Resolution on 6/17 to Increase Premiums, Spousal Carve Out, Smoker Surcharge Increase

Whereas, the premiums for the Basic and Premier PPO plans have not been increased since FY 11 and for the past few years the healthcare fund balance has been negative due to Plan revenues not being increased to match Plan Expense FY 10 - the beginning balance for Health Fund was a positive $1.635 M. A $ transfer out resulted in a negative fund balance of $6.4 at year end – By design, the Healthcare fund frequently subsidizes the retiree fund (OPEB), as in this case the “transfer out” was to the OPEB Fund. The OPEB fund, considered a fiduciary fund for GAAP, was required to maintain a positive balance. Without the above noted transfer from the Healthcare Fund, the OPEB Fund would have had a negative balance. This transfer-out caused the Healthcare fund to have a negative balance of $6.4M at year end (Recall, this was Today, we no longer allow negative balances in any Fund, including the Healthcare Fund). This is an example of the chronic underfunding problem caused by setting health care premiums too low. FY 11 & FY 12 – the negative fund balance of $6.4M was reduced to $510k – The negative balance improved not because premium revenue increased or claims decreased, but mostly because in 2012 the City received a one time federal grant of approximately $5M in Early Retiree Reinsurance Program (ERRP) subsidies. Without the ERRP grant the fund balance would have been negative by greater than $5.0 M. The structural problem of revenue (premiums) not keeping up with expenses (actual health care costs) persisted during this period. The 24% premium increase passed in the FY 2015 Budget is intended to address this ongoing structural deficit. 2

Whereas, in FY13 the healthcare fund ended the year with a negative fund balance of $2.685 FY13 - $22M in employer paid retiree healthcare was not included in budget which was originally planned to be covered by OPEB trust – Only $6M of OPEB trust (originally funded by the Healthcare Fund) was used and not paid back The 2013 Budget contemplated the use of approximately $22 M of OPEB Trust Funds to be used to pay retiree health claims that in FY 2012 had come from the General Fund. In FY 2013, this freed-up extra General Fund dollars to be used for court-ordered payments to Memphis City Schools. Fortunately, not all $22M was needed from the Trust Fund. The OPEB Trust fund was tapped in 2013 for retiree health care payments, but by the end of the year, the net change in the Trust Fund was only a negative $6M. Healthcare fund ended with a net deficit of $2.685M Inconsistent FY13 Actuals makes it difficult to interpret the funds activities for that FY – FY15 Proposed Budget, FY15 Adopted Budget, FY15 HR budget presentations, and 2013 CARF all contain different FY13 Actuals as it pertains to the Healthcare Fund During the course of the Budget cycle, the forecast changes multiple times. The most consistent and/or reliable place to look for actual performance of any line item is in the CAFR. The forecast is a moving target that must be kept in this context. Administrations and Councils have always been able to produce workable budgets despite the inherent uncertainty involved. 3

Whereas the administration forecasted a deficit of $11.5M for the FY14 budget; however, Council approved additional funding for only $4.2M – This is correct. The deficit the administration forecast did, in fact, occur. As a result, the Administration had to ask Council, at mid-year clean-up, to transfer $7.4M from the General Fund to cover the deficit. FY14 Adopted Budget Excerpt – The Healthcare Fund is budgeting revenues of $125.1 and expenses of $127 million for FY This will produce a deficit for FY 2014 of $1.9 million; however the general fund will transfer $4.0 million to the health fund which will eliminate the deficit. This reflects the compromise reached among Council members on the premise that expenses would not be as high as the Administration predicted. However, as noted above, the deficit was much higher than $1.9M. An additional $7.4M was needed to fund the deficit at mid-year clean-up. FY15 Adopted Budget – Showed FY14 forecasted revenue to be higher than plan and claims expense forecasted was less than plan resulting in a net positive fund balance for FY14 As noted immediately above, this forecast includes the additional $7.4M transfer-in, and as such it represents our best estimate that the fund will be slightly positive – which is required by accounting rules. We are optimistic that this forecast will hold. Without the $7.4 transfer noted above, the fund would be negative. Significant FY14 forecast variances when comparing FY15 Proposed Budget, FY15 Adopted Budget, FY15 HR budget presentations – During the course of the Budget cycle, the forecast changes multiple times. The most consistent and/or reliable place to look for actual performance of any line item is in the CAFR. The forecast is a moving target that must be kept in this context. Administrations and Councils have always been able to produce workable budgets despite the inherent uncertainty involved. 4

Internal Service Fund Concerns Fund Balance for FY11 Actuals (both beginning of year and end of year) in Internal Service Summary within FY13 Adopted Budget shows a positive balance when it should be a negative – This typo (positive sign should have been a negative sign) was in the FY 2013 Budget. It had no impact on the actual fund and has not reappeared or impacted any subsequent financials. The “Internal Service Funds Combining Statement of Revenues, Expenses, & Changes in Fund Net Assets” within the CAFR (FY10 – FY13) contain significant variances when compared to the Internal Service Summary within Adopted Budgets – Budget and CAFR accounting do not have the same purpose and reporting requirements. The CAFR is a final, “point in time” number with specific requirements concerning how items are categorized – mostly for use by outside analysts. The budget is not a static document reflecting a point in time measurement. Budgeting is a dynamic process, used by the administration and council to make decisions, that requires continuous monitoring and occasional revisions to incorporate changing economic environments and operational developments. – Accordingly, budget Books and CAFRs are sometimes arranged differently. The Budget Book includes OPEB revenue within the Internal Service Fund page. The CAFR includes OPEB revenue within the Fiduciary Fund Section. This would make revenue appear much higher in the Budget Book than in the CAFR. Starting FY13 – Death Benefits of $522k paid out of Healthcare Fund; as well as $22k in capital outlay – The Council authorized the use of these funds from the Healthcare Fund to pay the first-year premiums on an insurance policy that restored the death benefits for retirees. The benefit had been eliminated as part of overall efforts to balance the city budget. Before the elimination, the benefit payout had exceeded budget for a couple of years. – The $22,000 was spent to move the benefits office from city hall to its current location at Union Extended. The new location made the office more accessible to employees by improving the parking situation and the new location provides private meeting space for analysts to have confidential discussion with employees and retirees seeking information and guidance on their benefit options. Significant formula errors – FY14 forecast for Fleet Management (FY15 Adopted budget) shows a $7.4M loss that should have been a $7.4M gain – FY13 Adopted Budget for Healthcare shows a $3.5M loss that should have been a $3.5M gain – These typos (negative signs should have been positive signs) are human errors in summary sections that did not impact the 2015 proposed or adopted budget. 5

Retirement Healthcare Cuts 6

Excerpt From FY15 Adopted Budget The City will continue to pay for the retiree healthcare cost for persons that are not eligible for Medicare, and the City will identify ways to ease this transition of all impacted employees and retirees. – The details of the plan are contained in numerous presentations made to Council over the past several months. This single sentence was a reference to the post 65 population and not intended to be a full description of the plan. 7

Council Rationale for Cuts: Healthcare ARC when combined with Pension ARC creates a $100M expense from State Treasurer states the following: – No statute or rule that requires immediate payment of OPEB unfunded liability – Multiple jurisdictions only use a pay as you go policy By creating and investing in an OPEB trust (created in 2009), the city of Memphis represents prudent financial practice as it pertains to OPEB Until this year, there was no rule requiring that we pay the full Pension ARC either. This could very well change. GASB is already considering an OPEB accounting change similar to the Pension change. Regardless of accounting rules, not paying the full ARC only kicks the can down the road – if ARC is not paid today, the “pay as you go” payments will eventually increase to levels higher than today’s ARC. The next generation of Memphians will pay tomorrow for the commitments we are making – but not funding - today. These payments will compete for funding with other services. This will either “crowd out” other services (e.g. public safety cuts) or necessitate revenue increases. 8

Council Rationale for Cuts: Healthcare ARC when combined with Pension ARC creates a $100M expense What is the true expense of the Healthcare Unfunded Liability? – $1.22 Billion unfunded liability, $84M ARC – before reforms. However, after the reforms made in the adopted Budget, the new unfunded liability is $756.4M (down $467M) and the ARC has decreased to $33M, down $51M – Only one actuarial estimate obtained for the Healthcare Unfunded Liability PwC is the City’s actuary The actuary used to provide the Healthcare Unfunded Liability misstated Pension Unfunded Liability by $200M Not correct. PwC most recently estimated the unfunded liability to be $709M. Later, after the TN legislature passed a reform bill that specified certain assumptions and after extensive consultation with Segal (hired by Council), a new (not a misstated) unfunded liability was determined to be $551M. This was a reduction of $158M based on revised assumptions, not a misstatement by PwC. 9

Council Rationale for Cuts: By Cutting Retiree Benefits, We Can Repurpose Those Dollars to Fund the Pension ARC Proposed FY15 Budget reflected a $27M savings with only $15M going to Pension ARC. What happened to the additional $12M in savings? – In the proposed budget, this $12M in savings was made part of a $15M “Pension and Public Safety Fund” (PPS Fund) to be allocated by council, as needed, during the course of FY During the budget hearings, however, Council directly apportioned this $15M between Pension ARC and funding for MPD and MFD recruiting/training classes, effectively eliminating the PPS Fund. – $12M decrease in property tax revenues going to the General Fund as a result of the Property Tax Reapportionment to Debt Service Adopted Budget reflects a $23M savings with $15M going to Pension ARC. What happened to the additional $8M in savings? – Council amendments used this savings to fund MPD and MFD recruit classes. – $8M decrease in property tax revenues going to the General Fund as a result of the Property Tax Reapportionment to Debt Service Higher overall property tax revenue in adopted budget; as well as, a small decrease in amount of property tax reapportioned to debt service The adopted budget included a $0.17 cent transfer of property tax revenue from the General Fund to the Debt Service Fund to meet rising debt service payments in

The City has a Debt Crisis not a Healthcare Crisis 11

Impact of 2010 Debt Refinancing Over the past 2 fiscal years, property tax revenue has been reapportioned from the General Fund to the Debt Service Fund No slowing down on new Debt – FY15 proposed budget exceeded the policy for G.O. Bond issuance by approx. $20M – Goal is $65M/year CIP, on average. – Council approved the CIP budget that included approximately $20M for the Raleigh Springs project. CIP projects funded with GO Bonds of this magnitude are infrequent. 12

Additional Concerns Police Division – The FY15 Proposed Budget for Police Division was based on a “new mission” that has not been defined; however, the purpose is to no longer offer a Full Service Police Department in Memphis in FY15 No recruitment class expense in Proposed Budget (included in adopted budget) 236 reduction in authorized complement (through attrition) – Inflated expenses Ex. In fY15, over $4M transferred to debt service for vehicles that are budgeted in General Services (MPD vehicles are purchased by GS with CIP funds. The Police Division pays the Debt Fund for the Debt Service costs on its vehicles). – The use of attrition line to capture savings on vacant positions that are budget at 100% with no intention of backfilling Over $40M in attrition savings over FY14 and FY15 Police Director has always included the full Authorized Complement in budget process so that full cost could be displayed. The attrition line has been routinely used to net that salary expense down to expectations. 13

Additional Concerns Budget accuracy and transparency – Council analyst denied “read only” access to the legal level detail of the Adopted Budget Read Only access given to Council analyst for security reasons. Only Budget Department and Division analysts are given system access. Further access into the budget system would involve unacceptable data security risks. – Numerous formula errors i.e. Internal Service Funds See comments on page 5 – Forecasting errors i.e. FY14 forecasted expense (in FY15 Proposed Budget) for sick leave was included in Full Time Salaries expense line; as well as, Sick Leave expense line resulting in an over statement of expense of $2M within Police Division alone. New Budget software used for the first time in FY 2015 collapses all ”salary” sub-categories used in prior years into a single expense line. This does not result in an overstatement. 14

Proposal Based on the information we have provided today, delay the healthcare changes for FY15. – Any delay will substantially increase the City’s employee and retiree healthcare expenses in This increased expense would have to be offset from either reducing ARC payments or GF reserves. This will increase total pension costs and potentially hurt our credit rating. – Delay increases the pressure to find additional funds for the pension in the FY 2016 budget. – The OPEB program, without the reforms being implemented, had an ARC of $84M. With reforms, the ARC is $33M. Failure to implement the approved reforms will continue to cause our unfunded liability to increase, costing the City hundreds of millions of dollars over the long term. During the next FY, obtain the following: – Get accurate information to obtain a baseline Independent audit and analysis of city financials specific to the Internal Service Fund; as well as, OPEB Trust – The City’s financial statement, including the healthcare and all funds are audited every year (CAFR) by a nationally recognized accounting firm with expertise in municipal fund accounting. Obtain multiple actuarial estimates on Healthcare Unfunded Liability (similar to pension) based on current benefit offerings – The administration does not believe that additional actuarial analysis is needed. Further, our OPEB liability is so substantial that any conceivable adjustment would not change the magnitude of the issue and the need for reform. – Explore ALL options Create financial models for both Healthcare and Pension Unfunded Liabilities – Adjust variables/assumptions to see unfunded liability impact – Actuarial models, developed by PwC, one of the oldest, largest and most respected actuarial firms in the world, are in place and these is no need for further delay. RFP for insurance (CIGNA contract will be up) Agree, RFP will be issued this fiscal year. High deductible option – As reported to Council last month, this plan was reviewed by the Administration and health care consultant Mercer, and not found to be a viable option. 15