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An Interview About Municipal Investments and Reserves
Victor Garofalo is serving as the Finance Director and Treasurer/Collector for the Town of Sudbury. He was kind enough to answer our questions on Town investments and reserves. We are publishing the full Q&A interview here with gratitude for his time.
Capital projects and operating budgets are discussed frequently among residents in towns all across Massachusetts, but reserves and investments get less attention. Let’s start with reserves. What types of reserves does the Town of Sudbury have? How are they funded and how are they accessed when needed?
The Town of Sudbury has several reserve accounts, these include the General Stabilization Fund, Capital Stabilization Fund, Turf Reserve, and Other Post-Employment Benefits (OPEB) fund.
The Town of Sudbury General Stabilization, Capital Stabilization and Turf fund are permitted by M.G.L. Chapter 40, Section 5B. These funds are funded by Town Meeting either from Free Cash or the Tax levy, and it requires a 2/3 vote to transfer money from these funds.
The Town’s OPEB Fund is a trust fund established for the benefit of retired employees and their dependents; payment of required contributions by the governmental unit for the group health insurance benefits provided to employees and their dependents after retirement; and reduction and elimination of the unfunded liability of the governmental unit for those benefits. These funds are funded by Town Meeting either from Free Cash or the Tax Levy, and voted as part of the budget process for use.
Free cash is a revenue source which results from the calculation, as of July 1, of a community’s remaining, unrestricted funds from operations of the previous fiscal year based on the balance sheet as of June 30. It typically includes actual receipts in excess of revenue estimates and unspent amounts in departmental budget line-items for the year just ending, plus unexpended free cash from the previous year. Division of Local Services (DLS) advises that free cash, as a nonrecurring revenue source, should be restricted to paying one-time expenditures, funding capital projects, or replenishing other reserves. DLS also advises that under sound financial policies, a community should strive to generate free cash in an amount equal to three to five percent of its annual budget. Free Cash is not available for use until it is certified by the Director of Accounts at the Department of Revenue.
The current balance in each of these accounts is
- General Stabilization Fund – $5.96M
- Capital Stabilization Fud – $1.8M
- Turf Field – $90K
- OPEB Fund – $16M
- Free Cash – $7.27M
The Division of Local Services provides guidance on best practices for reserves, but within that guidance there’s room for municipalities to tailor their approach to their specific needs. How would you characterize Sudbury’s unique needs, if any, and what is the role of reserves in Sudbury’s financial strategy?
The DLS consistently recommends that communities review and update all financial policies periodically. They recommend that communities
- Establish target balances for the stabilization fund, annual free cash, and other reserves, either as a total dollar amount or as a percentage of the annual budget. It will set a schedule of annual appropriations (e.g., to stabilization) or limitations on use (e.g., of free cash) designed to gradually reach and sustain the target balances over time.
- Direct the use of all or portions of free cash as a funding source for stabilization or as an outlay for one-time capital projects. It can also direct the use of revenue from a specific, recurring income source (e.g., rental income) for a special purpose stabilization fund.
- Restrict the use of unexpected, nonrecurring revenue, or surplus revenue, to one-time costs.
- Restrict the use of stabilization funds to nonrecurring expenditures and only in amounts above a certain dollar threshold. Set similar guidelines on the use of free cash.
- Measure performance to policy statements and determine remedies for noncompliance.
The Town of Sudbury has well established Financial Policies that set target balances, use of these funds and thresholds. The Fiscal Policies are located at https://sudbury.ma.us/policies/financial-policies-manual/
It can be tricky to determine target funding levels for reserves, especially as economic conditions and municipal needs are constantly changing. How does the Town make determinations on the right level of reserves?
Within the Town of Sudbury Fiscal Policies (https://sudbury.ma.us/policies/financial-policies-manual/) it identifies the funding for these reserves.
General Stabilization: The Town will endeavor to maintain a minimum balance of 5% of the prior year’s General Fund budget in its general stabilization fund. Withdrawals from general stabilization should only be used to mitigate emergencies or other unanticipated events that cannot be supported by current General Fund appropriations. When possible, withdrawals of funds should be limited to the amount available above the 5% minimum reserve target level. If any necessary withdrawal drives the balance below the minimum level, the withdrawal should be limited to one-third of the general stabilization fund balance at a time, endeavoring to never fully deplete it. Replenishment of the funds should be made annually at the Fall Town Meeting, or the earliest available meeting after free cash has been certified. The General Stabilization Fund current balance is $5,960,000, which 4.9% of the General Fund Balance.
Capital Stabilization: The Town will appropriate annually to the capital stabilization fund so that over time it achieves a target balance sufficient to cover the Town’s cash outlay for capital. Doing so enables the Town to pay outright for moderate-range (under $1M) capital expenditures and thereby preserve debt capacity for major, higher-dollar purchases or projects. This approach balances debt with pay-as-you-go practices and protects against unforeseen costs. The Town should endeavor to achieve and maintain a combined target balance for all capital-related special purpose stabilization funds equal to 2% of prior year General Fund budget. Withdrawals from the Capital Stabilization Fund should be avoided until the target balance has been achieved. Once achieved, funds can be used towards items on the CIP. Once funds are used, the Town will seek to make annual contributions to the fund until the target balance is achieved. The Capital Stabilization Fund current balance is $1.8M, which 1.8% of the General Fund Balance.
Turf Stabilization: The Town maintains a special purpose fund to offset the cost of repairs or replacement of Town owned and operated synthetic turf fields. Contributions to this fund should be made annually from the General Operating Fund and Field Maintenance Enterprise Fund.
Free Cash: The Town shall set a year-to-year goal of maintaining its free cash in the range of 3-5% of the prior year’s General Fund budget. To achieve this, the Finance Director shall assist the Town Manager in proposing budgets with conservative revenue projections, and department heads shall carefully manage their appropriations to produce excess income and budget turn backs. Further, budget decision makers will avoid fully depleting the Town’s free cash in any year, so that the succeeding year’s calculation can begin with a positive balance. Moreover, as much as practicable, the Town will limit its use of free cash to funding one-time expenditures (like capital projects or emergencies and other unanticipated expenditures) and should appropriate any free cash excess above 5% of the General Fund budget to reserves, to offset unfunded liabilities, or to set aside for existing debt. The current Free Cash balance is $7.27M, which is 5.98% of the General Fund balance.
OPEB Fund: The Town of Sudbury is committed to funding the long-term cost of the benefits promised its employees. To do so, the Town will accumulate resources for future benefit payments in a disciplined, methodical manner during the active service life of employees. The Town will also periodically assess strategies to mitigate its OPEB liability. This involves evaluating the structure of offered benefits and their cost drivers while at the same time avoiding benefit reductions that would place undue burdens on employees or risk making the Town an uncompetitive employer.
- Accounting and Reporting the Finance Director will obtain actuarial analyses of the Town’s OPEB liability every two years and will annually report the Town’s OPEB obligations in financial statements that comply with the current guidelines of the Governmental Accounting Standards Board. The Town Auditor shall ensure that the Town’s independent audit firm reviews compliance with the provisions of this policy as part of its annual audits.
- Mitigation On an ongoing basis, the Town will assess healthcare cost containment measures and evaluate strategies to mitigate its OPEB liability. The Finance Director shall monitor proposed laws affecting OPEBs and Medicare and analyze their impacts. The Human Resources Director shall regularly audit the group insurance and retiree rolls and drop any participants found to be ineligible based on work hours, active Medicare status, or other factors.
- Funding To address the OPEB liability, decision makers shall analyze a variety of funding strategies and subsequently implement them as appropriate with the intention of fully funding the obligation. The Town shall derive funding to invest in the OPEB trust from taxation, free cash, and any other legal form.
Let’s switch over to investments. You have a successful track record managing investments for municipalities. Can you tell us a bit about your investment strategy for Sudbury? How do investments fit in the bigger picture of the annual budget?
To ensure the Town’s public funds achieve the highest possible, reasonably available rates of return while following prudent standards associated with safety, liquidity, and yield, this policy establishes investment guidelines and responsibilities. It is further designed to comply with the Governmental Accounting Standards Board’s recommendation that each community disclose its key policies affecting cash deposits and other long-term investments to ensure they are managed prudently and not subject to extraordinary risk. The Finance Director shall invest funds in a manner that meets the Town’s daily operating cash flow requirements and conforms to state statutes governing public funds while also adhering to generally accepted diversification, collateralization, and the prudent investment principles regarding safety, liquidity, and yield. Investments are also addressed in the general Financial Policies.
Is it typical for towns to invest like this, or is Sudbury unique among its municipal peers?
The Town of Sudbury is not unique to its Municipal peers, when it comes to investing its funds. The town uses several investment strategies, but adheres to the Legal List of Investment as established under Massachusetts General Law Chapter 167 Section 15A when it comes to investing its General Funds and OPEB Funds. As for the Town’s General Funds, it has been my position to only invest in high yielding US Treasuries, Certificate of Deposit taking into consideration FDIC insurance, as well as working with our current banks to take advantage of high yielding interest bearing accounts. The Town has been very fortunate in the last year where it has seen in increase in interest rates. With that said, as the Feds start to adjust the rates down, this will have an impact as the interest the Town will earn its banks in the future.
The Town’s Investment Policies can be found at the following links.
Town Trust Investment Policy: https://sudbury.ma.us/finance/revised-trust-invest-policy-6-9-05/
Town Investment Policy: https://sudbury.ma.us/finance/town-investment-policy/
It should be noted that the investment policy is outdated and needs to be revised, as there are several things that have changed since it was issued in 2005. This is something I will be reviewing and revising in the future.
Let’s bring the two topics back together here: Can reserves be invested to generate additional income for the Town?
All Town funds, General Funds, Community Preservation Funds, Stabilization Funds, OPEB Funds, Trust Funds are invested, and the interest Earned or market changes stay within those funds.