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HomeMy WebLinkAbout2026-09-15 Finance Committee Summary MinutesFINANCE COMMITTEE SUMMARY MINUTES Page 1 of 8 Regular Meeting September 15, 2026 The Finance Committee of the City of Palo Alto met on this date in the Community Meeting Room and by virtual teleconference at 4:00 PM. Present In-Person: Lauing (Chair), Burt, Lu Absent: Call to Order Chair Lauing called the meeting to order. The clerk called the roll and noted all were present. In-Person Public Comment None Chair Lauing noted Item 2 would be addressed before Item 1. Agenda Items 1. Accept California Public Employees’ Retirement System (CalPERS) Pension Annual Valuation Reports as of June 30, 2025; CEQA Status—Not a Project. Budget Manager Jonathan Rewers gave an overview of the presentation. Slide 3 illustrated "Pension Buck" & terminology for pension funding sources. The first category was CalPERS Investment Earnings. More than half of every pension dollar comes from investment returns. Because market returns represent the majority of funding, investment volatility is the primary driver of employer rate fluctuations. Fiscal year (FY) 2025 returns came in at 11.6 percent against the 6.8 percent target. The second category was Employer Contributions, reflecting 34 percent, which consists of Normal Cost and Unfunded Accrued Liability (UAL). The third category was Employee Contributions at 11 percent, consisting of the statutory member share plus cost-sharing. Budget Manager Rewers said they want to consider the Pension Trust, which stands at $131M and provides a stabilizing buffer that improves funded status by 7.6 percent to 78.4 percent. SUMMARY MINUTES Page 2 of 8 Finance Committee Meeting Summary Minutes: 09/15/2026 Budget Manager Rewers showed a slide summarizing the findings of the June 30, 2025, CalPERS Valuation Reports. CalPERS has maintained the discounted rate at 6.8 percent and adopted updated demographic and inflation assumptions from the FY 2025 Asset Liability Management Study. There is $1.7M in anticipated savings due to stronger market returns and lower UAL payments. Preliminary returns for FY 2026 are 14.8 percent. While this has been a good run of investment earnings, Staff's concern is that it is a hot market, so there is upcoming risk. Slide 5 detailed the UAL and the funded status across the safety and miscellaneous plans. Favorable investment performance caused a drop in the UAL from $566M to $504M. The miscellaneous UAL decreased to $294.6M and the safety UAL decreased to $209.9M. On a CalPERS-only basis, the City is 70.8 percent funded but factoring in Section 115 Trust, the net UAL is reduced to $373M and combined funded status rises to 78.4. Slide 6 displayed projected employer contribution rates as a percentage of payroll. Rates will peak in FY 2029 at 36.2 percent for miscellaneous and 76.1 for safety. This peak reflects the 5th and final year of the negative 6.1 percent return from FY 2022 ramping into rates. Rates decline steadily from FY 2029 through FY 2033 to 29.7 percent for miscellaneous and 66.3 percent for safety as favorable investment returns phase in and workforce savings compound. Budget Manager Rewers talked about the discounted rate on the UAL due to prepaying. Budget Manager Rewers presented a slide showing Anticipated Outlook. The preliminary FY 2026 investment return of 14.8 percent will be recognized in the next valuation and begin phasing. It will phase into employer rates in FY 2029. CalPERS has adopted a 75 percent equity and 25 percent bond reference portfolio, which increases potential earnings and increases risk. Assembly Bill 1383 is pending before the governor. Staff is monitoring and will model budget impacts if enacted. In November 2026, there will be a comprehensive 4-year retirement benefit policy review. They will continue to review OPEB and make recommendations regarding retiree benefit policy. In December/January, they will come forward with the Long Range Financial Forecast (LRFF). Then, they will go through normal budget deliberations for budget adoption in June. Chief Financial Officer/Administrative Services Department Director Lauren Lai answered questions from Councilmember Lu. She said the policy anchors around being 90 percent funded but the bigger question is whether that is sufficient to de-risk for the City. They will bring that back in November. The current projections indicate they will meet the 90 percent funded status. They will have to strategically evaluate. Ultimately, they want 100 percent funded but she emphasized the strategy between funded status and Section 115 Trust strategy, which they will bring back. She said the discount rate used by CalPERS is the long-term estimate of long- term investment returns, which is 6.8 percent. They felt that assumption was too optimistic, so they reduced it to 5.3 percent. That requires them to contribute more. They will reevaluate and continue to de-risk. Councilmember Lu thought translating some percentages to numbers would be useful. Councilmember Burt talked about the employer contribution trend being unclear. His recollection is that it is now an improvement over the last projection. He asked what the previous projection was. CFO Lai recalled the peak year being FY 2030. Councilmember Burt SUMMARY MINUTES Page 3 of 8 Finance Committee Meeting Summary Minutes: 09/15/2026 asked if long-term projections are adjusted as they get individual years. Assistant City Manager Kiely Nose said every year is like a new mortgage. Annual costs move on a downward trend because they pay off each year's mortgage. Councilmember Burt asked if they could translate percentages into dollar amounts and how it would affect budgets. He was interested in trends of when they peak on percentage of employer contribution and what that means in terms of dollars on their budget. CalPERS Actuary Matthew Biggart said the amortization schedule has the dollar amounts and they can use the normal cost rates in the projections and multiply it based on projected payroll to determine dollar amounts going forward. He did not know how the peak year has evolved over time. He referred to Table 2 showing the normal cost trending up. The total ADC is $68.5M in FY 2026 and goes up. The difference in the total ADC is only $200,000 between FY 2027 and 2028. It goes up another $3M in 2029. Councilmember Burt said they should look at it in the context of inflation adjustments. CalPERS Actuary Biggart agreed and said it is a component of the payroll cost. Councilmember Burt said it is a component of the total budget and total income. It is more favorable in that sense because it is going down as a percentage of total budget. CalPERS Actuary Biggart said it was a good point to bring up total ADC because the percent is one factor and payroll is the other. When they come back in November and look at scenarios, they will include the formula with the percent and dollars. Councilmember Burt thought it was important to show how far they have come. A committee member talked about the impact of Section 115 as it translates to funded status on unfunded liability. Councilmember Burt wondered about stability of returns if equity and bonds are hit at the same time. A committee member talked about giving the investment team more agency to be responsive. Item 1 Public Comment: None MOTION: Councilmember Burt moved, seconded by Councilmember Lu, to recommend the City Council recommend that Council accept the California Public Employees’ Retirement System (CalPERS) Pension Annual Valuation Reports as of June 30, 2025 for the Miscellaneous and Safety Plans. MOTION PASSED: 2-0-1, Lauing absent 2. Discussion of Baker Tilly Reserves Advisory Report and Recommendation to the City Council of Proposed Policy Updates to the Utilities Reserve Management Practices: CEQA – Not a Project Utilities Department Director Alan Kurotori said this item has gone to the UAC. Utilities Department Assistant Director Lisa Bilir said this was accepted by the City Council in June. She said this report is about staff recommendations and UAC recommendations on implementing the recommendations from the Baker Tilly Reserves Report. She talked about a workflow that staff has developed to review and revise reserve policies for Council SUMMARY MINUTES Page 4 of 8 Finance Committee Meeting Summary Minutes: 09/15/2026 consideration. The focus of today's discussion is electric, gas, and water utilities. They are aware that the regional water quality control plant is bringing forward recommendations on the treatment side of wastewater treatment, and they will have more information to include when they bring forward the wastewater collection recommendations to the UAC in November and Finance Committee in November or December. They are envisioning a second phase looking at specific reserves and supply-related information. She gave a brief overview of recommendations from the Advisory Report. The 2 main recommendations are on the Capital Improvement Program (CIP) Reserve and the Rate Stabilization Reserve (RSR). The staff and UAC recommendation on the CIP Reserve is consistent with the Baker Tilly recommendation. They are recommending to replace the current CIP Reserve policy that has a minimum and maximum guideline level with a target that is based on the average annual CIP budget. They are recommending to get to the target level within a 5-year timeline for gas and water utilities and within a 10-year timeline for the electric utility. The 10-year timeline for the electric utility would mean a 0.1 percent rate impact each year. The gas utility would have a 0.2 percent rate impact and the water utility would have no rate impact. For the RSR, the Advisory Report recommends setting the target to align with the bond covenants and the levels of the benchmark communities. The sampled benchmark communities had targets ranging from 10 percent to 65 percent of operating revenues or expenses. Palo Alto's existing rate stabilization policy does not have a target or guideline level for the RSR. It states that if there is a balance in the reserve, staff must develop a plan to result in the withdrawal of all funds by the end of the 5-year planning period. Assistant Director Bilir explained that the RSR provides a financial buffer against volatility in revenue and expenses and helps maintain stable rates. Revenue risks that would be stabilized with the RSR are weather events, economic conditions, and slower growth than expected in a community. Expense risks are unexpected fluctuations in operating costs, non-CIP emergency repairs, and supply chain pressures. The recommendation for the RSR is to come in at the low end of the Baker Tilly recommendation to mitigate rate impacts. They are recommending 10 percent of operating expenses as the target level for each utility. She showed a table with rate impacts of that recommendation. Staff is recommending the 5-year implementation period of 0.3 percent rate increase each year. They brought this to the UAC, who had a discussion focusing on the benefits of potentially combining the RSR and the Operations Reserve. They would like to see more information about pros and cons of the RSR. Staff recommends to remove the provision that requires them to withdraw all funds from the RSR by the end of the planning period. The reason for that is to retain a certain target level of funds in the RSR for use in unplanned situations. There are supply-related reserves that have to do with rate stabilization, and they will look at those in more detail with a rate consultant and bring it back in a second phase. She mentioned that as they thought about the RSR, they wanted to try to write the reserve policy in a way that would allow staff to draw down funds in the RSR as long as it is within a preapproved range and within the preapproved purposes. The aim would be to allow staff to take care of routine types of reserve transfers while elevating any policy-level recommendations to the Council. SUMMARY MINUTES Page 5 of 8 Finance Committee Meeting Summary Minutes: 09/15/2026 They thought about the pros and cons of combining the RSR with the Operations Reserve versus keeping it separate. If they are combined, there may be greater flexibility in use of funds. Two separate reserves would each have a clearly defined purpose and restrictions on use of funds. Keeping them separate is more consistent with the sampling of peer utilities in the Advisory Report and is consistent with Baker Tilly's recommendation to not change the City's currently existing reserves. She showed a slide of 5-year rate forecasts. The top table showed the rate forecast as adopted by the City Council in June. The bottom table showed that the only utility that has an impact of 1 percent each year is gas. The impacts for electric and water are less than 0.5 percent. Staff and UAC recommend the Finance Committee recommend that the City Council adopt revisions to the Utilities Reserve Management Practices using a target of the annual average CIP budget in the CIP Reserve, getting to that target within 5 years for the gas and water utilities and within 10 years for the electric utility and using the workflow that staff proposed. There are options for the RSR. Staff recommends a target of 10 percent of operating expenses, adjusting the rules for excess reserve balance, and implementing this over a 5-year time frame. The UAC recommendation was for Staff to return with pros and cons of the RSR. Councilmember Lu asked about the flexibility they have to loan in between funds in the context of this plan. Assistant Director Bilir said they don't have flexibility to loan in between funds. It was only done in instances where there was an urgent need to do so. Councilmember Lu thought they have some built-in flexibility even though the number is technically zero. Assistant Director Bilir said they made a plan to recover additional funds in the gas utility even outside of the Baker Tilly Report. They plan to restore the reserves to within the guideline ranges. Councilmember Lu asked how they would handle flexibility if they need money they don't have in the CIP Reserve. Assistant City Manager Kiely Nose said Staff would look to find if there are expenses they can repurpose within the gas fund. They could deprioritize something that is not as high level and prioritize the emerging challenge. Depending on the order of magnitude of that challenge and whether they are able to find repurposing or reprioritization within existing resources and depending on the size of the investment, they would look at financing it internally or externally. Regardless, it has to be a loan with fair loan terms with a quick repayment if it was done internally. Alternatively, the Council could decide it was important and direct them to take it from the General Fund. Director Kurotori added that they tried to keep rates flat in the wastewater utility during the pandemic, so there was a loan from the fiber utility to the wastewater utility. Those situations are not ideal. They want to plan for each utility to stand on its own; that is why they have built back reserves. Councilmember Lu agreed. He said there is a last resort that gives them flexibility to build reserves more slowly and asked for a reaction to that concept. Director Kurotori said the intent for the reserves was for the utility to be able to weather those storms. It should not rely on another utility as a backstop. If there was something catastrophic, yes, but they intend to prevent catastrophes by making prudent investments. Director Kurotori's gut reaction is they SUMMARY MINUTES Page 6 of 8 Finance Committee Meeting Summary Minutes: 09/15/2026 need to maintain reserves. Councilmember Lu said if they go over 10 years or 5 years, there is not that much downside risk to going over 10 years, so he was trying to understand whether that was true. Assistant City Attorney Caio Arellano said it is not something they plan for but it is legal and doable. In the instances they have made interfund loans in the past, it was with Council approval. Chief Financial Officer/Administrative Services Department Director Lauren Lai asked if Councilmember Lu was saying it is okay to build reserves over a period longer than 10 years or the repayment period. Councilmember Lu saw that the CIP timeline was recommended at 5 years for gas and water and wondered how much more risk there was in the interim if they build the reserves up more slowly. CFO Lai said that based on study and peer review, they are standing behind the recommended timelines. Director Kurotori said it was a prudent approach to try to replenish in a shorter time frame given needs and risk profiles. He said the difference on the electric utility is that they have the electric special project reserves. Having prudent reserve policies in place and effective days of cash on hand associated with the utilities helps them get low rates as they go out to the markets. Councilmember Lu said it sounds like there is a strong preference for 5 years and that 10 years is a one-off with electric. Looking back at scenarios where they have used their RSR, he wondered what the equivalent percentage would be if they are proposing to set aside 10 percent of operating costs. He clarified that he was asking about the percentage of rate stabilization on operations that they used in prior emergencies like COVID. Assistant Director Bilir said they tried to pull those numbers for the meeting but it is complicated. She knows they used about $20M on the water utility during the drought of 2022- 2023 where the revenue is about $50M, so 40 percent. Councilmember Lu said it is not that much in the context of how they spend the money. Assistant Director Bilir said they use the money quickly. Councilmember Lu thought that was useful context. Councilmember Burt asked what the reserve target was for the CIP Reserve, what percent of the average annual CIP. Assistant Director Bilir replied that it would be 100 percent of the annual average CIP. Councilmember Burt thought they should include that it is 100 percent. Assistant Director Bilir thanked him for the suggestion. Councilmember Burt asked what would drive the need for a significant rate stabilization reserve on electric. Assistant Director Bilir said they were trying to extract the rate stabilization reserve from other types of risks. The risks are things like fluctuating revenue, weather events, and economic downturns. They impact distribution system revenue in addition to supply revenue. They are focusing on distribution revenue and how it can be affected by changes in revenue or unexpected changes in expenses. Councilmember Burt asked what the recommendation was on that reserve amount. Assistant Director Bilir answered that it was 10 percent of operating expense. She clarified that that was SUMMARY MINUTES Page 7 of 8 Finance Committee Meeting Summary Minutes: 09/15/2026 for just the distribution operating expense. Councilmember Burt asked on which commodities was the 10 percent. Assistant Director Bilir replied electric, gas, and water. Councilmember Burt asked if they need the same percent on electric that they do on gas on water. He noted that gas has potentially wildly fluctuating commodity costs and water can fluctuate as well with droughts. He asked when was the last time they had a need for rate stabilization on electric. Assistant Director Bilir said they were trying to extract the supply cost volatility for the utilities and focus on the distribution system but they had to implement the hydro rate adjuster in 2023, which was expensive. They had to raise rates when they took it out of being implemented. Councilmember Burt noted that it was really the drought impact because they are heavily hydro, which Assistant Director Bilir confirmed. Director Kurotori agreed, saying the hydro rate stabilization reserve is very important for Palo Alto because they get more than 40 percent and up to 60 percent of their supply from hydro. A bad hydro year impacts revenues and customer rates, so they need the ability to stabilize that. Councilmember Burt noted the 10-year period to get to the reserve target for electric and 5 years for gas and questioned why there was a difference in the timeframe. Assistant Director Bilir said there are no funds available for the gas and water utilities and the reserves are low. They are concerned that there is not a buffer. The electric utility has some funding in the Electric Special Projects Reserve and has a special council policy that governs it. Director Kurotori added that they are doing a grid modernization and have planned out capital projects. They have looked at those costs to minimize risks of failure. That investment reduces unexpected CIP costs. Councilmember Burt noted the different recommendations between Staff and UAC on the Rate Stabilization Reserve. He wanted to know why they should go forward right now versus having additional discussion. Assistant Director Bilir thought UAC was looking at the simplicity of having the Operations Reserve and Rate Stabilization Reserve combined. They are happy to have further conversations with UAC on that but right now they are trying to be consistent with the recommendations from Baker Tilly. They are looking forward to the FY 2028 rate cycle and trying to make sure they can do something now that they can implement within that time period because there is a cumulative effect on building funds for the Rate Stabilization Reserve. They are trying to move forward during this fiscal year, so implementation can be done in 2028. Councilmember Burt asked how much time the UAC needs for additional pros and cons. Director Kurotori said UAC wanted more information on the nuances associated with the Rate Stabilization Reserve. Councilmember Burt asked how it would impact them if they took a couple more months. The answer was that it would be fine. He said they value the Baker Tilly recommendations, staff's insights, and UAC. If there is no urgency, he does not want to default to Baker Tilly. He wants to give UAC the opportunity to flesh it out. Assistant Director Bilir said as they prepare preliminary rates and proposed rates this fall and early next year, they have to go through reserve policies and update language, so they are trying to gather as much information as they can as early as possible. They will be talking with UAC. SUMMARY MINUTES Page 8 of 8 Finance Committee Meeting Summary Minutes: 09/15/2026 Chair Lauing noted that everyone was concerned about the high reserves and not being able to pay bills. He thought Baker Tilly was aggressive on best practices and there is still a UAC and Council debate on the issue relative to policy. He questioned the wording on Slide 8 and if funds must be drawn down only for a proposed rate increase. Assistant City Manager Nose said Staff wanted it to be part of the policy to pull excess funds as part of annual financial forecasting, so money would not accumulate. Chair Lauing asked what recommendation was needed with Councilmember Burt's request. Councilmember Burt thought it would be to adopt the UAC recommendations. Assistant City Manager Nose clarified the committee would recommend the reserve alignments for water, gas, and electric on the CIP Reserve recommendations and would like Staff to take another stab at the review of the RSR Reserve when they go back to UAC on the wastewater collection. She said even if they were to combine the reserves, they would likely need to reset their operating reserve targets. Councilmember Burt thought it would more likely be that if you combine them, you would not need an amount that would assume they would get drained at the same time. Assistant City Manager Nose said that was correct and she would expect a modest increase in the operations reserve. They can have the conversation with the UAC and revisit the topic before the end of the year. Item 2 Public Comment: None MOTION: Councilmember Burt moved, seconded by Councilmember Lu, to recommend the City Council adopt the following revisions to the Utilities Reserve Management Practices; 1. Replacing minimum/maximum guidelines with a target based on Average Annual CIP Budget 2. CIP Reserve Target timeline: 5 years for Gas and Water Utilities; 10 years for Electric Utility 3. FY 2027 WORKFLOW: staff recommends Council adoption of proposed FY 2027 workflow for revising and approving the Utilities Reserve Management Practices. 4. Direct staff to return to the Utilities Advisory Commission on the pros and cons of the Rate Stabilization Reserve MOTION PASSED: 3-0 Future Meetings and Agendas There will be several meetings In October studying reserves more focused on wastewater as well as discussion about grid modernization financing. Virtual Public Comment None Adjournment: The meeting was adjourned at 5:13 P.M.