and formally known as the Post Retirement Insurance Liability Fund-that may be invested in vehicles that are reasonably expected to yield investment returns that are compatible, on an average annual basis over a decade or several decades, with the discount rate noted above. The balance in the trust fund should ultimately yield sufficient investment earnings to lower the amount that must be budgeted by the Town in any given year to pay the Town's portion of that year's retiree health and dental insurance,thus buffering other services from the impact of rising cast of medical benefits. Policy: It is the policy-of the Board of Selectmen to recommend to Town Meeting each year a budget contribution to the OPEB Trust Fund in an amount that ranges from.35 to 100 percent of the estimated Normal Cost for the upcoming budget year,with the General and Enterprise Funds bearing their respective shares of those contributions. This approach will mitigate growth in the Unfunded Actuarial Accrued Liability, eventually reducing the amount the Town will need to budget for health insurance by approximately one-third,as the assets of the OPEB Trust Fund will be used to underwrite the annual cost of retiree benefits. Further, it is recognized that there are competing claims for limited Town funds, which are considered as part of the annual budget process. Consequently, the annual recommendation for OPEB funding shall be made in the context of other capital and operating budget needs, such that recommended OPEB funding shall not have a material detrimental impact on service delivery or the maintenance of Town capital assets and infrastructure. This olio should be reviewed following each update to the actuarial study. policy Recommended by the OPEB Working Group to the Town Manager. Deb Mauger, Board of Selectmen Glenn Parker, Appropriation Committee Alan Levine, Appropriation Committee Rob Addelson, Assistant Town Manager for Finance TOWN OF LEXINGTON OTHER POST-RETIREMENT EMPLOYEE BENEFITS ANALYSIS FOR FISCAL YEAR DULY 1,2012-JCJNE 30,2013 REVISED FEBRUARY 21,2014 FINANCIAL RISK ANALYSTS FINANCIAL RISK ANALYSTS, LLC ACtUaries 1 nsu ranee+CO11 UI&I(I t5 February 21,201.4 Sent Via]Email Mr. Robert N. Addelson Assistant Town Manager for Finance Town of Lexington 1625 Massachusetts Avenue Lexington,MA 02420 Dear Mr.Addelson: Enclosed please find our revised report regarding indicated other than pension post-retirement employee liabilities as of June 30, 2013 for the Town. This report revises our report dated December 31, 2013 to reflect a correction to the amortized unfunded actuarial accrued liability, an adjustment to the expected annual contribution and some changes the alternative funding scenarios we provide. The liability calculation is in accordance with Governmental Accounting Standards Board Statement 45 (GASB-45). It has been a pleasure being of service to you on this project. If after reviewing this report you have any questions please do not hesitate to contact us. Sincerely, Robert W. Van Epps,FCAS,MAAA Managing Principal John D. Stiefel,FSA, MAAA Associated Consultant TOWN OF LEXINGTON TABLE OF CONTENTS P� INTRODUCTION...............................................................•.....................►s.s....•3 CONDITIONS &LIMITATIONS.....................................................................4 DISTRIBUTION&USE...@games @******a 0 00004 a 000000***a mass$00*0 so**so*as a as @at*so**s o s.*as..6 REQUIRED DISCLOSURES ............................................................................7. SCHEDULE OF EMPLOYER CONTRIBUTIONS........................................1 0 ANALYSIS... EXHIBITS FINANCIAL RISK ANALYSTS 2 s TOWN of LEXINGTON INTRODUCTION Financial Risk Analysts,LLC has been retained by the Town of Lexington(the Town) to provide an actuarial valuation of the Town's retiree medical and life insurance post-retirement benefits program for the fiscal year ending June 30, 2011 Medical and life insurance are the two most common types of other (than pension)post-retirement employee benefits (OPEB) rovided bp y an employer to retirees and their beneficiaries. This is the Town's fifth year of reporting OPEB liabilities. The Town presently provides life, health and dental insurance benefits for active and retired employees and their covered dependents. The Town has reported to us 1,109 active employees, 125 pre-Medicare retirees, 910 Medicare retirees and 88 over-65 non-Medicare retirees who have elected health insurance. Since the Town joined the Group Insurance Commission, all of its plans are on a premium basis and none are self-insured. Life and dental insurance benefits provided by the Town are fully insured. For health insurance, active employees and retirees not on Medicare have a choice among several plans sponsored by the Massachusetts Group Insurance Commission. As required by Massachusetts law, retirees not on Medicare have the same benefit options as active employees. Most retirees on Medicare are in the Harvard Pilgrim,-or Unicare plans. For retiree life insurance, the only option is a flat$2,000 benefit(reduced from$5,000). A detailed description of the Town's census, benefit, and premium information is presented on Exhibits 7, S and 9. FINANCIAL RISK ANALYSTS 3 TOWN OF LEXINGTON. CONDITIONS &LEWITATIONS DA TA within this report we used data and other information provided to us by the Town. This data consisted of the following: • Census Information - the demographics of the active, pre-Medicare. retiree and Medicare retiree population covered for medical and life insurance benefits as of the date of the most recent pension valuation. For active employees, date of hire was also included. Data was valued as of November 2013. • Benefit Information-a description of the different health and life insurance plans available to participants. • Funding Information--a description of how the life and health insurance plans are funded including the contributions required from employees and retirees. • Premium Rates the premium rates for the various plans and the percentage of each premium rate that the Town pays. • Life Insurance In-Force Information--a summary of the life insurance schedules for actives and retirees and the participant contributions required. • Requirements for Retirement--the age/service requirements for retirement with an unreduced pension benefit and the amount of benefit reduction for early retirement. • Probabilities of Retirement--the probability that a general or uniformed employee eligible to retire will actually retire. • Retirement Election Rates-The percentage of active participants who opt to continue their life and health insurance benefits(and pay the associated premiums)at retirement. Although the data supplied were reviewed for purposes of reasonability, we have not independently audited or verified this information and we assume it to be accurate and complete. The results of our analysis will be contingent upon the reliability of the information supplied to us and such reliability is the responsibility of the Town. Should the Town become aware of any significant discrepancies in the data reported to,us, we should be notified of such discrepancies and this report will be amended,if necessary. FINANCIAL RISK ANALYSTS 4 TOWN OF LEXINGTON UITCERT'�4IN7T Actuarial projections, by their nature, are estimates of future contingent events wh ich hich cannot be known with certainty. The Town's ultimate liability for medical, life and dental insurance benefits will be subject to events that have yet to occur such as.the future employee attrition rate retirements, and particularly interest rates and medical cost inflation. While we believe the results presented in this report are reasonable and reflect the use of accepted actuarial principles and standards of practice, it is possible that the actual future OPEB liability of the Town will differ, perhaps materially, from what we have projected herein. Nothing in this report should be construed as a warranty or guarantee as to the adequacy of the liability estimates contained herein. FINANCIAL RISK ANALYSTS 5 TOWN OF LEXINGTON DISTRIBUTION& USE This report is provided solely for the use of the Town of Lexington in evaluating its OPE B liability for the fiscal year July 1,2012 through June 30,2013. A copy of this may report also be p Y provided to the Town's auditor with the proviso that the report is copied in its entire and that p entirety each party receiving a copy of this report agrees to not distribute the an report to other third p Y party-, FINANCIAL RISK ANALYSTS 6 TOWN OF LEXINGTON REQUIRED DISCLOSURES Required Information for the Fiscal Year July 1,2012 through June 30,2013 As required by GASB-45,the table below presents a 3-year summary of the results of our results. Lexington GASB45 Re wire d Disclosures FYE 2011 FYE 2012 FYE 2013 Full Valuation Town Financials Full Valuation 2.50% 2, 50 4 A.Expected.Post Retirement Benefit obligation(EPBo) $429,781,233 $ 176,784,446 B.Funded Status 1 Actuarial Accrued Liabil y Active Employees $ 9798425403 $ 40,9129449 Retirees $ 20698619958 $ 9094939620 Total AAL $ 30497049360 $ 131,406,069 2 Actuarial Value of Assets $ 2,500,000 $ 35069,273 3 Unfnded Actuarial Accrued Liabil y(1)-(2) $ 30292049360 $ 128,3369796 4 Funded Ratio(2)/(1) 0.82% 2.34% 5 Annual Covered Payroll Town to provide $ 83,486,497 6 Ratio of Unfimded AAL to Covered Payroll (3)1(5) (3)l(5) 1.537 C.Annual Re quire d Contribution 1 Normal Cost(Service Cost) $ 897019341 $ 3,3701054 2 Amortization of Unfunded AAL $ 14,8895767 $ 811089106 3 Annual Required Contribution(ARC)(1)+(2) $ 23,5915108 $ 11,478,160 D.OPEB Cost 1 ARC $ 23,5915108 $ 235058,694 $ 11,478,160 2 Interest on Net OPEB obligation $ 855,580 $ 1,257,664 $ 3,019,667 3 Adjustment to ARC $ 1,6725359 $ 29458,776 $ 4,2399501 4 Annual OPEB Cost (1)+(2)-(3) $ 229774,328 $ 21,857,582 $ 10,258,326 E.Net OPEB obligation 1 Net OPEB Obl gationrbegmi ning of year $ 34,223,182 $ 52,665,101 $ 67,103,713 2 Annual OPEB Cost $ 225784,328 $ 21,857,582 $ 105258,326 3 Expected Contz7butions during the.year $ 6,837,760 $ 7,418,970 $ 69050,165 4 Net OPEB Ob' tion-end of ear(1)+(2)-(3) $ 50115%750 $ 67,103,713 $ 719311,574 FINANCIAL RISK ANALYSTS '] TOWN OF LEXINGTON The table above represents results using a partially-funded discount rate of 4.50%. The weighting is based on discount rates of 7.75% for a fully funded program and 4.00% for an unfunded program. Since the Town has only partially funded its GASB-45 liabilities, the weighted,partially-funded discount rate is appropriate for financial reporting purposes. � g The following is an explanation of the above; Expected Post-Retirement Benefit obligation (EPBO)—This is the present value of the future post-retirement life and health insurance benefits for all currently retired employees and active employees eligible for those benefits. For active employees,the EPBO includes the full present value of benefits even though some employees have not yet fully earned or vested in those benefits. The municipality needs to be aware of this liability but does not need to disclose or recognize it on any of its financial statements. Actuarial Accrued Liability (AAL) — This is also known as the Accumulated Post-Retirement Benefit obligation (APBO) or the Transition obligation. This is that portion of the EPBO that has been accrued to date. For existing retirees and active employees who have fully earned their benefit, the AAL equals the EPBO. Upon implementation of GASB-45, the APBO is the transition obligation (current liability) that must be recognized on the Municipality's balance sheet if the Municipiality chooses immediate recognition. Alternatively, the Municipiality can choose to amortize the current APBO. GASB-45 permits amortization over a period of from 10 to 30 years. Plan Assets--The amount of assets held in trust to fund the plan(if the plan is funded). Unfunded Actuarial Accrued Liability--The excess of the AAL over the plan assets. Normal Cost -- Also known as the Service Cost. This is the portion of the EPBO for active employees attributable to employee service during the year. FINANCIAL RISK ANALYSTS S k a TOWN of LEXINGTON Amortization of Unfunded Accrued Liability—This is the annual amortization of the AAL if the -entity chooses to amortize the AAL. If the entity chooses to amortize the AAL, the amortization cost should be booked as a current year expense. Lexington elected to amortize the AAL, and we use the level dollar amortization method for this calculation. We used an initial 30 year period for purposes of amortizing the AAL. This is the maximum period of time allowed under GASB. GASB allows amortization on an open, closed or level % of payroll basis. We selected the closed basis; i.e. the amortization period declines 1 year every year. Annual Required Contribution (ARC) — This is the total amount that should be booked as a current year expense. GASB-45 recommends, but does not require, that the ARC actually be contributed(funded)each year. Net OPEB obligation—Beginning of Year --This is accumulated excess of each year's ARC over the actual contributions (premium payments)actually made that year. Interest of Net OPEB obligation — This is interest, at the assumed interest rate, on the Beginning of Year Net OPEB Obligation. Adjustment to ARC — This is the Beginning of Year Net OPEB Obligation divided by the amortization factor. Annual OPEB Cost--This is the ARC+Interest on Net OPEB Obligation-Adjustment to ARC Expected Contributions During the Year—This is the amount of OPEB payments and funding the Municipality made during the just-completed fiscal year. Net OPEB obligation — End of Year Estimate -- This is the Beginning of Year Net OPEB Obligation+Annual OPEB Cost-the Expected Contributions during the Year. FINANCIAL RISK ANALYSTS 9 TOWN OF LEXINGTON SCHEDULE OF EMPLOYER CONTRIBUTIONS The schedule below is based on 4.50%interest, the normal cost and amortization of the unfund ed actuarial accrued liability calculated as of June 30, 2012, future normal costs increasin at 5.0% per year and future amortization payments increasing at the assumed future healthcare trend rates. Schedule of Employer Contributions 4.50% Discount Rate Fiscal Year Normal Amortization Total Town Ending in Cost Payment ARC 2013 $3,3701054 $8,108,106 $111478,160 2014 $3,538,557 $8,2 83,500. $11,822,057 2015 $39 715,484 $8,541,301 $121 256,786 2016 $3,901,259 $8,888,185 $12,789,444 2017 $4,096,322 $9,333,507 $139 429,82 9 2018 $4,301,138 $9,889,719 $14,190,857 2019 $49 516,195 $109476,636 $14,992,831 2020 $41 742,004 $11,0951876 $15,837,880 2021 $49 979,105 $11,749,139 $16,728,243 2022 $5,228,060 $12,4381212 $17,666,271 2023 $5,4891463 $13,1649973 $18,654,436 2024 $5,763,936 $13,931,397 $19,695,333 2025 $6,052,133 $140 739,558 $2 0,791,690 2026 $6,354,739 $15,591,634 $211946,373 2027 $6,672,476 $16,489,916 $23,162,392 2028 $71006,100 $171457,422 $24,463,522 2029 $79 356,405 $18,478,371 $25,834,776 2030 $7,724,225 $19,555,602 $27,279,828 2031 $8,110,437 $20,692,102 $289 802,539 2032 $89 515,958 $21,881,889 $30,397,847 2033 $8,941,756 $23,126,591 $32,068,348 2034 $9,388,844 $24,427,832 $33,816,676 2035 $9,858,286 $25,787,221 $35,645,507 2036 $101-351,201 $2 7,206,353 $37,557,554 2037 $10,868,761 $28,686,803 $39,555,564 2038 $11,412,199 $30,230,120 $411 642,318 2039 $11,982,809 $31,837,819 $43,820,628 2040 $12,581,949 $33,511,382 $461 093,331 2041 $13,211,047 $35,252,246 $48,463,293 2042 $13,871,599 $371 076,801 $50,948,400 2043 $14,565,179 $38,988,694 1., _$531 553,873 FINANCIAL RISK ANALYSTS 10 r ToVVN OF LEXINGTON ANALYSIS Assumptions 1. Interest discount rate - 4.50% per year, net of expenses, for a partially-funded plan, 4.00% per year, net of expenses, for an unfunded plan and 7.75% per year, net of expenses, for a fully-funded plan. The Town is partially funding its plan(contributions to date being about$4 million or 5.5%of the Net OPEB obligation), so this warrants an interest assumption in excess of the unfunded discount rate. GASB-45 requires that the selection of an unfunded interest discount-rate be based on the expected long term rate of return on the (General Fund) assets expected to be available to pay the benefits when due. We note that a 1% increase in the assumed interest discount rate decreases the Town's liabilities by about 25%. 2. Trend-Medical Costs are assumed to increase each year according to the following schedule: Year Medical Trend 2013 2.16% 2014 3.11% 2015 4.06% 2016 5.01% 2017 5.96% 2018 5.93% 2019 5.91% 2020 5.89% 2025 5.78% 2030 5.81% 2040 5.,19% 2050 5.00% 2060 4.83% 2070 4.35% 2080 4.35% 2085+ 4.3 5% The above trend rates were developed using the baseline projection of the SOA Long- Run Medical Cost Trend Model version 12.11 (November 2012). The short-term(first 4 years)trend rates were based on the fact that the Town's most recent rate increase for retirees. The long--term(after 4 years)trend rates were based on the following assumptions: Rate of Inflation 2.8% Rate of Growth in Real Income 1 GDP per capita 1.5% FINANCIAL RISK ANALYSTS 1 R TOWN OF LEXINGTON Income Multiplier for Health Spending 1.30 Extra Trend due to Technology and other factors 1.1% Health Share of GDP Resistance Point 23.0% Year for Limiting Cost Growth to GDP Growth 2060 The Society of Actuaries' (SOA's) -Run Medical Cost Trend Model and its Lon g baseline projection are based on an econometric-analysis of historical US medical expenditures and the judgments of experts in the field. The long-run baseline projection and input variables have been developed under the guidance of an SOA Project Oversight Group. The above schedule represents a reasonable medical trend projection for the current plan provisions and demographics of the Town's Retiree welfare Benefits Plan, and no changes to these baseline assumptions are necessary. 3. Amortization Period - Thirty years (initial), 26 years (remaining). 30 years is the maximum period permitted by GASB-45. GASB-45 permits amortization payments to increase at a rate not to exceed projected salary growth. we assumed level amortization payments,which we think are more realistic for budgeting purposes. 4. Retirement Eligibility-As prescribed by the terms of the Town's Retirement System. 5. Marital Status-Active participants are assumed to keep their current marital status upon retirement. 6. Turnover-Representative values of assumed annual turnover rates for general and uniformed employees are as follows. General Uniformed Age Group Employees Employees <20 15.00% 1.50% 20-24 13.13% 1.50% 25-29 10.12% 1.50% 30-34 8.33% 1.46% 35-39 6.78% 1.22% 40-44 5.96% 0.28% 45-49 5.13% 0.03% 50--54 3.23% 0.03% 55-59 2.45% 0.00% 60-64 2.07% 0.00% 65-69 1.94% 0.00% 70-74 1.22% 0.00% 75+ 0.00% 0.00% In 2011, we checked these turnover rates against those used by the Town's pension actuary(David Driscoll, FSA). They are consistent(although his turnover rates are based on service). For instance, his turnover rates also start at 15% for general employees and o 1.5/o for uniformed employees. FINANCIAL RISK ANALYSTS 12 J TOWN of LEXINGTON 7. Mortality-Mortality assumptions are used to project the expected number of employees who will be receiving benefits each year in the future. we used the RP-2000 mortality table(combined healthy lives)with projected mortality. 8. Disability - Disability assumptions are used to project the number of people who will retire early due to disability. The possibility of disability was accounted for by assuming average retirement ages that were 1 year younger than were observed by the Town (see (10)below) 9. Requirements for Retirement-The Town has informed us it requires attainment of age 55 for general employees to retire with an unreduced pension benefit. For uniformed employees this age is 65. Early retirement with a reduced benefit is available with twenty years of service. For Uniformed employees, there is a mandatory retirement age of 65. 10. Age at Retirement- Representative assumed average retirement ages are shown below. These values are consistent with the requirements for retirement stated above, the input provided by the Town and the adjustment for disability retirements(see (8) above). General Uniformed ,Ae Em to ees Employees 45 63 58 50 63 59 55 64 61 60 66 64 62 67 65 65 69 65 69 72 nla 70 72 nla 11. Retirement Election Rates - The Town provided us data for each group showing total retirees and how many retirees have elected to continue post-retirement benefits and pay the associated premiums. That data showed that retirement election rates have been as follows. All Em to ees Health Insurance Only participants electing health insurance included Life Insurance 49% Dental Insurance 59% 12. Affordable Care Act-The Affordable Care Act indicates that premiums over $10,2001$27,500 (Single/Family) in 2018 will be subject to a 40% excise tax. Some of the Town's premiums might exceed these thresholds in 2018 (based on current trend assumptions); but we did not calculate or include any additional GASB-45 liability for this FINANCIAL RISK ANALYSTS 13 TOWN OF LEXINGTON eventuality. In our judgment,the Town's benefits and premiums are"normal"for a government,not"Cadillac."Also,the Town is likely to take action to avoid the tax if necessary. Finally,the current thresholds($10,200/$27,500)are projected to trigger the tax with over 50%of government employers; so it is quite likely that Congress will change them before 2018. 13. Plan Changes - The Town joined the Massachusetts Group Insurance Commission effective 7-1-1 2. As a result, there were be savings to the Town resulting from changes in benefits, premium rates and increased member contribution requirements. These changes have been reflected in the data the Town provided us as of November 2013, so we have reflected these savings in this valuation. 14.Expenses - We did not make an explicit assumption for expenses because our p p assumed interest discount rates are net of expenses. Methodology We used the Projected Unit Credit actuarial cost method in our analysis. The '. y following is a summary of the steps employed in this methodology. 1. Determine current annual subsidy for life and health insurance for the pre-Medicare retirees, Medicare retirees and retirees over'age 65 not on Medicare. We used the most recently available census data, current premiums, participant contribution requirements and age- sex adjustment factors to make these calculations. Z. Calculate the EPBO. This is the present value of future subsidies for life and health insurance for the actives, pre-Medicare retirees, retirees over 55 not on Medicare and Medicare retirees. Separate calculations were required for active general and active uniformed employees. to ees. 3. Calculate the AAL from the EPBO and the active employee age and service information from the'census. 4. Calculate the other GASB-45 required disclosures. FINANCIAL RISK ANALYSTS 14 TOWN OF LEXINGTON APPENDIX 1—GASB45 Required Disclosures at 7.75%Interest Le xingto n GASB45 Required Disclosures FYE 2013 Full Valuation 7.75% A.Expected Post-Retirement Benefit obligation(EPBO). $ 11093957098 1. Impact of a 1%Change in the Interest Assumption 16% B.Funded Status 1 Actuarial Accrued Liability Active Employees $ 22,300,753 Retirees $ 67,9639373 Total AAL $ 909264,126 2 Actuarial Value of Assets $ 39069,273 3 Used Actuarial Accrued Liability(1)-(2) $ 879194,853 4 Funded Ratio(2)/(1) 3.40% 5 Annual Covered Payroll $ 8394869497 6 Ratio o f Used AAL to Covered Payroll 1.044 C.Annual Re quire d Contribution 1 Normal Cost(Service Cost) $ 1 711 184 2 Amortizatson of Unfiuided AAL $ 794311014 3 Annual Required Contribution(ARC)(1)+(2) $ 91142,199 D. OPEB Cost 1 ARC $ 99142,199 2 Interest on Net OPEB Obligation $ 592009538 3 Adjustment to ARC $ 59635,776 4 Ama1 OPEB Cost (1)+(2)-(3) $ 8,7069961 E. Net OPEB Obligation 1 Net OPEB Obligation beginning of year estir ate $ 67,103,713 2 Anmal OPEB Cost $ 8,7069961 3 Expected Contributions during the year $ 6,0501165 4 Net OPEB Oh' bonend of year(1)+(2)-(3) $ 69,760,509 FINANCIAL RISK ANALYSTS 15 J ■ TOWN OF LEXINGTON APPENDIX 2—Alternative Contribution Scenarios Lexington Alternate Fwxft Scenarios 50-Year Rmiection at 4.5%Interest) $0 Flat $500,000 $1,000,000 $19500,000 Contributions $500,000 Increasing by Incre as ing by Increasing by in Fulure err ea 4%R Year 4%Mr Year 4%per Year A.Expected Post-Re tim ment Benefit Obligation(EPBO) $ 176,794,446 $ 176,784,446 $176,784,446 $176,784,446 $ 1769784,446 1.Impact of I%Change in the Interest Assunption 25% B.Funded Status 1 Acftmrial Accrued Llability Active Employees $ 40,9121449 $ 4029121,449 $ 40,912,449 $ 40,912,449 $ 40,912,449 Retirees $ 90,493,620 $ 90,493,620 $ 90,493,620 $ 901,493,620 $ 90,493,620 Total AAL $ 131,406,069 $ 131,406,069 $131,406,069 $131,406,069 $ 1312406,069 2 Acftmrial Value of Assets $ 3,069,273 $ 12,95%277 $ 25,244,3.17 $ 473,419,360 $ 69,594,404 3 UnfiWed Acitmial Accrued Liability(1)-(2) $ 128,336,796 $ 118,4551,792 $1069161,752 $ 83,986,708 $ 619811,664 4 Funded Ratio(2y(.1) 2.34% 9.86% 19.21% 36.09% 52.96% 5 Annrnral Covered Payroll $ 83,486,497 $ 83)486,497 $ 83,4861497 $ 831,486,497 $ 83,486,497 6 Ratio ofUnfimded AAL to Covered Payroll 1.537 1.419 1.272 1.006 0.740 C.Annual Required Contribution 1 Normal Cost(Service Cost) $ 32370,054 $ 3,370,054 $ 3,370,054 $ 3,370,054 $ 3,370,05.4 2 Amortization ofUnfunded AAL $ 821087106 $ 7,483,841 $ 6,707,123 $ 5,306,141 $ 3,905,158 3 Annal Required Cortnbution(ARC)(1)+(2) $ 11,478,160 $ 10,853,894 $ 10,077,177 $ 81676,195 $ 7,275,212 D.OPEB Cost 1 ARC $ 11,478,160 $ 10,853,894 $ 10,077,177 $ 8,676,195 $ 71275,212 2 Interest on Net OPEB Obligation $ 3701%667 $ 3,019,667 $ 3,019,667 $ 3,01%667 $ 3,019,667 3 Adjustment to ARC $ 4,23%501 $ 4,23%501 $ 4,239,501 $ 4,239,501 $ 4223%501 4 Annual OPEB Cost (1)+(2)-(3) $ 1032589326 $ 9,634,060 $ 8,857,343 $ 7,456,361 $ 6,055,378 E.Net OPEB Obligation $ - 1 Net OPEB Obligationbeguming of year estimate $ 67,103,713 $ 67,103,713 $ 67,103,713 $ 67,103,713 $ 6791031,713 2 Arm of OPEB Cost $ 10,258,326 $ 9,634,060 $ 8,857,343 $ 7,456,361 $ 6,055,378 3 Expected CoMbutions during the year $ 6,050,165 $ 6,050,165 $ 61050,165 $ 6,050,165 $ 65050,165 4 Net OPEB Ob' Lion-end of (1)+(2 3 $ 71,3111874 $ 702687,608 $ 69,910,891 $ 68,50%909 $ 67,108,926 FINANCIAL RISK ANALYSTS 16 A TOWN OF LEXINGTON APPENDIX 3--Enterprise Funds Lexington Ente rise Funds FYE 2013 Allocation to Alllocation to Allocation to Total Water Se vie r Recreation 100.00% 0.65% 0.25% 0.41% A.Expected Post-Retirement Benefit Obligation(EPBO) $ 176,784,446 $ 111499099 $ 4413,961 $ 724,816 1.Impact of a 1%Cbange in the Intemst Assumption 25% B.Funded Status 1 Actuarial Accrued Liability Active Employees $ 401912,449 $ 2653,931 $ 10 A I $ 1671741 Retirees $ 909493,620 $ 5883209 $ 226,234 $ 3713,024 Total AAL $ 1319406,069 $ 8549139 $ 328,515 $ 538,765 2 Actuarial Value ofAssets $ 3,06%273 $ 191950 $ 79673 $ 121,584 3 Unfunded Actuarial Accrued Liabflity(1)-(2) $ 12893361,796 $ 8349189 $ 3209842 $ 526,181 4 Funded Ratio(2y(1) 2.34% 2.34% 2.34% 2.34% 5 Annual Covered Payroll $ 83,486,497 Town to provide Town to provide Town to provide 6 Ratio of Unfunded AAL to Covered PayroH 1.537 (3y(5) (3y(5) (3y(5) C.Annual Required Contribution 1 Normal Cost(Service Cost) $ 31370,054 $ 211,905 $ 82425 $ 139817 2 Amortization of Unfunded AAL $ 81,108,106 $ 529703 $ 209270 $ 33,243 3 Am=]Required Contribution(ARC)(1)+(2) $ 119478,160 $ 74,608 $ 28,695 $ 479060 D.OPEB Cost 1 ARC $ 11,478,160 $ 749,608 $ 28,695 $ 47,060 2 interest on Net OPEB Obligation $ 3,01%667 $ 19,628 $ 7,549 $ 12,381 3 Adjustnerit to ARC $ 4,2399501 $ 27,557 $ 103,599 $ 173382 4 Amual OPEB Cost (1)+(2)-(3) $ 109258,326 $ 66,679 $ 259646 $ 429059 E.Net OPEB Obligation 1 Net OPEB Obligation-be6 ming of year estimate $ 675103,713 $ 4369174 $ 1671,759 $ 275,125 2 Annual OPEB Cost $ 10,2581326 $ 663679 $ 25,646 $ 42,059 3 Expected Contnbution5 during the year $ 61,050,165 $ 39,326 $ 15,125 $ 243,806 4 Net OPEB Obi lion-end of ear 1 2 3 $ 71,3119874 $ 463,527 $ 1785280 $ 292,379 FINANCIAL RISK ANALYSTS 17 Z a -two Z. � t ul LU - r C] r co � CD t-] 0 to [o G) 0 N f%- C] r r Q7 00 00■`� t� q 0 CIO CIO r it N r + F w w 6 � C'r7 d4 N 69. 6c.� r C 4 dg r r rg r! ! 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W c TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN FoREwoRD The Selectmen's charge to the Committee (See Exhibit A.) seeks recommendations that will improve the Town's fiscal policies. To develop a context for its recommendations, the Committee first reviewed the fiscal realities of the recent past and evaluated current financial policies. We believe the Town: ■ Is not investing enough each year to maintain its fixed asset base. The Town's "cash capital"policy is subject to political will. Funding capital reinvestment has been a lower priority than sustaining Town services. The cash available for capital investment has been used consistently to balance the operating budget, resulting in deferred maintenance, while forcing the Town to rely on within-levy debt to renew and replace fixed assets. ■ Has seen the costs of Town services grow faster each year than the growth in property tax receipts. Proposition 21/2 limits annual growth in the tax levy to 2.5%, plus new growth in the Town's tax base. ■ Has demonstrated its willingness to sustain services and finance major capital projects by passing both operating and debt exclusion overrides of Proposition 21/2. ■ Has not set aside reserves to buffer the impact of declines in state aid and local receipts during economic downturns. Since they reflect the general business cycle, these two key revenue sources are the Town's most volatile. ■ Does not have adequate mechanisms to respond to fluctuations in volatile expenses other than the Appropriation Committee's historically modest Reserve Fund and supplemental appropriations from"Free Cash." ■ Relies on Free Cash as its primary reserve, although calculating Free Cash requires evaluating several items on the Town's June 30 balance sheet, and the amount is neither confirmed nor available for appropriation until the late fall, after it is certified by the State's Department of Revenue. ■ Does not have adequate reserves to absorb the financial consequences of certain major claims and liabilities, such as multiple workers' compensation claims or extraordinary medical expenses. ■ Does not yet know the magnitude of the liability for retiree health benefits nor does the Town have a plan to fund this liability. ■ Has a Aaa debt rating,but no stated policies articulating target levels for within-levy or outside-the-levy borrowing, for annual debt service for within-levy debt, or for long-term versus short-term debt. ■ Does not engage in long-term financial planning or modeling, yet such an exercise would identify the most significant budget drivers and focus efforts to contain costs and/or generate addi ti onal revenue Ad Hoc Financial Policy Committee Page 1 of 18 March 15,2006 TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN In response to these realities, we suggest the following goals: ■ Maintain the Town's investment in its physical assets, but use debt prudently to do so. ■ Establish reserves to buffer the impacts of declining revenues, volatile expenses, and of specific incidents and events not fully covered by insurance. ■ Quantify and meet post retirement obligations. ■ Maintain the Town's Aaa credit rating and follow coherent borrowing policies. ■ Address the Proposition 21/2 dynamic-that the annual increase in expenses will probably continue to outpace the allowed growth in annual property tax receipts. To advance these goals, the Committee respectfully submits these financial policy recommendations for your consideration. March 15, 2006 March 15,2006 Page 2 of 18 Ad Hoc Financial Policy Committee TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN FINANCIAL POLICY RECOMMENDATIONS CAPITAL FINANCING POLICIES A. Objectives Preserve the Town's fixed asset base and ensure that the Town's buildings, facilities, and equipment efficiently and effectively support the Town's programs and operations. B. Financial Policies To achieve these objectives, the Town should provide consistent and stable funding sources for the timely and periodic renewal and/or replacement of building systems, building envelope components, vehicles, and equipment. 1. Establish and fully fund one or more Asset Renewal and Replacement Reserves funded by annual General Fund appropriations linked to the value of the Town's General Fund fixed assets. Rigorous analysis as described in Exhibit C should be the basis for "fully funding"these reserves. The Committee recommends that the Board of Selectmen establish at least two separate funds, one for buildings and one for equipment. 2. Appropriate funds annually from these Asset Renewal and Replacement Reserves for specific building renewal projects and for the replacement of vehicles and equipment. These renewal reserves should not be used to pay debt service for within- levy debt. 3. Pending the rigorous analysis recommended above, target 2% of annual General Fund revenues as an interim goal for funding building renewal projects and equipment replacements The Committee prefers appropriations from either this cash allocation or from Asset Renewal and Replacement Reserves rather than short-term borrowing to renew and replace assets. This funding policy ensures that future taxpayers are not unfairly burdened with the entire cost of such renewal and replacement investments. The reserve funding mechanism spreads the costs of such investments over several years without incurring borrowing costs. 4. Continue the policy of seeking debt exclusion overrides to finance the replacement of Town buildings and major facilities and the construction of new facilities to expand or upgrade Town programs. Ad Hoc Financial Policy Committee Page 3 of 18 March 15,2006 TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN March 15,2006 Page 4 of 18 Ad Hoc Financial Policy Committee TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN FINANCIAL POLICY RECOMMENDATIONS RESERVE POLICIES A. Objective Enable the Town to sustain service levels despite the adverse financial impacts of economic downturns and of unforeseen and extraordinary expenses. B. Financial Policy Achieve this objective by adequately funding a portfolio of stabilization funds, reserve funds, and continuing balance accounts that will stabilize the annual operating budget. This policy represents a change in course from the Selectmen's ten-year goal voted in 1997 to establish adequate financial reserves by building"Free Cash"to 5% of the tax levy. 1. Build a Stabilization Fund large enough to buffer the General Fund from the impact of two to three years of reduced state aid and declining local receipts. The Committee prefers a Stabilization Fund designated specifically as a"rainy day"fund rather than building"Free Cash"because: ■ Town meeting must take specific action to either add monies to or appropriate funds from a Stabilization Fund. A two-thirds vote of town meeting is required for either action. ■ A Stabilization Fund designated for operations and funded by Town meeting appropriations clearly segregates funds for this intended purpose. ■ The amount in this Stabilization Fund is known to all Town and external constituencies, will not fluctuate during the fiscal year, and is not subject to adjustment or certification. ■ Such a Stabilization Fund and the level of funding would be subject to public discussion, debate, and scrutiny—a very healthy and open process for establishing key financial policies. During the economic downturn affecting fiscal years 2003 through 2005, the town lost nearly$4.8 million from its two most volatile sources, state aid and local receipts. $000 Three-year Revenue Source FY2002 FY2003 FY2004 FY2005 Loss State Aid $91603 $91465 $71709 $71871 $31764 Local Receipts 10,118 10,095 81978 10,247 1,034 Total $19,721 $19,560 $16,687 $18,118 $4,798 Sources:Revenue Summary, Town Manager's FY 2006 Recommended Budget, February 9, 2005, and Warrant to the 2006 Annual Town Meeting State aid has not yet recovered to FY2002 levels. For FY2007, the Town Manager projects state aid to be only$8.7 million, still $900,000 less than FY2002 aid. The Town would have needed a Stabilization Fund approaching$7 million to replace these revenues lost during this three-year economic decline($4.8 million) and to offset the state aid shortfalls ($1.9 million) during the two following years of economic recovery. If and when the Town draws monies from such a Stabilization Fund, then the Selectmen should also present a plan for replenishing the fund. Ad Hoc Financial Policy Committee Page 5 of 18 March 15,2006 TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN FINANCIAL POLICY RECOMMENDATIONS RESERVE POLICIES(CONTINUED) 2. Determine the annual appropriation to the Appropriation Committee's Reserve Fund by a rigorous analysis of historically volatile expense items or of those expenses that have the potential to be volatile during the upcoming budget year. The Committee believes that there would most likely be 15 to 20 line items with significant volatility, and for each, the potential impact should be estimated and probability-weighted. The Committee recommends funding the Appropriation Committee's Reserve Fund at a much higher level than the historical level of$150,000, in conjunction with the following sound financial practices: ■ Build the operating budget based on line-by-line analyses of historical revenues and expenses and of factors affecting income and expense projections. ■ Do not budget for contingencies within departmental or program budgets, except for introducing an emergency building maintenance and repairs contingency. More precise budgeting with a somewhat larger Reserve Fund will minimize the inclination to create contingency funds within departmental budgets. Better to have one larger Reserve Fund than to continue the historical pattern of flexible departmental budgets and a smaller Reserve Fund. ■ Acknowledge that the Reserve Fund may fund school as well as municipal expenses that meet the criteria of"extraordinary and unforeseen" expenses. A Reserve Fund of up to 0.5% of the annual General Fund budget may be prudent to provide a reserve for"extraordinary and unforeseen" municipal and school expenses as set forth in M.G.L. Ch. 40 §6. A specific target should be established after analyzing the volatile expenses as recommended above. 3. Establish, fund, and monitor "continuing balance accounts"—accounts which are not closed at the end of each fiscal year—to protect against the financial consequences of certain risks and liabilities. a. The Board of Selectmen should establish and adequately fund"continuing balance accounts"to address the following potential risks, claims, and liabilities: Workers' Compensation Claims for Police, Fire, and other town and school employees Property Damages and Liability Claims for uninsured losses and claims not covered by deductibles Compensated Absence Payments made to town and certain school employees eligible to"buy back" sick days upon retirement Extraordinary Health Insurance Claims that do not reach the Town's $90,000 stop-loss threshold per employee, retiree, or dependent. The Town is self-insured against such claims and could be forced to appropriate supplemental funds in any year with extraordinary major claims. March 15,2006 Page 6 of 18 Ad Hoc Financial Policy Committee TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN FINANCIAL POLICY RECOMMENDATIONS RESERVE POLICIES(CONTINUED) b. The Board of Selectmen should monitor the funding levels in the following existing"continuing balance accounts"to ensure that reserves are adequate, but not over-funded, and take action if analysis demonstrates that adjustments should be made: Board of Assessors' Overlay for Tax Abatements Health Insurance Claims Trust, the trust fund to cover incurred-but-not- yet-reported claims. Auditing guidelines require the Town to maintain 10 to 20%of the annual claims paid—roughly two months of annual claims. 4. Target a Free Cash balance of 0.3 to 0.6% of General Fund revenues at June 30 of the current year when the Board of Selectmen votes the budget for the coming fiscal year. The Town should consider Free Cash as a check book balance and de- emphasize reliance on Free Cash as a reserve in favor of the portfolio of reserves, including the Stabilization Fund, as recommended above. The Committee believes that relying on Free Cash as the Town's primary"rainy day" fund is problematic because: ■ Free Cash is the available fund balance in the General Fund at a moment in time, June 30, as certified by the State's Department of Revenue. ■ Free Cash is not available for appropriation until certified by the State's Department of Revenue—often as late as November or December—for the preceding June 30. ■ The level of Free Cash can not be known with certainty during the fiscal year. The Town can only estimate what Free Cash will be at June 30 by recording any proposed or actual appropriations by Town Meeting and by forecasting actual revenues and expenses versus revenue estimates and appropriations. ■ Each year Town Meeting votes to appropriate a sum of money from available funds - Free Cash—to balance the operating budget and reduce the tax rate. The remaining funds constitute an undesignated reserve. Town Meeting does not vote to establish a specific amount for this undesignated residual reserve. ■ Free Cash is not a reserve that appears in the Town's financial statements. The amount of Free Cash is derived from various balance sheet accounts. ■ The Department of Revenue's Free Cash certification is an administrative, accounting process, not driven by management discretion or policy imperatives. This administrative process is neither readily understood nor transparent as a financial policy. Until the Town funds this recommended portfolio of reserves, the Committee would prefer to transfer any Free Cash exceeding this target to the Stabilization Fund or to continuing balance accounts rather than apply such Free Cash to balance future budgets. Ad Hoc Financial Policy Committee Page 7 of 18 March 15,2006 TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN FINANCIAL POLICY RECOMMENDATIONS POST-EMPLOYMENT BENEFIT POLICIES A. Objectives Define and adequately fund the Town's pension and health benefit responsibilities and obligations to its retired employees. B. Financial Policies for Pension Obligations The Board of Selectmen and Town Meeting should continue to support the Retirement Board's track record of prudent judgment and actions. 1. Continue the current practice of bi-annual actuarial valuations of the Contributory Retirement System. 2. Contribute to the Retirement System annually so as to amortize the unfunded accrued pension liability no later than 2015. 3. Ensure that annual contributions thereafter are sufficient to fully fund 100% of the actuarial liabilities. 4. Conduct an actuarial study of any early retirement incentive program, retirement contribution"holiday," or other proposal affecting either retirement benefits or contributions—prior to accepting such programs-to determine the actuarial liability to the retirement system and impact on the Town's annual retirement contribution. C. Financial Policies for Health Benefit Obligations The Committee understands that in the near future the Governmental Accounting Standards Board will require full disclosure of this liability in the Town's financial statements. The Board of Selectmen should take timely action to determine the magnitude of this liability and to develop a funding strategy for this obligation. 1. Engage a firm to conduct an actuarial valuation of the health benefit obligations to retirees and current employees, quantify this liability, and generate funding options. 2. To the extent possible, consult the Retirement Board in developing a strategy to fund the actuarial liability for such health benefit obligations. The Town should take advantage of the Board's exemplary track record and expertise in managing the Town's contributory retirement system. March 15,2006 Page 8 of 18 Ad Hoc Financial Policy Committee TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN FINANCIAL POLICY RECOMMENDATIONS DEBT MANAGEMENT POLICIES A. Objectives Prudently use debt as a funding source for preserving, renewing, or adding to the Town's physical assets. Do not borrow to finance operations. Ensure the lowest possible cost to the Town of short- and long-term borrowing. The Committee recognizes that borrowing is a means of transferring current costs of capital investments to future taxpayers, those who will presumably benefit from the use of the asset being financed. B. Financial Policies To meet these objectives, the Committee recommends that the Town: 1. Pursue the current and recommended financial policies necessary to maintain a Aaa bond rating. The Aaa rating by the municipal bond rating agencies essentially guarantees that the Town may borrow at the lowest tax-exempt rates available in the marketplace. The Town's bond rating is a consequence of all of its financial practices and policies, including maintaining an adequate and appropriate Stabilization Fund, Appropriation Committee Reserve Fund, continuing balance accounts, and reserves for replacement. Thus, the Aaa rating criteria also provide industry benchmarks and an external incentive for maintaining fiscal discipline. 2. Gradually phase out the Town's recent practice of issuing within-levy debt to finance small-ticket capital spending for the annual renewal and replacement of building components,vehicles, and equipment. Debt service for within-levy borrowing consumes dollars otherwise available to maintain services. Excessive within- levy borrowing could trigger the need for larger or more frequent operating overrides and unfairly burden future taxpayers. a. Appropriate cash or funds from asset renewal and replacements reserves— rather than issue short-term debt- to replace building components, vehicles, and equipment. b. Use short-term borrowing only as "bridge" financing—bond anticipation notes or BANs—to anticipate the issuance of long-term debt for capital projects. The Committee recognizes that the Town has used within-levy borrowing recently to renew and replace assets because available revenues have been used to balance operating budgets, and there have been no asset renewal reserves. Phasing out within-levy borrowing for capital items is linked to committing cash and/or establishing and funding appropriate reserves. 3. Restrict long-term borrowing to large scale capital projects—new buildings, total building renovations, land purchases, etc. -where the capital investment is large and cannot be smoothed or divided over several years. a. Ask the voters to approve debt excluded from Proposition 21/2 limitations for such large scale projects. b. Ensure that the maturity of issued debt does not exceed the expected life of the asset financed. Ad Hoc Financial Policy Committee Page 9 of 18 March 15,2006 TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN FINANCIAL POLICY RECOMMENDATIONS OVERRIDE POLICIES A. Objective Enable the voters to choose the level of services and the scope and scale of significant capital projects, such as new buildings and major renovations, by proposing operating overrides and debt exclusions of the Proposition 21/2 tax levy limitations. The Town's costs to educate children and to deliver Town services are likely to increase at an annual rate that exceeds core inflation rates. Each year these escalating costs are likely to exceed the Town's ability to raise tax revenue within the limits of Proposition 21/2. The Town also needs to undertake major capital projects, such as the replacement or renovation of four elementary schools and construction of a new DPW facility and school administration building. B. Financial Policies The overrides necessary to sustain town services and fund large scale capital projects should be governed by the following policies: 1. Include specific amounts to balance future budgets when proposing periodic, multiyear operating overrides. If the Board of Selectmen propose an override designed to sustain Town services for more than one year, then the Selectmen should disclose fully the amount raised by the override to be carried over to balance future budgets. 2. Continue the policy of seeking voter-approved debt exclusion overrides to finance major new construction projects or significant renovations. March 15,2006 Page 10 of 18 Ad Hoc Financial Policy Committee TOWN OF LEXI NGTON AD HOC FINANCIAL POLICY COMMITTEE REPORT TO BOARD OF SELECTMEN FINANCIAL POLICY IMPLEMENTATION STRATEGIES IMPLEMENTATION STRATEGIES A. Objective Make a smooth transition from current financial policies to the recommended policies without adversely affecting the Town's ability to deliver services valued by the community or to preserve and revitalize the various classes of Town assets. B. Maintaining the Town's Investment in its Physical Assets 1. Undertake detailed analyses of the various classes of the Town's fixed assets to quantify the annual level of investment needed to sustain each asset class. The Committee recommends three steps in this analytic process: Step 1: Consider defining the following asset classes for analyses: (1) School buildings and facilities (2) School vehicles and equipment (3) School technology (4) Town buildings and facilities (5) Town technology (6) DPW equipment (7) Fire apparatus (8) Other Town vehicles and equipment (9) Roads and streets Step 2: Identify and assess the best practices for financing renewal and replacement of fixed assets used by other governmental entities and non-profit organizations. (See Exhibit C for a discussion of some such practices.) Step 3: Determine which best practice is most appropriate for each asset class and apply that method to establish what the annual funding level should be and whether cash appropriations or an Asset Renewal and Replacement Reserve is appropriate. For vehicles, equipment, and technology-assets with shorter useful lives and generally predictable replacement costs-depreciation funding maybe most appropriate. (See Exhibit D, Capital Financing Sources and Issues.) 2. Give highest priority in the FY 2007 Capital Budget to critical building and facility renewal projects and timely replacement of vehicles and equipment. For example, at the November special town meeting, the School Committee outlined a program of critical building renewal projects that they have since detailed for consideration at the 2006 annual town meeting. 3. Defer the establishment of Asset Renewal and Replacement Reserves until FY 2008 to allow time to identify and analyze asset classes, study reserve funding options, and assess the impact on Town finances of alternative funding levels. These analyses and studies should be completed by October 1, 2006,to ensure adequate time to dune the policies that will govern the development of the FY 2008 budget. Ad Hoc Financial Policy Committee Page 11 of 18 March 15,2006 TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN FINANCIAL POLICY IMPLEMENTATION STRATEGIES IMPLEMENTATION STRATEGIES(CONTINUED) 4. Increase cash appropriated for asset renewal and replacement from General Fund revenues, but cap the percentage of General Fund revenues applied to within- levy debt service at FY 2008 levels. As noted under Capital Financing Policies above, we propose an initial target of 2% of revenues for asset renewal and replacement until detailed analysis establishes a specific funding target. This is a transition strategy. The Committee recognizes that in the short term the Town must rely on within-levy debt to finance capital investments. However, the Committee strongly prefers cash and asset renewal reserves as funding sources for asset renewal and replacement. In FY 2007 the Town will pay$3.7 million in principal and interest for within-levy debt. If the Town were not to issue any further within-levy debt, then annual debt service would decline to $1.9 million by FY 2010. The Town should seize this opportunity to gradually reduce the General Fund's within-levy debt service obligations and reallocate these funds to capital renewal and replacement. C. Building a"Rainy Day" Stabilization Fund 1. Preserve the $1,522,111 balance anticipated in the Stabilization Fund as of June 30, 2006. 2. Target between$400,000 and$700,000 as the projected level of Free Cash as of June 30, a level consistent with the recommended Free Cash target range of 0.3% to 0.6% of General Fund revenues. 3. Add$2,650,000 to the Stabilization Fund at the 2006 Annual Town Meeting by approving the appropriation proposed by the Town Manager and supported by the Board of Selectmen. This appropriation would build the Stabilization Fund to nearly $4.2 million, thus allowing the recommended reduction in estimated Free Cash without adversely affecting the Town's overall financial reserves. 4. Continue to allocate between$500,000 and $1 million each year until the Stabilization Fund reaches roughly 7% of the prior year's General Fund revenues. 5. Consider approaching the voters to approve a Proposition 21/2 override to set aside monies to establish or add to a Stabilization Fund as a"rainy day" fund or as an asset renewal and replacement reserve. The Proposition 2V2 statute was amended in 2003 to enable the voters of any city or town to approve operating overrides to place monies in a Stabilization Fund. Passage of such an override would enable the Board of Selectmen to use its taxing authority in subsequent years to build reserves until a target level is reached. For example, if voters approved a $300,000 operating override in 2007 to add to a Stabilization Fund, then in each following year, the Selectmen could vote to raise this authorized tax levy capacity, plus the allowable 2.5%growth, to build up the reserves in that Stabilization Fund. The Town could use this mechanism to build the Stabilization Fund to a targeted level. March 15,2006 Page 12 of 18 Ad Hoc Financial Policy Committee TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN FINANCIAL POLICY IMPLEMENTATION STRATEGIES IMPLEMENTATION STRATEGIES(CONTINUED) D. Establishing and Funding"Continuing Balance Accounts" The Committee commends the Town Manager for identifying the need for targeted reserves and for proposi ng i n hi s FY2007 Budget that the Town establ i sh Conti nui ng bal ante accounts for uninsured liabilities and for worker's compensation. The Committee recommends that the Board of Selectmen extend this initiative to all potential claims and liabilities listed above in paragraph 3. under Reserve Policies. To do so, the Selectmen should commission a study that will: 1. Quantify the Town's financial exposure to each potential liability. 2. Confirm whether a continuing balance account or some other reserve is appropriate for managing each risk. 3. Establish a desired funding level for each continuing balance account or reserve. 4. Develop a multiyear funding strategy to achieve the desired balance in each account or reserve. The Selectmen should strive to complete this analysis by October 1, 2006, so that the results of the study could be considered i n devel opi ng the FY 2008 Budget. E. Instituting Long Range Financial Planning and Modeling The Committee recommends that the Board of Selectmen undertake an ongoing long-term f i nanci al pl anni ng and model i ng exerci se proj ecti ng the Town's f i nances over a f i ve- to f i fteen- year per od. The Commi ttee bel i eves that many of the I ong-term dri vers of the Town's f i nances can be quanti f i ed by usi ng an hi stori cal trend anal ysi s as a basi s f or f orecasti ng. Theref ore, i t shoul d be possi bl e to perform I onger term f i nand al proj ecti ons wi th some I evel of preci si on. As a base case, the model should assume that: 1. The Town will maintain its current level of services. 2. Property taxes (absent overrides) will grow at the limits of Proposition 21/2 (a 2.5% increase from the prior year's tax levy plus taxes on an assumed level of new growth.) 3. Local receipts and state aid will reflect economic cycles. 4. Historical trends in the growth of specific operating expenses will prevail. 5. The Town will pay the debt service on existing outstanding debt , and the voters will approve debt exclusion overrides for the major capital projects on the horizon. 6. The Town will make its annual contributions to the Retirement System, and after quantifying its post-employment health insurance obligations, will begin to make annual payments to amortize these liabilities. 7. The Town will follow this Committee's recommendations by allocating cash and establishing asset renewal funds to maintain the Town's physical assets and by building a Ad Hoc Financial Policy Committee Page 13 of 18 March 15,2006 TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN portfolio of reserves, including the Stabilization Fund, continuing balance accounts, and the Appropriation Committee's Reserve Fund. March 15,2006 Page 14 of 18 Ad Hoc Financial Policy Committee TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN FINANCIAL POLICY IMPLEMENTATION STRATEGIES IMPLEMENTATION STRATEGIES(CONTINUED) E. Instituting Long Range Financial Planning and Modeling (Continued) The Board of Selectmen and the appropriate boards and committees could use this model to devel op reasonabl a best-case and worst-case scenari os and answer some key questi ons, such as: ■ Which expense drivers have the most significant impacts on future budget deficits? ■ What level of property taxes will be necessary to maintain the current level of services and meet other commitments? ■ Can this level of property tax be raised within Proposition 2 V2 limitations? ■ If not, what level of property tax increases will the voters have to approve to sustain current service levels? ■ Alternatively, if the required level of property taxes appears difficult or undesirable to achieve, what strategies can the Town pursue to raise other revenues or aggressively manage down expenses? The Commi ttee recogni zes that the Town i s operati ng i n a very chal I engi ng f i scal envi ronment, and that annual budget deci si ons are extremel y di ff i cul t. Accordi ngl y, we bel i eve that thi s pl anni ng and model i ng exerci se woul d be easi er to compl ete outsi de of the normal annual budget process, possibly through the work of another committee that the Selectmen would appoi nt. F. Correcting Policy Exceptions The Committee recognizes that from time to time the Board of Selectmen will propose actions to Town Meeting that deviate from these financial policies. When so doing, the Selectmen should also describe their strategy for taking corrective actions to reinstate the policy. Ad Hoc Financial Policy Committee Page 15 of 18 March 15,2006 TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN TABLE OF EXHIBITS Exhibit A: Committee Charge and Membership Exhibit B: Definitions of Capital Expenditure Terms Exhibit C: Discussion of Capital Financing Funding Strategies Exhibit D: Capital Financing Sources and Issues March 15,2006 Page 16 of 18 Ad Hoc Financial Policy Committee TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN EXHIBIT A COMMITTEE CHARGE AND MEMBERSHIP Selectmen's Ad Hoc Financial Policy Committee Members: 7 Appointed By: Board of Selectmen Length of Term: Recommendations should be made by December 2005 Description: This Committee will recommend to the Board of Selectmen fiscal policies that seek to ensure structurally balanced budgets and adequate reserves while accommodating the possibility of operating overrides among other means to ensure the consistent delivery of balanced services. Specifically, this Committee will address: • A Reserve Policy by examining existing reserve funds (stabilization, overlay, enterprise) and recommending appropriate funding levels, circumstances under which funds can be drawn upon, timelines for replenishment, and suggestions for additional reserve funds if warranted. • A Free Cash Policy that defines appropriate targets and timelines for accumulating free cash as well as the circumstances under which free cash can be appropriated. • A Debt Management Policy by defining appropriate levels (ratios) of debt(both exempt and within levy), the appropriate use of bond anticipation notes (BANs) in funding capital projects, and if not otherwise addressed • A `Cash' Capital Policy that defines the small capital projects loosely referred to as `cash capital,' currently funded within the tax levy, and recommends a funding mechanism for these expenses. Criteria for Membership: Knowledge and interest in fiscal policies Reference: Charge adopted by the Board of Selectmen at its meeting on June 27, 2005. Members: Paul Asquith; William Dailey, Jr.; Peter Enrich; Alan Fields; Michael Kennealy; Paul Lapointe, Chair; and Robert Rieth (through November 2005) Liaisons: Board of Selectmen, Jeanne Krieger; School Committee, Tom Griffiths; Appropriation Committee, Deborah Brown; Capital Expenditures Committee, Charles Lamb Staff: Town Manager, Carl Valente; Budget Officer, Michael Young; Management Intern, Thomas Watkins Ad Hoc Financial Policy Committee Page 17 of 18 March 15,2006 TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN EXHIBIT B DEFINITIONS OF CAPITAL EXPENDITURE TERMS Capital Expenditure A major, non-recurring expenditure that meets all of the following criteria: • Massachusetts General Laws permit the Town to issue bonds to finance the expenditure; • The expenditure is $25,000 or more for a single item, or five times this threshold ($125,000)for a capital program consisting of multiple units of less than $25,000; • The expenditure will have a useful life of 10 years or more for buildings or building components and five years for vehicles and equipment; • Planning, engineering, or design services may be considered capital when such services are integral to a construction, renewal, or replacement project that meets the criteria for a capital expenditure. Examples of a capital expenditure include: Acquisition of land for a public purpose, Rehabilitation, renovation, or repair of a building,facility, water or sewer lines, or equipment; Construction of, or addition to, a public building,playfields. or other town facility. Fixed Asset Any tangible asset with a useful life exceeding one year that generally accepted accounting practices require the Town to record in its schedule of fixed assets. March 15,2006 Page 18 of 18 Ad Hoc Financial Policy Committee TOWN OF LEXI NGTON AD H OC FI NANCI AL POLI CY COM M I TTEE REPORT TO BOARD OF SELECTMEN EXHIBIT C DISCUSSION OF CAPITAL FINANCING FUNDING STRATEGIES The Town may consider several alternatives for establishing the level of investment needed to maintain its physical asset base and for funding these investments. Some approaches are appropriate for buildings and other facilities; others are applicable to vehicles and equipment. DEVELOP MULTIYEAR RENEWAL AND REPLACEMENT PLANS. Though most organizations develop multiyear capital budgets, some focus extra effort on long-term(10 years or longer) asset renewal and replacement plans for classes of fixed assets: buildings, operating and maintenance equipment, vehicles, computer equipment, etc. For each asset class, these plans determine the annual allocations to renewal and replacement reserves necessary to fully fund the plan. CONDUCT FACILITIES AUDITS AND ASSESSMENTS. Many organizations commission facilities audits conducted by design and construction professionals experienced in performing such audits. These audits determine the anticipated useful lives of the building envelope components; HVAC, plumbing, and electrical systems; and any other building systems whose failure would compromise the operation and function of the building. These professionals conduct physical inspections in the field; develop schedules for the systematic replacement of such systems and components; estimate renewal and replacement costs; and use this data to establish the annual funding levels needed to build the reserves to support the renewal and replacement program. The Town should consider pilot programs of facilities audits for selected buildings. For example, the Board of Selectmen might audit the former Munroe School and the East Lexington Library to determine the condition of these buildings and any upgrades needed to bring each building up to functional and regulatory standards. The School Committee could retain a firm to conduct facilities audits of the four elementary schools not yet replaced. These audits would identify the renewal and replacement investments needed over the next ten years or so. For the Committee and the community, these audits would highlight the costs of delaying the replacement of each of these schools and could inform the decision as to the sequence of these school renewal projects. FUND DEPRECIATION(USING HISTORICAL COSTS AS A BASIS). If the useful life of a building were 40 years,then annual depreciation would be 2V2 % (1/40thof the useful life) of the original cost of the building. If the useful life of a fire truck were 16 years, then annual depreciation would be 6.25% of the original cost(1/16 th of the useful life). Some organizations treat depreciation as an operating expense and set aside funds equal to depreciation each year to establish reserves to replace these assets. MAINTAIN INFLATION-ADJUSTED RESERVES(USING REPLACEMENT VALUES AS A BASIS). Some assets have particularly long useful lives, and in some cases replacement costs rise faster than core inflation rates. Such is true of buildings and other facilities. If an institution were to rely on replacement reserves to replace such assets, then the annual"depreciation" funding should be adjusted annually to reflect replacement values. Ad Hoc Financial Policy Committee Page 19 of 18 March 15,2006 PERSONAL PROPERTY TAX RECOMMENDATION ISSUE—A number of members of the Board of Selectmen and Appropriation Committee have raised the issue in recent years that Residential Property tax rates are being impacted by new growth from Personal Property, which depreciates over time, leaving the Residential base to absorb them. The purpose of this white paper is to explore the issue more in-depth, begin to offer options to address it, and propose an initial recommendation for further discussion by town policy makers. BACKGROUND—TAX LEVY VOCABULARY: To better understand the remainder of the document, a few terms are important to understand— PROPOSITION 2 V2—The law passed in 1980 which limits the rate at which the tax levy can grow to 2.5% each year. LEVY LIMIT—The total amount the Town can raise via property tax bills. The levy limit is calculated by taking the amount raised in the prior year, adding 2.5%, and then adding any new growth during the year. NEw GROWTH—The taxed amount from value added to a property from one year to the next. OVERRIDE—Taxpayers can vote to exceed the Levy Limit in two ways— • OPERATING OVERRIDE—results in a permanent increase to the Levy Limit, compounded by 2.5%per year • DEBT EXCLUSION— authorizes the Town to issue debt for a capital project. The debt service is added to the levy limit and is recalculated each year. Once the bonds for a project have been paid, no further obligations above the levy limit are required. TAX TO THE MAX—This is the approach that has been favored by the Town of Lexington, and many other communities. The tax rate is calculated to raise an amount as close to the Levy Limit as possible in a given year. In recent years, it has been the Town's policy to transfer any excess funds to the Capital Stabilization Fund, or other one-time uses, rather than build up the operating budget to the full tax capacity. The reserves are planned for use in future years as a way of offsetting or preventing an override vote. EXCESS LEVY CAPACITY—If a community does not"Tax to the Max", there is excess capacity available under the levy limit. Those values are not raised in the levy in a given year, and thus are not available to spend or earn interest. However, they are available to be raised in a future year, meaning that within levy tax bills in a given year will grow by more than 2.5%. UNDERRIDE— Taxpayers or Town Meeting can vote to permanently reduce the Levy Limit by a specific amount. BACKGROUND—TYPES OF TAX LEVY CATEGORIES,AND IMPACT OF NEW GROWTH: 1 Under Proposition 2V2, municipalities are limited in the amount that base taxes can grow, known as the tax levy. Each year, the base tax levy can grow by no more than 2.5%. However, there is a provision where a community can recognize what is known as "new growth", which is the incremental increase in value created by an improvement, new construction, or a new asset. That new growth can also be taxed at the same rate charged for comparable property, and is added to the base for the tax calculation in the following years. Examples of new growth are best understood in the following categories RESIDENTIAL—A home that is valued at $500,000 is purchased and torn down, resulting in a new home valued at $1,500,000. In the first year, the incremental $1,000,000 is added to the base tax value, and the residential tax rate is applied. In the second year, the base tax on the home increases by 2.5%, assuming no further improvements. Other examples that would trigger"new growth" for a home would be an addition or other improvement to the property. In general, the value added to a home is fairly stable and is maintained from one year to the next, with adjustments due to market conditions. COMMERCIAL/INDUSTRIAL—As with residential, if a commercial or industrial property is improved or added during the year, any incremental increase in value is added to the base for the tax calculations. Increases tend to be maintained, with adjustments for market conditions. PERSONAL PROPERTY—This category is primarily made up of durable equipment used in commercial and industrial business, and is taxed at the same rate as Commercial/Industrial. However, a key distinction is that the value is set to depreciate over 5 years. Yet, because the value was initially set as new growth and added to the base, there is no mechanism in the Proposition 2 V2 formula for the value to be removed, so it is redistributed to the remaining taxpayers. As an example, if new growth of$100,000 in Personal Property is recognized in one year, that is added to the base tax, and grows by 2.5% each year. However, the actual tax bill for that particular group is reduced by 20% each year, until it is $0 after 5 years. ILLUSTRATION OF PERSONAL PROPERTY ISSUE— The new growth described above is illustrated in the example below from the FY2018 actual new growth values— FY2018 New Depreciation FY2019 Depreciation FY2020 Depreciation FY2021 Depreciation FY2022 Tax Depreciation FY2023 Tax Levy Category Growth Shift Tax Base Shift Tax Base Shift Tax Base Shift Base Shift Tax Base Total Shift Residential $1,908,536 $ 103,995 $2,062,844 $ 106,595 $2,223,675 $ 109,260 $2,391,258 $ 111,991 $ 2,565,830 $ 114,791 $2,747,636 $ 546,631 Commercial/Industrial $ 743,645 $ 40,521 $ 803,770 $ 41,534 $ 866,436 $ 42,572 $ 931,734 $ 43,636 $ 999,754 $ 44,727 $1,070,594 $ 212,990 Personal $ 704,954 $ (144,516) $ 574,449 $ (148,128) $ 436,979 $ (151,832) $ 292,276 $ (155,627) $ 140,065 $ (159,518) $ - $ (759,621) Total Added to Base $3,357,135 $ - $3,441,063 $ - $3,527,090 $ - $3,615,268 $ - $ 3,705,649 $ - $3,818,230 $ - 2.5%Growth $ 83,928 $ 86,027 $ 88,177 $ 90,382 $ 92,641 $ 95,456 Note: This is intended as an illustrative example only. The exact share of Residential vs. Commercial is notprecise, and depends on the overall value of the property in each category. 1 The descriptions in this paper are meant to be illustrative only,for the purpose of informing the reader of the most typical situation so that all will have the same general understanding and can make an informed decision. There will of course be technical differences and nuances,which are not attempted to be captured in full. 2 In the example, the Personal Property new growth of$704,954 in FY2018 depreciates over 5 years to $0 in FY2023. By that point, it had grown to $759,621 via annual increases of 2.5%, and had been reallocated to the other two categories. The 10-year experience for new growth in Lexington is captured in the following table— Commercial/ Fiscal Year Residential Industrial Personal Total FY2010 $1,206,197 $2061414 $1105 81669 $21471,280 FY2011 $1,1121487 $11212,054 $11105,704 $3,430,245 FY2012 $1,222,142 $9601174 $11164,220 $31346,536 FY2013 $1,400,099 $1,2971354 $841,492 $31538,945 FY2014 $1,451,904 $6351052 $9301379 $310171335 FY2015 $116861061 $4081312 $8021610 $218961983 FY2016 $117121987 $2151442 $7431704 $216721133 FY2017 $1,8581460 $5071820 $943,064 $31309,344 FY2018 $1,9081536 $743,645 $704,954 $3,357335 FY2019 $2,022,777 $4801671 $766,558 $3127005 Totals $15,581,650 $6,6669938 $9,0619354 $319309,941 OPTIONS TO ADDRESS SHIFT OF PERSONAL PROPERTY TO RESIDENTIAL/COMMERCIAL/INDUSTRIAL— As illustrated above, the shift highlighted by various members of boards and committees is real. However, there is no mechanism in the current tax levy formula to address it. Likewise, there is no option to not include tax the new growth in personal property. An interest has been expressed to limit the impact of the shift. To that end, the following options are suggested for further discussion: 1. Petition the Legislature to Revisit the Tax Levy formula—There have been some informal discussions with the Department of Revenue, but timing is uncertain. Many other communities which are not as affluent as Lexington may fight any change as it further restricts their already tight budgets. 2. Continue the Status Quo, but Ensure that Amounts Generated from Personal Property are Set-Aside for One-Time Needs—Be more rigorous in identifying and ensuring that revenue from Personal Property is used for one-time costs such as Cash Capital or Stabilization Funds. 3. Determine the Amount of the Shift in a Given Year, and Leave Excess Levy Capacity—The amount would build over the years, and would be available for future policy makers if so desired. This could reduce or eliminate the need for future operating override votes or debt exclusions. 4. Determine the Amount of the Shift in a Given Year, and Vote an Underride for All or a Portion of It—Vote at Fall Town Meeting to reduce the tax levy by an amount to be 3 determined from year to year. This would be a permanent change that could only be undone via a townwide operating override or debt exclusion vote. RECOMMENDATION—GENERATE EXCESS LEVY CAPACITY RECOMMENDED POLICY SOLUTION— To develop a rational formula that would recognize that a portion of personal property new growth becomes permanent value added to the personal property tax base and to utilize the remaining new growth as one-time revenues to be used for one-time expenditures such as capital expenditures, including debt service related to capital projects. Use for debt service should include a formula to demonstrate that only the new growth portion identified as "one-time"was being used for debt service (see Tables 1 &2 below). • Methods utilization a calculation to provide a sustainable formula based on either: 1. An average, to normalize (3-year to level impacts) increase in personal property total property taxes with the remainder of new growth in personal property simply going to increase the excess levy capacity. 2. Use the previous year's increase in personal property value over the prior year as the amount to apply in the ensuing year as the "personal property new growth" value and then let the remainder of new growth in personal property go to increase the excess levy capacity. Using an estimate for the ensuing year would make it difficult to budget since the budget is done in the December—March timeframe and final values and tax levy is in the October—November timeframe. • Using bullet#1 above as an example, in FYI 9 the following would be the annual impact: Table 1 Us inM a 3-Ye ar Ave rake on Total Pe rs onal Prope rty Tax Inere as e s Personal Personal Property Property Tax Personal CIP Tax Rate Total Taxes Increase FY 16 184,3 81,060 28.40 5,23 6,422 n/a FY 17 195,6751130 28.13 5,5041341 2671919 FY 18 195,8961760 27.69 514241381 (799960) FY19 197J251770 27.69 54581413 345031 Three Year Average: 731997 Amount to Apply as New Revenues for Budgeting 731997 Amount that would be Set Aside as One-Time Revenues 6921560 4 In the above example, the $692,560 of the $766,557 (FY19) in new growth would not be raised on the tax recap sheet and correspondingly, the same amount ($692,560) would not be transferred to the Capital Stabilization Fund, but would become excess levy capacity that would accrue each year. The result would be that the amount used as part of the total revenue calculation would be reduced by this amount, but would provide a more sustainable tax base relative to personal property values and provide excess levy capacity that could be used for one time capital projects in the future. • Using bullet#2 above as an example, in FYI 9 the following would be the annual impact: Table 2 Us inp,the Diffe re nce in Pe rs onal Prope rty Total Value Ye ar to Ye ar Residential Commercial Industrial Personal Total FY 17 91361110030 6861522J 70 34611581680 19516751130 10158914561610 FY18 %952J38,700 701,819,100 3774461000 195,8961760 11,22713 0015 60 FY19 M5701638,820 727126500 427X01345 197J251770 11X24001015 FYI 8 to FY19 Increase 1,229,010 FY19 CIP Tax Rate 27.69 Amount to Apply as New Revenues for Budgeting 341031 Actual New Growth Tax Value 7661557 Amount that would be Set Aside as One-Time Revenues 732,526 The example above is similar to Table 1 but since this only takes into account a one year change, is more dramatic and would also likely be subject to greater fluctuations (increases/decreases) each year in relation to revenues available for the operating budget. USING THE ONETIME REVENUES FOR ONE-TIME EXPENSES— The portion of new growth revenues that are part of personal property new growth and identified as one-time revenues, would become classified as "excess levy capacity". One-time expenses would be either single year capital or other one-time costs (studies, design, equipment, etc.) including debt service costs. If the one-time revenues were used for debt service, the policy would need to require an exact accounting each year for the amount of the excess levy capacity being utilized. Table 3 is an example that shows the amount of growth in excess levy capacity that would occur using the example in Table 1 above (for demonstration purposes assuming it remains the same for the next 22 years). Table 4 demonstrates the potential impact of this type of a policy recommendation on debt service payments on a specific project, such as the Police Station (assuming permanent debt is issued in FY23)2. 2 Assumes a Fall 2019 Appropriation/Debt Authorization;Summer 2020 Construction Start;Spring 2022 Construction Completion;and FY23 Permanent Debt Issuance. 5 Table 3 Unused Personal Prop Tax Accrued as Excess Levy Capacity Amount Pers Prop+ Amount of Previously Former Cap Cap Stab Personal Accrued Transferred Stab Fund Fund Fiscal Property Taxes Excess Levy to Cap Stab Accrued to Accrued Year Not Utilized Capacity Fund Excess Levy Excess Levy 2020 692,560 6921560 2,5571440 3,2501000 359421560 2021 6921560 113851120 215571440 518071440 7J925560 2022 6921560 2,0771680 215571440 8,36400 1014421560 2023 692,560 2,770240 215571440 1019221)320 1316921560 2024 6921560 34621800 2,5571440 134791760 161942,560 2025 6921560 4J551360 2,557440 16,0371200 203921560 2026 692560 41847020 215571440 1815941640 2314421560 2027 692,560 5,5401480 2,557440 21,1521080 26021560 2028 6921560 612331040 2,5571440 2357091520 291942,560 2029 6921560 60251600 215571440 262661960 3311921560 2030 6921560 7,6181160 215571440 2818241400 3614421560 2031 6921560 8,3101720 2,5571440 31,3815840 391692,560 2032 6921560 %0031280 2557440 3303%280 420421560 2033 692,560 %695,840 2,5571440 364961720 46J921560 2034 6921560 1013881400 215575440 3910541160 4914421560 2035 692,560 11001960 2,5571440 41,6111600 52021560 2036 6921560 1117731520 215571440 4411691040 5599421560 2037 6921560 124661080 2,5571440 461726480 59J921560 2038 6921560 1311581640 2,5571440 4912831920 624421560 2039 6921560 13,8511200 2,5571440 5118411360 65021560 2040 6921560 145431760 2557440 54,39800 68,942,560 2041 692,560 15,236,320 2,557,440 56,9561240 72J921560 Table 4 Debt Service-Police Station Example Excess Levy 3.5% Applied to Excess Levy Year Balance Principal Interest Total Debt Balance 2022 290000 1450,000 1,015,000 2465,000 2,077,680 - 2023 27,55000 1,450,000 964,250 2414250 2,414,250 355,990 2024 26,100,000 1,450,000 913,500 21363,500 2,3639500 1,099,300 2025 24,650,000 15450,000 8625750 213125750 2,3121750 1,842,610 2026 23200,000 1,45000 812,000 21262,000 292629000 255859920 2027 21,750,000 1,450,000 761,250 21211,250 292111250 313299230 2028 20,300,000 1,450,000 710,500 21160,500 2,1601500 41072,540 2029 18,85000 145000 659,750 21109,750 2,1091750 4,815,850 2030 17,400,000 1,450,000 609,000 21059,000 2,0591000 51559,160 2031 1505000 145000 558,250 2,008,250 2,0081250 6,302470 2032 14,50000 1,450,000 507,500 11957,500 1,957,500 7,045,780 2033 13,050,000 1,450,000 456,750 1,906,750 1,9061750 7,789,090 2034 11,600,000 15450,000 406,000 1185600 1,856,000 8,532400 2035 10,150,000 1,450,000 355,250 11805,250 1051250 91275,710 2036 8,700,000 19450,000 3041500 11754,500 197541500 1010199020 2037 7,250,000 1,450,000 253,750 11703,750 1,703,750 10,762,330 2038 5180000 1450,000 203,000 1165300 1,653,000 111505,640 2039 4,350,000 1450,000 152,250 11602,250 1021250 12,248050 2040 200000 19450,000 101500 11551,500 1,5511500 12,992260 2041 11450,000 1,450,000 50,750 11500,750 115001750 1317351570 6 SUMMARY— This policy recommendation provides one method to address the concerns raised as these concerns relate to personal property new growth not being reflected in permanent growth in the tax base and recognizing these revenues in a financially sustainable manner and at the same time recognizing the Town's needs related to capital spending by utilizing the one-time revenue source for one-time expenses, including debt service for one-time expenses. 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N E O ® O +-j � N •E Ln E m � by un � O L 4A tw u ,w 4-1 w �, O O x G jw I Town of Lexington I�" MEMORANDUM TO: Board of Selectmen; Appropriations Committee, Capital Expenditures Committee, School Committee FROM: Jim Malloy, Town Manager; Carolyn Kosnoff, Assistant Town Manager for Finance; Jennifer Hewitt, Budget Officer DATE: May 7, 2019 RE: Fiscal Policy Review PREFACE It is a best practice for communities to have an established, written set of fiscal guidelines for reference by town staff and financial boards to ensure consistency and continuity. While the Town of Lexington has followed many best practices and guidelines over the years and is currently in a strong financial position, we do not have a comprehensive set of documented policies or guidelines. The purpose of this memoranda is to provide policy makers with background information and context on Lexington's current fiscal policies, practices and guidelines, and to highlight areas for further review and discussion. The information in the memoranda was compiled from multiple sources including the Final Report of the Ad Hoc Fiscal Policy Advisory Committee from 2006; a 2014 Policy on OPEB Adopted by the Board of Selectmen, past budget documents, presentations, documentation files and from the knowledge of Town Staff. This document is not intended to be an exhaustive list of the Town's policies and practices, but may be useful in preparing for upcoming policy discussions, short- and long-term financial planning and annual budget preparation. In the coming months Town Staff will begin to document policies and guidelines with input from the Town's boards and committees to ensure transparency and consistency in the Town's financial planning process. Key areas of focus for the upcoming Fiscal Policy Summit on May 15, 2019 are as follows: • Eliminating Use of Free Cash for the Operating Budget • Tax to the Levy Limit vs. Creating Excess Levy Capacity • Personal Property Tax New Growth • Use and Funding of Stabilization Funds • Strategy and Commitment for Funding OPEB LEXINGTON'S CURRENT GOALS AND OBJECTIVES The following overriding goals apply to all of the policy areas noted herein: • Develop a fiscally responsible, balanced budget each fiscal year. • Avoid the need for an operating override for either municipal or school operations. • Stabilize the change in residential tax bills from one year to the next through use of fiscal reserves, where feasible. • Maintain the Town's AAA bond rating to minimize the costs of future debt issuances, particularly for the high school. • Prioritize investments in the Town's physical assets in a way that minimizes operating expenses and maximizes the useful life of the assets. Develop and utilize a long-term capital plan for prioritizing capital project requests. • Establish and maintain fiscal policies that address the goals above, as well as the establishment, funding and use of fiscal reserves. OUTLINE OF CURRENT LEXINGTON FISCAL POLICIES Current and recommended policies fall under a number of different areas, which are outlined below, with further detail provided in the remaining pages. A number of current policies originated in a 2006 Report from the Ad Hoc Financial Policy Committee, which is attached as an appendix for reference purposes. I. Over-Arching Policies a. Long-Term Forecast— 10-15 Years b. Fiscal Reserves I. Pension Funding ll. Other Post-Employment Benefits (OPEB) Funding 111. General Stabilization Fund iv. Capital Stabilization Fund v. Other Stabilization Funds vi. Other Available Funds vii. Continuing Accounts vlll. Free Cash ix. Overlay Account Balance II. Operating Budget a. Budget Summits b. Tax to the Levy Limit c. Excess Levy Capacity d. Personal Property New Growth e. Revenue Forecasting f. Funding Short-Term Capital via Operating Budget g. Within Levy Debt Service h. Excluded Debt Service I. Revenue Allocation Model j. Level-Service Budgets k. Funding Program Improvement Requests 2 1. School Enrollment Projections m. Snow and Ice Budget III. Capital Budget a. Definition of Capital Project b. Prioritized Capital Plan c. Targeted Cash Capital Investments d. Annual Limits on Authorized Within Levy Debt Projects e. Use of Capital Stabilization Funds f. Use of Other Funds I. OVER-ARCHING POLICIES The policies below reflect the higher level fiscal principals which govern decision making for the various boards and financial committees for the overall operating budget and capital plan. a. LONG-TERM FORECAST— 10-15 YEARS Town Staff have historically presented a 3-year forecast as part of the initial Budget Summit, and the Appropriation Committee develops a 5-year forecast in their annual report to Town Meeting. For the FY2020 budget, Town Staff developed a 5-year forecast, and intend to continue this practice going forward. In order to develop a more realistic outlook,particularly with the anticipated fiscal challenge of replacing the high school, a 10-15 year projection should be developed, which will provide context for making other fiscal decisions, particularly around funding and utilizing reserve funds, and establishing annual tax rates. b. FISCAL RESERVES In general, the Town should establish reserve funds for specified purposes, but should also actively use them when the anticipated need arises. Such reserves are a best practice and indicate solid financial management, which are key indicators reviewed by the rating agencies in their annual recertification of the town's AAA bond rating. All fiscal reserves are invested and earn interest that accrues to the individual reserve funds. Investments in the Pension and OPEB Funds are managed by the Town Retirement Board and are invested in a diversified portfolio including equity and fixed income securities. The General Stabilization Fund is invested by the Town Treasurer in short-term liquid securities; and the remaining funds, including the Capital Stabilization Fund are invested in the MMDT account with the State Treasurer, which currently earns an interest rate of approximately 2%. i. Pension Funding— State Law requires that all public pension funds are managed to reach full funding status by 2040, but the Public Employee Retirement Administration Commission (PERAC) has a goal to have each retirement system reach full funding by 2035. This funding status is determined by an actuarial evaluation which factors in multiple variables including investment and discount rates, mortality rates and data from actual pension plan participants. Lexington conducts a full actuarial valuation every two years, including updated assumptions, and conducts an update for interim years. Given current assumptions, Lexington's pension fund is currently 87.1% funded, and is on track to fully fund the obligation by 2024. At that point, the annual assessment will be reduced 3 by more than $4 million, providing an opportunity to fund other financial needs. The projected Pension Funding schedule is displayed below for context, and is based on the actuarial valuation as of January 1, 2018. Note that future actuarial valuations and changes in actuarial assumptions may have an impact on the funding schedule below. Appl'opllatioii Forecast Fiscal Eiiapl y t- A io ti atioiil Employer Eil ply r Year Employee Noini l,Cost. Payments Total,Cost Total Cost Fluid d End . P'u9 �. �' i.ittt. Interest ,4h I�tt. Itt Voe Pl a Rat;:io 0 20 19 "3 8.6 0 7,6 6 5 $3,439.,198 $1.494,975 $4.,5 10.5 62 W005."53715.6 8-7. 2,020 4 ,345. l 0 3,629.643 1,1524.,244 4.8 8 1,12 9 3 6.4105.5 3 7 159 89, 2021 42,1160.535 3,830.2M, 1 1,553.,12 1 5.202A 16 6,17 55 53 7 16.10 91, 2022 44,1057.,759 4,104 1.591 1,58105109 5.524 028, 7.11 5,5311 16,.1 93.3 02 4 , 410., 5' 4,264, 1 1,1609."3108 5. 4 '229 ,4 5 5."5-'37 62 95,6 2,024 ��8X,112."l 75 4,498.620 1, 3 6.410 4. 9, � 6,45 2 -'A 98. 2025 5 ,2 '.223 4,745.523 11,6 6 2.6 3 0 1. 62.68 1 3,3 100.10 2,026 52,5 9. 98 5.101 5.5 38 1, 88o, 12 0 1,6 88."1 12 3.2 100.1 11. Other Post-Employment Benefits (OPEB) Funding—The Town of Lexington established an OPEB Trust Fund in 2002 to begin funding its obligations to provide health insurance to current and future retirees. Unlike the Pension Fund, the State of Massachusetts has not mandated that municipalities fully fund their OPEB obligations. Similar to the Pension Fund, the Town conducts a biennial actuarial valuation and annual update of its OPEB Trust Fund. As of June 30, 2018, the OPEB Trust Fund had a net liability of$13 8M. In 2013, the Town began to slowly fund the OPEB obligation, and in 2014, the Board of Selectmen established a policy of funding 3 5-100% of the OPEB Normal Cost in each fiscal year to address this liability. Recent years have provided a steadily increasing contribution from both the General Fund and Enterprise Funds. The General Fund sources have been from a combination of Free Cash, and a $750,000 annual transfer from the Health Claims Trust Fund. The balance in the fund is sufficient to continue those contributions through FY2023, with a partial contribution in FY2024. The recent FY2020 budget funded approximately 21% of Normal Cost ($1,879,721 of$8,930,723 attributed to General Fund). As of June 30, 2018 GASB standards changed and biennial valuations will no longer reflect a normal cost. Therefore, the funding policy will need to be revisited. Staff recommends continued annual contributions to the OPEB liability through FY2023, funded from a mix of the Health Claims Trust Fund and transfers from Free Cash, increasing by $50,000 per year. In FY2024, the Health Claims Trust Fund will be depleted and the remainder could be made up from the Tax Levy. As noted previously, this same year will have a reduced pension assessment as that obligation approaches full funding, thereby freeing up tax levy revenue that can be allocated to other financial needs. 4 Beginning in FY2025, when the Pension Fund is expected to be fully funded, a more aggressive OPEB funding schedule could be implemented. The following tables present the historical and anticipated fund balance and activity in the OPEB Trust Fund and the Health Claims Trust Fund: Historical Levels of OPEB Funding 51112019 FY2015 FY2016 FY2017 FY2018 FY2019 FY2020 FY2021 FY2022 FY2023 FY2024 Opening Balance $4,482,338 $ 5,798,656 $ 7,997,042 $10,532,069 $13,137,657 $15,845,902 $17,731,388 $19,667,162 $21,653,239 $23,689,634 Additional Contributions Tax Levy* $ - $ - $ - $ - $ - $ - $ - $ - $ - $ 325,000 Health Claims Trust Fund* $ 1,000,000 $ 1,858,947 $ 1,200,000 $ 750,000 $ 750,000 $ 750,000 $ 750,000 $ 750,000 $ 750,000 $ 425,000 Free Cash** $ 119,000 $ 3,247 $ 312,318 $ 1,079,721 $ 1,079,721 $ 1,129,721 $ 1,179,721 $ 1,229,721 $ 1,279,721 $ 1,329,721 Water/Sewer $ - 1$ - I$ - 1$ 13,174 $ 13,174 $ 5,765 $ 6,053 $ 6,356 $ 6,674 $ 7,007 Total OPEB Contribution $ 019,000 $1,862,194 $ 1,512,318 $ 1,842,895 $ 1,842,895 $ 1,885,486 $ 1,935,774 $ 1,986,077 $ 2,036,395 $ 2,086,728 Fund Gains/(Losses) $ 197,318 $ 336,192 $ 1,022,708 $ 762,693 $ 865,350 $ - $ - $ - $ - $ - Ending Balance $ 5,798,656 $ 7,997,042 1$10,532,069 $13,137,657 $15,845,902 $17,731,388 $19,667,162 $21,653,239 $23,689,634 $25,776,362 *Because the Health Claims Trust Fund can only he used for health insurance costs,the transfer from thatfund to the General Fund frees up tax levy funds that are then used for OPEB.For presentation purposes,that two-step transfer is shown as one for FY2015-19. **Free Cash must be appropriated by Town Meeting.If certified Free Cash is not_fully appropriated by Tune 30th,the balance will go to fund balance,and will be included in the amount of Free Cash certified for the following year. Health Claims Trust Fund FY2015 FY2016 FY2017 FY2018 FY2019 FY2020 FY2021 FY2022 FY2023 FY2024 Opening Balance $8,567,189 $7,559,595 $ 5,693,188 $ 4,540,875 $ 3,851,400 $ 3,178,612 $ 2,500,824 $ 1,818,035 $ 1,130,247 $ 437,459 Transfers to General Fund $(1,000,000) $(1,858,947) $(1,200,000) $ (750,000) $ (750,000) $ (750,000) $ (750,000) $ (750,000) $ (750,000) $ (425,000) Transfers to Special Revenue Fund $ (178,405) Expenses $ (5,196) $ (75,641) Revenue $ 160,951 $ 43,851 $ 6,486 $ 328 Interest Earnings $ 15,054 $ 24,330 $ 41,202 $ 60,197 1$ 77,212 1$ 72,212 1$ 67,212 1$ 62,212 $ 57,212 1$ - Ending Balance $7,559,595 $5,693,188 $ 4,540,875 1$ 3,851,400 1$ 3,178,612 1$ 2,500,824 1$ 1,818,035 1$ 1,130,247 1$ 437,459 1$ 12,459 Because a significantportion of OPEB Funding is taken fi-om the HCTF,this chart is provided to show actual activity in the HCTFfrom FY2015 when it was first tapped for OPEB,and projecting forward until the fund is fully depleted in FY2024. DOR has asked the Town to transfer the balance of the HCTF more quickly.Staff have deferred action,preferring to show a consistent transfer from the operating budget to OPEB to demonstrate a commitment to fimd OPEB for the ratings agencies. General Stabilization Fund-In the 2006 report, the Ad Hoc Committee recommended the establishment of a General Stabilization Fund to offset potential future shortfalls in State Aid and Local Receipts. Given that Free Cash was the primary reserve at that time, a target of 7% of the prior year's General Fund revenue was established. The balance in the General Stabilization Fund as of April 8, 2019, is $9,719,462, or 4.7% of FY2019 projected net General Fund revenue. An infusion of$4.8 million would be needed to achieve the recommended 7% level from 2006. Given the existence of numerous additional reserves and fund balances which did not exist in 2006, and the numerous additional pressures on the town's finances, staff do not recommend continued funding of the General Stabilization Fund at the current time. The Town enjoyed several years of aggressive growth Chapter 70 Aid, which has leveled off in the last two years as the Town has reached its minimum aid threshold set by the Department of Education. Staff expect Chapter 70 funding will be stable in the coming years. The current balance in the General Stabilization Fund is approximately 30% of the Town's total State Aid and Local Receipts revenue. This would allow the Town to absorb a 30% decrease in these revenues for 3 consecutive years. The balance in the General Stabilization Fund should be monitored annually in conjunction with economic and legislative trends. If a decrease in either State Aid or Local Receipts is anticipated, the Town should consider setting aside additional funds to address future revenue needs. 5 The following table presents the General Stabilization Balance as a% of State Aid and Local receipts for the previous three fiscal years. FY2017 FY2018 FY2019 State Aid $ 15,7373052 $ 15,996,335 $ 16,1877516 Local Receipts $ 16,738,858 $ 13,727,959 $ 14,086,885 Gen'I Stab. Balance $ 9,447,867 $ 9,649,865 $ 9,719,462 % State/Local Rev. 29.09% 32.46% 32.10% Going forward staff and policy makers may want to revisit the purpose of the General Stabilization Fund, its target funding levels, and guidelines for utilizing these reserves. The original purpose was to restore lost State and/or Local revenue; and staff suggest that should be maintained. However, State Aid is expect to be stable, and other economic pressures such as inflation may impact the budget in coming years. If a transfer from the Fund is voted, the method to restore funds in future years should be identified, and acknowledged in future budgets. iv. Capital Stabilization Fund— Staff and policy makers anticipated several large capital projects being implemented in a short period of time (reconstruction of school buildings, public safety, and other municipal infrastructure projects). Establishing and funding the Capital Stabilization Fund (CSF) was a key strategy to address these future capital needs. The Town has aggressively funded the CSF over a number of years, reaching a peak balance of over $28M in FY2018. To accomplish this, the Town's practice has been to tax to the Levy Limit and set aside surplus revenues into this fund for future use. This fund has primarily been used to reduce the annual increase in tax bills from exempt debt service for projects which were approved by the voters via debt exclusions. However, in recent years the CSF has also been used to stabilize the impact of within levy debt on the operating budget. Staff s modeling projects that transfers into the fund will be surpassed by transfers out of the fund for the next 5 years, and that the balance of the CSF will decrease significantly during this time. Future funding and use of the CSF should be topics for discussion by policy makers. In particular, the following items should be addressed— 1. Future transfers into the CSF (including re-building the fund to address a future High School reconstruction project); 2. Use of funds for Within Levy Debt Service (current practice is to ensure that within-levy debt service does not grow by more than 5%per year); 3. Used of funds for Excluded Debt Service (currently used to mitigate increases in residential tax bills to 4.0% or less) The following table present the history and future balance of the CSF. This model was recently updated to reflect the outcome of the 2019 Annual Town Meeting. 6 History of Capital Stabilization Fund (CSF Anticipated Anticipated Appropriations Use of CSF Use of CSF and Interest for Within for Excluded Ending into the CSF Levy Debt Debt Balance FY2013 $1,601,835 $0 $0 $156015835 FY2014 $359885868 $0 ($1,6003000) $359905703 FY2015 $559265762 ($9195000) ($9505000) $850485465 FY2016 $97513,048 ($215,000) ($6207567) $1677257946 FY2017 $751875263 $0 ($710,000) $23,2039209 FY2018 $851195224 ($3249500) ($2,4003000) $2835975933 FY2019 $355605335 ($573,500) ($4,5003000) $2730845768 FY2020 0) $19536,759 $0 ($552003000) $2334215527 FY2021 est. $0 ($1,9105000) ($65200,000) $15,311,527 FY2022 est. $0 ($1,474,000) ($450001000) $%8371527 FY2023 est. $0 ($193295000) ($252003000) $653085527 FY2024 est. $0 ($190255000) $0 $552839527 FY2025 est. $0 ($198,000) $0 $5,085,527 FY2026 est. $0 $0 $0 $5,0851527 FY2027 est. $0 $0 $0 $57085Y527 FY2028 est. $0 $0 $0 $550859527 (')As appropriated at 2019 Annual Town Meeting v. Other Stabilization Funds—The Town is fortunate to have a number of additional funds available for either ongoing or one-time expenditures. The current balance of these funds is noted below, along with a description of the source of funding and anticipated uses. Specialized Stabilization Funds FY2016 FY2017 FY2018 as of 3/28/19 Special Education Stabilization Fund $ 19078,170 $ 19088,001 $ 13105,262 $ 131205867 Debt Stabilization Fund $ 8955503 $ 778,494 $ 664,828 $ 549,506 Transportation Demand Management $ 3005766 $ 2145309 $ 2265906 $ 1815379 Traffic Mitigation Stabilization Fund $ 1475401 $ 1465701 $ 3213751 $ 3543948 TMOD Stabilization Fund $ 985164 $ 985263 $ 3333310 $ 3423445 Center Improvement Stabilization Fund $ 865872 $ 875664 $ 615628 $ 355190 • The Special Education Stabilization Fund was established to cover any unanticipated special education expenses that may arise in a given year that cannot be covered in the operating budget. This includes new students moving into the district or the needs of current students changing in an impactful way. No new deposits have been made since FY2011, but the fund continues to earn interest each fiscal year. • The Debt Stabilization Fund was initially established as a holding account for an MSBA payment that was received after a project was fully funded. These proceeds 7 are being used to offset debt service for that project. Each year, Town Meeting authorizes a transfer for that purpose. The fund will be depleted in FY2023, which coincides with the maturity of the bond for that project. • The following funds were established to reserve payments from developers and property owners that were paid to the Town to mitigate negative traffic impacts or improve transportation. Typically these payments related to projects where zoning changes were approved or new developments were built. These payments are a mix of one-time and ongoing revenues. o Transportation Demand Management (TDM) is used to supplement tax levy support for the Lexpress bus service and the 6-year pilot program for the REV Shuttle. o Traffic Mitigation funds are used for making targeted traffic and pedestrian safety improvements. These funds are allocated at the recommendation of the Transportation Safety Group. o Transportation Management Overlay District (TMOD) funds are directed to infrastructure improvements in the Hartwell corridor. • The Center Improvement Stabilization Fund has been funding the 3-year Bike Share pilot program at Economic Development. vi. Other Available Funds—In addition to the Stabilization Funds, the Town has a number of Special Revenue Funds with significant available balances that are being held in reserve for particular purposes. The current balance is noted below, along with a description of the source of funding and anticipated uses. B alanc a as Name of Fund FY2016 FY2017 FY2018 of 4/30/19 PEG TV Special Revenue Fund $ 904,114 $1,069,481 $1,338,459 $1,160,444 DPW Compost Revolving Fund $1,099,754 $1,013,807 $ 891,356 $ 626,357 Sale of Cemetery Lots Fund $ 5561683 $ 6161900 $ 6511051 $ 62%329 Parking Fund $ 691,817 $ 7171006 $ 9441365 $1,015,15 6 • The PEG TV Special Revenue Fund receives the proceeds from cable contracts in town, and uses them to fund the operating costs for LexMedia, as well as a portion of the AV Technician at DPF. The fund balance has been used in the past to upgrade technical equipment at Cary Hall and the Selectmen's meeting room. • The Compost Revolving Fund receives revenue from issuing disposal permits to landscapers, as well as selling the finished compost. The fund balance is paying for ongoing debt service for new equipment purchased to allow the facility to continue to maintain the same level of service on a smaller footprint. • The Sale of Cemetery Lots Fund receives a portion of the fees generated from selling cemetery plots. The fund balance will potentially fund debt service for the replacement of the Westview Cemetery Building (if it is authorized by Town Meeting) or to pay for future capital improvements at the Town's cemeteries. 8 • The Parking- Fund receives the proceeds from parking meters and the Depot parking lot, and transfers funds to the General Fund each year to pay for parking enforcement and snow removal. The fund has also been used to fund Electric Vehicle Charging Stations and is available to fund replacement of municipal parking lots if needed. vii. Continuing Accounts—There are three General Fund accounts which are authorized to have their balances roll forward from one year to the next. The purpose of each account is described below, and the intent of these dedicated reserve funds is to provide a pool of sufficient funds to cover expenses in future years. Historical activity and current balances noted in the chart are as of March 28, 2019. • Workers Compensation—The Town is self-insured for Worker's Compensation claims (excluding public safety positons) and this account funds any claims that arise. The Town has used $1 M as a target balance to maintain in this account, and past appropriations were increased each year in an effort to grow the balance to that level. Since the account has reached the target $1 million balance, annual appropriations are set at levels which reflect historical expenses. In the event of an unexpected, or series of unexpected losses, the account balance could be utilized, though the Town has a stop-loss policy to cover extraordinary losses. The premium for the stop-loss policy is also paid from this account. • Uninsured Losses—This account covers and deductibles for the Town's general liability insurance along with other non-covered expenses. The Town Manager's Office plans to rebid the Property & Liability Insurance policies in FY2020, and may establish higher deductibles if policy premium savings would be achieved. • Salary Transfer Account—Each year, a projection is made for the financial exposure for unsettled municipal collective bargaining contracts in the coming year. Sick time and vacation buyback projections are also incorporated. These amounts are then available in future years for transfer to department personal service accounts. If a department is able to absorb the increases, the amounts in the Salary Transfer Account are allowed to fall to Free Cash. 9 Workers Compensation FY2016 FY2017 FY2018 FY2019 FY2020 Beginning Balance $ 7291589 $ 882,112 $110047223 $171977807 $176711707 Appropriation $ 643,112 $ 747,665 $ 807,136 $ 882,380 $ 887,346 Expenditures $ 490,589 $ 625,554 $ 613,552 $ 4087480 Ending Balance $ 882,112 $1,004,223 $1,197,807 $1,671,707 Uninsured Losses FY2016 FY2017 FY2018 FY2019 FY2020 Beginning Balance $ 5471279 $ 623,795 $ 832,675 $ 9621713 $111961031 Appropriation $ 2001000 $ 2251000 $ 250,000 $ 250,000 $ 250,000 Expenditures $ 1237484 $ 16,121 $ 1197961 $ 167683 Ending Balance $ 623,795 $ 832,675 $ 9625713 $1,196,031 Salary Transfer Account FY2016 FY2017 FY2018 FY2019 FY2020 Beginning Balance $2,095,397 $11 724,713 $11 877,696 $ 5311958 $11 014,988 Appropriation $ 820,316 $ 673,016 $ 7507592 $ 4837030 $ 750,594 Transfers Out $ 5917000 $ 120,033 $11 646,330 Drop to Free Cash $ 6007000 $ 400,000 $ 4507000 Ending Balance $1,7241713 $1,877,696 $ 531,958 $1,014,988 viii. Free Cash-Over a number of years, the Town has generated an increasing amount of Free Cash. Free Cash is generated from surplus revenues (revenue exceeding what was projected in the budget), and by spending less than originally budgeted. Free Cash is considered a one-time revenue source that may vary from year-to-year. Best practices indicate that one-time revenues should be used for one-time expenses, and not for continuing expenses, such as those in the operating budget. In Lexington Free Cash has been used for a variety of purposes, including to support the operating budget, summarized in the table below. Under the direction of the Town Manager, a concerted effort was started in FY2020 to reduce the amount of Free Cash used to support the Operating Budget. Staff further recommend that future use of Free Cash focus on one-time expenses, such as cash capital or the funding of reserves accounts. Are a FY2016 FY2017 FY2018 FY2019 FY2020 Operating Budget $400020 $30181300 $3,853,023 $3,7401000 $219001000 Cash Capital $2419,000 $2,5001000 $3,35000 $4,0501245 $44001000 OP EB Funding $3247 $3121318 $1,0791721 $1,0791721 $13291721 Capital Stabilization Fund $6,405,035 $3,100,000 $5,000,000 $502,085 $1,536,759 Retire Note- Land Purch. - - - $31050,000 $2,234,614 Getting to Net Zero $40,000 $40,000 - - Unallocated* $9241961 $5651125 $4801000 $110001000 Set-Aside - Current Year* $200,000 $200,000 $200,000 $160,000 $200,000 Total Free Cash $13,108,202 $10,995,579 $14,0871869 $13,0621051 $139401,094 *Iffunds are not used for the budget, the balance falls to Free Cash again 10 ix. Overlay Account Balances—The "Overlay" is an annual revenue offset built into the budget to cover tax abatements and exemptions. Prior to the Municipal Modernization Act(Muni Mod), the Town was required to maintain adequate overlay account balances in distinct accounts by fiscal year, with sufficient amounts in each account to cover potential claims. Passage of Muni Mod allows the Town to combine overlay accounts, thereby allowing balances from one year to cover exposures in another year and potentially freeing up excess account balances. Staff recommend conducting an annual review of the Overlay account with the Board of Assessors, including current balances and potential exposures. If it is determined that the overlay balance is more than sufficient to cover potential claims, a portion of the Overlay balance may be released by the Board of Assessors. These funds would revert to the General Fund and could be put into other reserve accounts or used for one-time expenses. II. OPERATING BUDGET The strategies below reflect the governing policies and procedures which provide a framework for staff to use in preparing the annual operating budget recommendations. a. BUDGET SUMMITS Lexington is fortunate to have a robust and active set of policy making boards and committees. The annual budget is arguably the most important policy document developed each year. In order for the budget to be developed in a cohesive, consistent way, the Town has developed a practice of holding a series of Budget Summits throughout the Fall and Winter which bring together the 4 key groups: Board of Selectmen, School Committee, Appropriation Committee and Capital Expenditures Committee. The purpose of the Summits is to share key fiscal information across all stakeholder groups, and provide a forum for discussion and collective decision-making. The current Summit schedule, and other key milestones, is— • Summit#1 —key financial indicators and out-year forecast, • Summit#2—revenue forecast for budget year, initial revenue allocation • Summit#3 —finalize revenue allocation, discussion of other budget concerns • Summit#4—presentation of Town Manager's preliminary recommended budget(White Book) and Superintendent's preliminary recommended budget • Summit#5 —follow-up conversation, if needed • Late February— Select Board votes to recommend budget; released to Town Meeting • Late March—Town Meeting votes on recommended budget b. TAX TO THE LEVY LIMIT Helpful Definitions— • Proposition 2V2—The law passed in 1980 which limits the rate at which the base tax levy can grow to 2.5% each year. • Levy Limit—The total amount the Town can raise via property tax bills. The levy limit is calculated by taking the amount raised in the prior year, adding 2.5%, adding any new growth during the year, and finally, adding any operating overrides. If the Town has 11 voted projects as excluded debt, that amount is added to the Levy Limit to get to the Maximum Allowable Levy. • New Growth—The taxed amount from newly created residential, commercial and personal property value in any given year. This incremental increase in value is created by an improvement, new construction, or a new asset. • Override—Taxpayers can vote to exceed the Levy Limit in two ways— • Operating Override—results in a permanent increase to the Levy Limit, compounded by 2.5%per year. • Debt Exclusion—authorizes the Town to issue debt for a capital project. The debt service is added to the levy limit and is recalculated each year. Once the bonds for a project have been paid, no further obligations above the levy limit are required. • Tax to the Levy Limit—This is the approach the Town of Lexington has practiced for many years, along with many other communities. The tax rate is calculated to raise an amount as close to the Levy Limit as possible in a given year. In recent years, it has been the Town's policy to transfer any excess funds to the Capital Stabilization Fund, or other one-time uses, rather than build up the operating budget to the full tax capacity. The reserves are planned for use in future years as a way of offsetting or preventing an override vote. c. EXCESS LEVY CAPACITY If a community does not tax to the Levy Limit, there is excess capacity available under the levy limit that remains untaxed. That revenue is not raised in the levy in a given year, and therefore is not available to spend or earn interest. The result of leaving levy capacity untaxed will be relatively lower tax bills for that particular fiscal year. However, excess levy capacity is available to be taxed in future years, meaning that base tax bills in those years could grow by more than 2.5%. Taxing to the Levy Limit versus creating Excess Levy Capacity will be a key decision point for staff and policy makers at the upcoming fiscal policy summit. If the Town elects to begin building excess Levy Capacity, we will need an additional policy to determine when that excess levy capacity should be utilized in future years. d. PERSONAL PROPERTY NEW GROWTH As previously noted, under Proposition 21/2, the base tax levy can grow by no more than 2.5% in any given year. In addition, a community can recognize New Growth which is added to the base tax levy in that particular year and becomes part of the base tax levy in all future years. Examples of New Growth are best understood in the following categories— • RESIDENTIAL—A home that is valued at $500,000 is purchased and torn down, resulting in a new home valued at $1,500,000. In the first year, the incremental $1,000,000 is added to the base tax value, and the residential tax rate is applied. In the second year, the base tax on the home increases by 2.5%, assuming no further improvements. Other examples that would trigger"new growth" for a home would be an addition or other 12 improvement to the property. Change in market value of a property is not considered new growth. • COMMERCIAL/INDUSTRIAL—As with residential, if a commercial or industrial property is improved or added during the year, any incremental increase in value is added to the base for the tax calculations. • PERSONAL PROPERTY—This category is primarily made up of durable equipment purchased or acquired in commercial and industrial business. Unlike residential and commercial new growth, many of these newly acquired personal property assets depreciate in 5 years or less and are often on a short-term replacement schedule. These assets may be sold or disposed of shortly after being purchased. The result is that the value associated with personal property new growth may disappear from the Town's total property valuation shortly after being recognized as new growth. However, there is no mechanism in the Proposition 2V2 formula for the value to be removed from the levy limit calculation, so the associated tax levy is redistributed to the remaining taxpayers. Whether or not the Town should address the impact of Personal Property New Growth will be a key decision point for staff and policy makers at the upcoming fiscal policy summit. e. REVENUE FORECASTING Lexington has traditionally been very conservative in forecasting revenues for the coming year, rather than striving for amounts that may not be achieved and result in a deficit. In general, the following principles are followed— • Property Tax Revenue—projected to increase by 2.5%, with New Growth limited to $2.5M. • State Aid—Chapter 70 is based on a per pupil increase, known as minimum aid; and Unrestricted Government Aid growth is based on historical averages. • Departmental Revenue—budgeted levels for the current year are set to adjust based on the historical 3-year averages, unless further background is known about a revenue source. • Available Funds—where feasible, alternative funding sources for budgetary items are identified and transferred to the General Fund, with the biggest variable coming from the amount of Free Cash certified each year. • Revenue Offsets—these include state aid assessments and offsets (MBTA, MAPC, library, etc.) which are projected to grow 3.5%; the Overlay account for potential tax abatements which is typically funded at $750,000, or $900,000 during a recertification year; and a set-aside for potential snow deficits, which has been traditionally funded at $4001000. • Enterprise Receipts— collected from the Water, Wastewater and Recreation enterprise funds for General Fund expenditures made on their behalf—also known as Indirect Costs. A detailed analysis for each fund is updated each year, and is used to determine the amounts to transfer. 13 f. FUNDING SHORT-TERM CAPITAL VIA OPERATING BUDGET As a practice, Lexington has sought to incorporate the routine replacement of smaller capital items into its operating budget. This is a best practice in that it ensures that items are replaced as needed, and it ensures there is sufficient capacity in the budget to continue that replacement over time. Examples include— • School Department—replacement of furnishings and equipment for staff and students, initiated in FY2019 • Police Department—routine replacement of police cruisers • Fire Department—routine replacement of fire protective equipment and command vehicles; a PIR was funded for $85,000 in FY2020 to provide an extra set of turnout gear for the significant number of new staff members in recent years, due to staff turnover. • Public Facilities—routine replacement of maintenance tools and vehicles, the maintenance of security cameras, and a new initiative in the FY2020 budget to fund classroom and office painting. • Public Works—routine replacement of town passenger vehicles, managed by DPW for other departments; ongoing maintenance, repair and replacement of guardrails. • Other—as needed, departments request one-time funding to replace or add new equipment. Recent examples include a wheel balancer for the Equipment Maintenance division at DPW, a mower for the Conservation Commission, and an electronic plan table for the Building and Zoning department. g. WITHIN LEVY DEBT SERVICE For projects funded by debt, and the subsequent debt service payments are funded within the Town's base operating budget, the debt service is referred to as "Within Levy" debt service. Those expenses are constrained by the limits of Proposition 21/2. In principle, the Town has strived to limit growth in within levy debt service to no more than 5% from year-to-year. Maintaining a consistent level of debt service avoids crowding out other expenses in the operating budget. This should be accomplished by limiting the value of debt-financed projects funded in the capital budget each year. In practice, the appetite for capital projects has grown in recent years, resulting in higher within- levy debt service costs. In order to limit within levy debt service growth to 5%per year, transfers have been authorized from the Capital Stabilization Fund (CSF), as noted in section I.(b)(iv). To maintain the 5% growth in debt service noted above, staff anticipate that transfers will be needed in FY2021 through FY2025, for a total of approximately $5.9M. This includes debt for projects that have been authorized but not yet issued, so the exact amount may vary. Staff recommends that this guideline be reevaluated in upcoming budget cycles for several reasons. First, given the Town's commitment to funding and maintain its valuable capital assets, and our current level of funding capital projects with cash, a target growth of 5% in debt service may not be adequate to continue funding our ongoing capital programs. Second, revenues have 14 historically averaged less than 5% growth each year, therefore the growth in debt service is outpacing the growth in revenues. h. EXCLUDED DEBT SERVICE Larger capital projects are typically brought to the taxpayers to be authorized via a "Debt Exclusion," which means the debt service needed to fund the project is not subject to the limits of Proposition 21/2. An affirmative vote by the majority of voters in a townwide referendum is needed to exclude a project from the limits of Proposition 21/2. The Town's goal has been to stabilize the year-over-year increases in excluded debt and hold them to a manageable level, thereby reducing the impact on the residential and commercial tax bills. To accomplish this, the town has increasingly used the Capital Stabilization Fund(CSF) as a funding source to offset the impact of excluded debt service, and"shave the peak" of anticipated growth. Projected use of the CSF is illustrated in section I.(b)(iv). i. REVENUE ALLOCATION MODEL For many years, the Town has utilized a method known as the Revenue Allocation model to project and allocate new revenues for the coming budget year. This involves a number of steps— 1. Project all sources of revenue for the coming year, 2. Subtract the following expenses— a. the municipal and school budgets from the prior year, b. projected Shared Expenses such as pension funding, employee benefits, within levy debt service, the department of Public Facilities, and other commitments, c. agreed upon funding for set-asides, such as transfers to the Capital Stabilization Fund and OPEB, cash capital including street improvements and municipal buildings, and paying down land purchase principal, 3. Split any remaining funds proportionally between municipal and school, based on the prior year's budget levels. 4. The amount from#3 is added to the amounts in 2(a) to provide the target budget levels for each budget. By establishing target budgets in the early stages of budget development, staff can more easily anticipate needs and develop alternate arrangements. For many years, it had been the accepted practice to return some of the Revenue Allocation funding, which would then be added to the Capital Stabilization Fund. Those funds would also be available in the following year to provide a higher revenue allocation. However, in FY2020, both the municipal and school departments fully budgeted their allocated revenue. j. LEVEL-SERVICE BUDGETS Each year, departments are instructed to propose a level-service budget, which means they anticipate providing the same services from one year to the next, though providing the same service may need increased funding due to outside factors. If management wishes to propose a programmatic enhancement, they submit a Program Improvement Request (PIR), which outlines the proposal, the rational for the request, the funding needed, and the ongoing costs. 15 k. FUNDING PROGRAM IMPROVEMENT REQUESTS (PIRs) In general, PIRs that propose a one-time expenditure are preferred over those that establish an ongoing commitment. PIRs which create efficiencies, future cost savings, or are environmentally sustainable, are also preferred. The Town Manager, with input from department heads and policy makers, makes the ultimate recommendation on which PIRS will be funded in any given year. Revenues must be available to fund any PIRs that are recommended by the Town Manager. 1. SCHOOL ENROLLMENT PROJECTIONS A major cost driver in recent years has been the growth in school enrollment at all levels, but especially at the high school. School staff have developed detailed projections to anticipate future enrollment growth. To better ensure that the Town has sufficient funds set-aside to educate all of its children, policy makers prefer to project enrollments at realistic levels. However, there is always a potential for actual enrollments to vary from projections. M. SNOW AND ICE BUDGET State law requires the Town to set-aside the same amount as it budgeted in the prior year. Lexington does this, and adds anticipated increases due to contractual obligations, fuel costs and other expenses. However, snow removal is a notoriously difficult item to project. If spending exceeds budgeted levels, other sources of funding which can cover the overage include— • Other items within the DPW personal services and expense budgets; • Allocations from the Reserve Fund, as approved by the Appropriation Committee; and • Carrying forward a portion of the deficit to the following year, to be raised in the tax levy, as anticipated in the Set-Aside revenue budget. The actual experience over the past 10 years is detailed below. Transfers Reserve Yeait End I 'iiii Surplus/ wii hlin I FEW Fund IRaised in Next Fiscal Year Budgelt Actulal hurff 1 1 Budget Tra n sfe rs Fiscall Year, Total ILO,261,,1605 $ 16,105,1738 $ 1 3 1 , ! r '1 F $ 216171705 16 III.CAPITAL BUDGET a. DEFINITION OF CAPITAL PROJECT A capital project is defined as a major, non-recurring expenditure that generally meets the following criteria: • Massachusetts General Law permits the Town to issue bonds to finance the expenditure; • The expenditure is $25,000 or more; • The expenditure will have a useful life of 10 years or more for buildings or building components and 5 years for vehicles and equipment; and • Planning, engineering, or design services may be considered capital when such services are integral to a construction, renewal or replacement project that meets the criteria for a capital expenditure. b. PRIORITIZED CAPITAL PLAN Under the direction of the Town Manager, the Town is currently developing an overall list of anticipated capital projects over the next 5 or more years, and will prioritize them using a set of to-be-determined criteria. It is anticipated that this process will better enable Lexington to constrain its capital budget. c. TARGETED CASH CAPITAL INVESTMENTS Fiscal leaders are very interested in limiting the issuance of new debt, particularly for items which have a shorter useful life, such as information technology. Wherever possible, cash funding streams are used to finance those projects, rather than debt. d. ANNUAL LIMITS ON AUTHORIZED WITHIN LEVY DEBT PROJECTS In principle, the Town has strived to limit growth in the General Fund capital budget (including cash and debt financed projects) to an increase of 5% per year. In practice, the appetite for capital projects has grown in recent years, resulting in capital budgets that far exceed the 5% target. This has the trickle-down effect of increasing within levy debt service costs, which in turn requires transfers from reserves. e. USE OF CAPITAL STABILIZATION FUNDS To-date, the Capital Stabilization Fund(CSF) has not been used to fund a project directly, but rather to offset the debt service for that project, thereby minimizing the annual increase required for residential tax bills. Going forward, particularly for the high school, leaders should consider whether to use the CSF to avoid the need to issue debt, thereby saving both interest and issuance costs. f. USE OF OTHER FUNDS Capital projects may be funded with cash or debt from the General Fund, from Enterprise Funds, from the Community Preservation Act (CPA) fund, or from a small subset of other funds, including stabilization, special revenue and revolving funds that are available for funding capital improvements. See section I.(2)(vi) and I.(2)(vii) for additional information. 17