HomeMy WebLinkAboutStaff Report 14502 and 14112 corrected
City of Palo Alto (ID # 14502)
Finance Committee Staff Report
Meeting Date: 6/7/2022 Report Type: Action Items
City of Palo Alto Page 1
Title: Supplemental Report - Item #3 Finance Committee 6/7/2022, Accept
June 30, 2021 Actuarial Valuation of Palo Alto's Retiree Healthcare and Other
Post Employment Benefits, Approve Annual Actuarially Determined
Contributions for Fiscal Years 2023 and 20 24, and Affirm Additional Payments
to Employers' Benefit Trust Fund
From: City Manager
Lead Department: Administrative Services
Subsequent to the issuance of staff report #14112, staff recognized an error throughout the
staff report that misstated the discount rate for the City’s California Employers’ Retirement
Benefit Trust (CERBT Fund) at 6.75 percent for a Strategy 1 asset allocation; this is the current
strategy selected by the City. CERBT and the City’s Actuarial Consultant Bartel and Associates
have reduced this discount rate from 6.75 to 6.25 percent since the issuance of the last
actuarial report and used for this June 30, 2021 valuation. The calculations in the attachment of
the original staff report remains complete and accurate. This report is being reissued to correct
for this error and has been redlined to identify areas that have been revised. These changes do
not impact actuary results, however, include revisions to the staff recommended funding
alternatives. Below is a complete revised recommendation for the Finance Committee’s
review:
Staff recommends that the Finance Committee recommend the City Council:
1. Review and accept the June 30, 2021 actuarial valuation of Palo Alto’s Retiree Healthcare
Plan;
2. Approve full funding of the annual Actuarial Determined Contribution (ADC) for Fiscal Year
2023 and Fiscal Year 2024 using the staff recommended adjusted assumptions; and
3. Affirm the continued the practice of transmitting amounts at a lower discount rate, 5.75
percent, as an additional discretionary payment to the City’s California Employers’ Retiree
Benefit Trust (CERBT) Fund.
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City of Palo Alto Page 2
Overall, the revised Table 1 below provides a summary of the corrected potential funding
options, as reflected throughout the redlined report:
Table 1: REVISED Funding for the FY 2023 OPEB Obligations
FY 2023 OPEB
Funding
$
Change
FY 2023 Proposed Budget (based on June 30, 2019 valuation) $16.9M -
Recommended
Funding
Adjusted
Assumptions
• Zero percent return 2021-22
• Proactive contribution at lower discount rate of
5.75 in ADC
• Shorten Amortization period
(from 22 to 15 years)
• Additional funding for FY 2023 Proposed staffing
$16.3M ($0.6M)
Alternative:
Baseline
• Current approved funding levels, assuming a
6.25 discount rate
• No proactive contribution at lower discount rate
• Assumed earnings in 2021-22 at planned levels
(6.25)
$11.4M ($5.5M)
*Approximately 65 percent of costs are allocated to the General Fund.
Attachments:
• Attachment A: Corrective Redlined Staff Report #14112
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City of Palo Alto (ID # 14112)
Finance Committee Staff Report
Meeting Date: 6/7/2022 Report Type: Action Items
City of Palo Alto Page 1
Title: Accept June 30, 2021 Actuarial Valuation of Palo Alto's Retiree
Healthcare and Other Post Employment Benefits, Approve Annual Actuarially
Determined Contributions for Fiscal Years 2023 and 2024, and Affirm
Additional Payments to Employers' Benefit Trust Fund
From: City Manager
Lead Department: Administrative Services
RECOMMENDATION
Staff recommends that the Finance Committee recommend the City Council:
1. Review and accept the June 30, 2021 actuarial valuation of Palo Alto’s Retiree Healthcare
Plan;
2. Approve full funding of the annual Actuarial Determined Contribution (ADC) for Fiscal Year
2023 and Fiscal Year 2024 using the staff recommended adjusted assumptions; and
3. Affirm the continued the practice of transmitting amounts at a lower 5.756.25 percent
discount rate as an additional discretionary payment to the City’s California Employers’
Retiree Benefit Trust (CERBT) Fund.
EXECUTIVE SUMMARY
In accordance with the Governmental Accounting Standards Board (GASB), the City Council is
required to review and approve the actuarial valuation for retiree healthcare plan on a bi‐
annual basis for the upcoming two fiscal years and approve funding of the annual Actuarial
Determined Contribution (ADC). This current study presents the fund’s status as of June 30,
2021 and will be used to inform the FY 2023 and FY 2024 annual operating budgets. This report
was finalized after the development of the FY 2023 Proposed Budget. Therefore, funding levels
in the FY 2023 Proposed Budget reflect the out years of the prior study completed on June 30,
2019 (CMR 11284). Funding levels recommended by the Finance Committee as part of this
discussion will be included as an amendment to the FY 2023 Proposed Budget and included for
City Council adoption of the budget on June 20, 2022.
The City continues to selecta Strategy 1 asset allocation, currently projected at a 6.75 6.25
percent discount rate for the California Employers’ Retirement Benefit Trust (CERBT) Fund,
managed by CalPERS. Beginning with the June 30, 2019, valuation (CMR 11284), the City
Council directed staff to calculate additional discretionary payments (“prefunding”) equivalent
to a 6.25 percent discount rate and transmit amounts above payments at a 6.75 percent
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discount rate to the CERBT Fund. The CERBT was subsequently reduced from 6.75 percent to
6.25 percent; therefore, this new target beginning with the June 30, 2021 valuation, is in‐line
with the prefunding assumptions used in the prior valuation. Through FY 2022, a total of $3.5
million in additional contributions are expected to be made to the CERBT.
The June 30, 2021, valuation includes several changes that have favorably impacted the CERBT
fund status, primarily due to healthcare and economic fluctuations resulting from the COVID‐19
pandemic and continued proactive funding contributions:
2020‐21 investment returns of 27.5 percent (6.75 6.25 percent target);
Lower than anticipated healthcare premiums; and
Accumulated contributions (full ADC payments and prefunding)
These favorable changes are advised to be taken in consideration of an uncertain environment.
Current portfolio earning is not expected to meet target return this year (FY 2022) and it is not
known whether the recent change in healthcare premiums will be ongoing or an anomaly due
to the significant governmental support of healthcare costs over the past two years. Because
we do not know whether these favorable changes are the beginning of a trend, or merely a
temporary anomaly, this report includes several options to fund Other Post‐Employment
Benefit (OPEB) obligations for Finance Committee review and discussion beyond the typical
recommended “baseline” strategy.
Recommended Funding: consider alternative assumptions that are intended to better
align with the current economic outlook and proactive funding of long‐term liabilities.
Alternative 1 (“baseline”): reflects the ADC for current City Council approved funding
levels and actuary assumptions.
The below table provides a summary of the options and a comparison of costs to the FY 2023
Proposed Budget in all funds. A more detailed discussion of these options is included in this
report. All options reflect expected savings when compared to assumptions currently built in
the FY 2023 Proposed Budget as reviewed by the Committee in May. Staff recommends that
any savings remain unallocated and fall to respective funds fund balance/reserves based on
standing policies, unless otherwise directed.
Table 1: Funding for the FY 2023 OPEB Obligations
FY 2023 OPEB
Funding
$
Change
FY 2023 Proposed Budget (based on June 30, 2019 valuation) $16.9M ‐
Recommended
Funding
Adjusted
Assumptions
Zero percent return 2021‐22
Proactive contribution at lower discount rate of
6.255.75 in ADC
Shorten Amortization period
(from 22 to 15 years)
Additional funding for FY 2023 Proposed staffing
$14.6M
$16.3M
($2.3M)
($0.6M)
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Alternative:
Baseline
Current approved funding levels assuming a 6.25
percent discount rate
No pProactive contribution at lower discount
rate of 6.25 in ADC
Assumed earnings in 2021‐22 at planned levels
(6.25 percent)
$12.3M
$11.4M
($4.6M)
($5.5M)
*Approximately 65 percent of costs are allocated to the General Fund.
BACKGROUND
The City of Palo Alto offers its employees and retirees a Retiree Healthcare benefit plan which is
managed and administered by the California Public Employees’ Retirement System (CalPERS), a
State of California Retiree Healthcare Trust program. Bi‐annually staff contracts with an actuary
firm that provides an actuarial report detailing the latest status of the City of Palo Alto’s Retiree
Healthcare plans for employees and retirees. The actuarial report is used to calculate the
annual ADC to the trust. In addition, updates on the rate of return, funding status, and changes
to the trust based on various impacts are detailed in the report. Unlike the pension actuary
reports, this actuary details impacts by Fund, Department, Employee Group, and Healthcare
Plans selected.
There are four groups of benefits within the CalPERS Retiree Healthcare benefit plans. Table 1
below outlines the different benefits levels by Group. These benefit levels are negotiated and
approved as part of the employee contracts. Employees and retirees have an open enrollment
window in October each year in which they can make changes to their healthcare plans that
take effect in January of the following year.
Table 2: City of Palo Alto Retiree Healthcare Benefit Plans and Tiers
Miscellaneous Safety: Fire Safety: Police
Group 1
Retired before January 1, 2007;
eligibility starting at the age 50
and 5 years of service; full
premium up to family coverage
Retired before January 1, 2007;
eligibility starting at the age of 50
and 5 years of service; full
premium up to family coverage
Retired before March 1, 2009;
eligibility starting at the age of 50
and 5 years of service; full premium
up to family coverage
Group 2
Retired between January 1, 2007
and May 1, 2011; eligibility
starting at the age 50 and 5 years
of service; same as Group 1, but
premium limited to 2nd most
expensive medical plan
Retired between January 1, 2007
and December 1, 2011; eligibility
starting at the age 50 and 5 years
of service; same as Group 1, but
premium limited to 2nd most
expensive medical plan
Retired between March 1, 2009 and
April 1, 2015 (POA), between
January 1, 2007 and June 1, 2012
(PMA) ; eligibility starting at the age
50 and 5 years of service; same as
Group 1, but premium limited to 2nd
most expensive medical plan
Group 3
(Retirees) Retired after Group 2, did not elect into Group 4, benefit same as active employees
Group 3
(Active EEs)
Currently active, not in Group 4.
Flat Dollar Caps equal to actives
N/A
(All active Group 3 IAFF & FCA
elected into Group 4)
N/A
(All active Group 3 POA & PMA
elected into Group 4)
Group 4
Vesting Schedule: 10 years gets
50%, 20 years gets 100%,
formula amount
Vesting Schedule: 10 years gets
50%, 20 years gets 100%,
formula amount
Vesting Schedule: 10 years gets
50%, 20 years gets 100%, formula
amount
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CalPERS Projected Contribution Levels
The actuary report has two components to the annual billing of the employer portion of
retiree healthcare contributions that comprise the Actuarial Determined Contribution (ADC),
1) the Normal Cost (NC), and 2) the Unfunded Actuarial Accrued Liability (UAAL).
NC: This reflects a rate of contribution for the plan of retirement healthcare benefits
provided to current employees based on the current set of assumptions.
Employer Amortization of UAAL: This is an annual payment calculated to pay down an
agency’s unfunded accrued liability. Assuming every assumption in the actuarial valuation
was accurate, an organization would eliminate its unfunded pension liability if it made these
payments annually for 30 years. The City Council approved a closed period to amortize the
entire net pension liability over a specific timeframe, and 22 years of payments remain as of
June 30, 2021. The total liability will vary from one year to the next because of assumption
changes and actuarial experience that is different from anticipated, such as actual
investment returns that do not meet expectations.
As established by the City Council, the City’s CERBT Fund is invested in a Strategy 1 asset
allocation at a 6.75 6.25 percent discount rate. Beginning with the June 30, 2019, valuation
(CMR 11284), consistent with the City’s proactive pension funding policy, the City Council
approved the calculation of ADC at a lower 6.25 percent discount rate, transmitting the
amounts above a 6.75 percent discount rate as an additional discretionary payment
(“prefunding”) to the CERBT Fund. Other proactive measures to mitigate the increasing costs of
healthcare plans for current and future retirees include cost sharing with employees, capping
the plans covered, and establishing a flat contribution that can be adjusted with each labor
agreement for active employees.
The City’s CERBT Fund was established in May 2008 at a level of $33 million and it has grown to
$164 million as of March 31, 2022.
DISCUSSION
Summary of Actuarial Report June 30, 2021
Staff contracted with Bartel Associates, LCC (BA) for this retiree healthcare actuarial report
(Attachment A) to determine the City’s retiree healthcare liability and the ADC for Fiscal Years
2023 and 2024. The actuarial analysis is based on current employees’ accrued benefit, and
retired employees as of June 30, 2021.
This updated valuation includes several changes that have favorably impacted the CERBT fund
status, primarily due to healthcare and economic fluctuations resulting from the COVID‐19
pandemic. Most notably, investment returns for 2020‐21 reached an unprecedented level of
27.5 percent for the period. This level of return had a significant impact on the overall status of
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the fund and is not expected to continue in future periods. Healthcare premiums were lower
than anticipated likely due to government funding of pandemic‐related healthcare costs,
deferral of individual healthcare visits during the pandemic due to personal safety decisions and
public health orders and use of CalPERS reserves to keep premiums down.
The full impact on healthcare costs resulting from the pandemic is yet to be determined and is
expected to be factored into future valuation reports based on actual experience in costs. As
an actuarial study, the calculation is based on the information at this time, which reflects this
significantly lower cost. Staff and Bartel Associates are skeptical on the longevity of these lower
costs, versus the immediate result of the variables noted previously.
Beginning with this valuation, based on the favorable changes, baseline projections reflect
accumulated contributions to the CERBT may be used to pay a portion of the annual retiree
medical costs. This is a result of asset growth, where returns generated on higher asset levels
are sufficient to contribute toward a portion of the annual benefit payments. The ability to use
returns for this purpose is a goal of the prefunding strategy and a sign that a good practice is in
place. Achieving this status was anticipated to occur as a result of prefunding, however, has
occurred sooner than anticipated due to the favorable impacts discussed above.
Discount Rate Assumptions
The City Council has taken great interest to ensure long‐term liability assumptions and costs
for pension and OPEB are being proactively addressed, including the adoption of a Pension
Policy that assumes a 6.2 percent discount rate for pension costs compared to CalPERS rate of
7.0 percent (CMR 11722) and starting in FY 2023 a potential phased‐in reduction to 5.3
percent or alternative rate as designated by Council, to better align with market survey results
included in the most recent CalPERS Asset Liability Management (ALM) study. Additionally,
the City Council has taken actions to invest at an estimated discount rate for OPEB of 6.75
percent and transmit additional contributions to prefund OPEB obligations at the equivalent
of a 6.25 percent discount rate. The CERBT has subsequently reduced the discount rate from
6.75 to 6.25 percent; therefore, no prefunding is necessary to meet this target beginning with
the June 30, 2021 valuation. Through FY 2022, a total of $3.5 million in additional
contributions are expected to be contributed to the CERBT.
Discussed above, the ADC is impacted when actual experience differs from assumptions. One
of the more significant impacts to ADC occurs when actual investment returns do not meet
expectations. The following graph presents historical returns, looking back to 2008‐09.
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Figure 1: Historical Returns of the OPEB Trust
(Market Value of Plan Assets (MVA) and Expected Return)
Projected Unfunded Actuarial Accrued Liability
This actuarial report includes the plan’s “Funded Status.” As of June 30, 2021, the CERBT Trust
is funded at 70 percent, up 1,200 basis points from 58 percent in the June 30, 2019 actuarial
valuation.
As of June 30, 2021, the Unfunded Actuarial Accrued Liability (UAAL) was $80.0 million for all
funds and $51.5 million for the General Fund. Beginning with the June 30, 2013 valuations, the
City aligned its actuarial analysis to align with GASB’s rules regarding the “implied subsidy”. The
calculation of implied subsidy requires an agency to recognize that it pays the same medical
premiums for active employees as those that are retired. The implied subsidy identifies and
accounts for the agency paying the same blended premium for both active employees and
retirees, even though the medical cost for active employees is lower than retirees.
Palo Alto had 874 active employees and 1,009 retirees as of June 30, 2021. The calculation
increases the UAAL by $15.1 million or 18.9 percent; without the implied subsidy the UAAL for
all funds would be at $64.9 million.
Table 3: Unfunded Actuarial Accrued Liability (UAAL)
As of
June 30, 2019*
As of
June 30, 2021
Projected
June 30, 2022
Citywide – UAAL $122,972 $80,027 $76,159
General Fund – UAAL $82,624 $51,522 $49,032
Funded Ratio) 49.0% 67.2% 70.0%
Citywide UAAL % Change from prior valuation ‐35.0% ‐38.1%
* The June 30, 2019 values are based on a 6.75 percent discount rate. Beginning June 30, 2021, the discount rate
has been reduced from 6.75 to 6.25 percent
Sensitivity Analysis: Discount Rate and Amortization Period
CalPERS recognizes the varying assumptions that may impact a plan’s unfunded actuarial
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accrued liability and therefore a retiree healthcare plan’s funding status, especially the
implications of the discount rate and amortization assumptions. Therefore, in addition to the
actuarial assumptions used to develop this annual evaluation, BA includes a sensitivity
analysis of the retiree healthcare plan. Table 4 below reflects the impact on UAAL resulting
from a reduction in the discount rate. Table 5 reflects the impact on ADC if the UAAL is
amortized over different timeframes. It should be noted that the Council has adopted a
Pension Funding Policy seeking to reach a 90 percent funded level in what remains to be
approximately 14‐15 years, a shorter period that the sensitivity scenarios below.
Table 4: Discount Rate Sensitivity
6.25% (Current) 5.75% 5.25%
Citywide – UAAL $80,027 $94,571 $110,567
General Fund – UAAL $51,522 $60,886 $71,184
Funded Ratio 67.2% 63.4% 59.8%
Table 5: Amortization Sensitivity
22 Years (Current) 20 Years 18 Years
Normal Cost $6,316 $6,316 $6,316
UAAL Amortization $5,112 $5,459 $5,887
Total ADC $11,428 $11,775 $12,203
ADC (% of payroll) 10.3% 10.6% 11.0%
* Includes administrative expenses
Funding for the FY 2023 Including Actuarial Determined Contribution (ADC)
This section outlines staff’s recommended funding level for OPEB obligations beginning in FY
2023 for Finance Committee review and discussion and an alternative. Due to the
uncertainties noted previously that are unique to this report and given the limited data on the
impacts of COVID‐19, staff recommend alternatives assumptions that are rooted in the City’s
Pension Funding Policy, may be adjusted later in a subsequent fiscal year, and position the
City to smooth potential volatility in projected liabilities. A key result of the recovery period as
the pandemic moves into an endemic is a need to foster and work towards stability as an
organization; this stability helps ensure continued focus on high priority projects, supports
recruitment and retention efforts in a competitive labor market, and ensures a readiness and
nimbleness to adapt to changes. Acknowledging these lessons, staff recommends the Finance
Committee consider an alternative funding approach that adjusts assumptions based on
current data and the principles noted above. Staff have also outlined an alternative, or
“baseline” scenario for consideration. This funding level may be adjusted annually based on
City Council direction, so long as the baseline ADC is met.
Staff Recommended Funding for FY 2023 OPEB Obligations
Staff recommend adjusting funding from the typical baseline calculation to better align with the
current economic outlook, the current instability in the assumptions used to calculate the
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baseline and continue to proactively fund long‐term liabilities. Recommended revisions to
baseline assumptions include:
o Assume a zero percent investment return for the current 2021‐22 period:
The most recent March 31, 2022 quarterly report from CERBT reported year‐to‐date
investment returns of negative 1.39 percent as compared to a 6.75 6.25 percent target.
This scenario assumes investment returns of zero percent for the period ending June 30,
2022 to hedge against returns that may not be realized.
o Exclude proactive contributions at a lower discount rate towards the ADC:
Consistent with the pension proactive funding, this would treat the proactive
contributions assuming a lower discount rate of 6.25 5.75 as if in a separate “trust” or
“saving account.” ADC calculations will remain at consistent levels and these proactive
contributions remain additive to baseline calculations of liability.
o Assume a shortened amortization period from 22 to 15 years:
This change in the amortization period will more closely align OPEB with the City’s
Pension Policy goals to reach a 90 percent funded status over 15 years (by FY 2036).
The City Council previously approved a 30‐year closed amortization period of which 22
years remain as of June 30, 2021.
o Assume additional normal costs or “pay‐go” costs:
Adjust funding to include costs for the recommended additional staffing as approved or
being considered for approval in FY 2023.
This option results in an FY 2023 Proposed ADC of $14.6 $16.3 million citywide ($9.2 $9.9
million in the General Fund), a $2.3 $0.6 million reduction from the $16.9 million ADC in the FY
2023 Proposed Operating Budget.
Baseline
The baseline calculation reflects standard actuarial calculations and existing City Council
direction assuming the Strategy 1 asset allocation at a 6.75 6.25 percent discount rate., Since
this rate reflects the 6.25 percent discount rate approved by the City Council to assume and for
additional discretionary payments to the CERBT Fund at the equivalent of a 6.25 percent
discount rate, no additional prefunding payments are assumed in the baseline calculation.
Unlike the CalPERS pension plan, additional City contributions do not go into a separate Section
115 trust; instead, they remain in the plan and are included as assets in the CERBT each
subsequent year, impacting the calculation of the ADC. This treatment of prefunding
contributions included in assets and effectively reduce the ADC each future year.
At the request of staff, BA included an adjusted calculation to exclude the additional 6.25
contributions in ADC calculations to ensure consistent treatment as the Pension 115 Trust Fund.
The exclusion of this additional contribution from ADC will ensure that the City maintains
prefunding at consistent levels, similar to how contributions are made to the Pension Trust.
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City of Palo Alto Page 9
Overall, this baseline reflects an FY 2023 Proposed ADC of $12.3 $11.4 million citywide ($7.7
$7.1 million in the General Fund), a $4.6 $5.5 million reduction from the $16.9 million ADC in
the FY 2023 Proposed Operating Budget.
FY 2023 Proposed Staffing Additional Normal Cost Contributions
To be factored in all calculations of funding for FY 2023 is the potential addition of nearly 60
full‐time staff since the June 30, 2021 valuation date: 20 full‐time positions during FY 2022, and
nearly 40 full‐time positions in the FY 2023 Proposed Budget (mostly in the General Fund). As
reported in this valuation, the average salary of active employees is approximately $120,000
and the variable portion of ADC, or normal cost for current employees, is 5.6 percent of payroll.
Under these assumptions, the retiree healthcare cost of the additional staffing is approximately
$400,000. Staff recommends that this associated retiree health cost be included in the final
budget for Council consideration for FY 2023 adoption in alignment with the assumptions in the
recommended option above.
Stakeholder Engagement
The transmittal of the actuarial valuation as of June 30, 2021 begins conversations regarding
the fiscal outlook for the City’s OPEB liabilities and the appropriate contribution for the FY 2023
Actuarial Determined Contribution. Public discussion will be held with the Finance Committee
on June 7, 2022, prior to City Council review and adoption of the FY 2023 Budget, currently
scheduled for June 20, 2022.
Resource Impact
The FY 2023 Proposed Budget includes an ADC of $16.9 million, an increase of $0.5 million from
FY 2022 Adopted levels of $16.4 million. Staff recommendations in this report result in funding
levels of $14.6 $16.3 million, a net savings of $2.3 $0.6 million from the FY 2023 Proposed
Budget in all funds. Funding levels recommended by the Finance Committee will be included as
an amendment to the FY 2023 Proposed Budget for City Council adoption of the budget on June
20, 2022. Staff will incorporate this direction on an ongoing basis beginning in FY 2024.
Future funding is subject to City Council approval through the annual budget process. The
recent market fluctuations and overall impact of the current pandemic are yet to be fully
realized. These reports are calculated bi‐annually and reflect market conditions at that point in
time. This Trust experienced gains in this most recent report, however, will continue to be
closely monitored.
Environmental Review
This report is not considered a project for the purposes of the California Environmental Quality
Act (CEQA). Environmental review is not required.
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