Overcoming fiscal hardships in government

Creative actions are helping finance leaders succeed in a challenging public-sector environment.
Overcoming fiscal hardships in government

CFOs of US state and local governments of all sizes must provide necessary services to their residents within budget constraints, including managing revenues, capital, and human resources. Even though the US economy has improved overall from recessionary pressures, recovery varies from state to state. Many organisations and municipalities are still recovering from stock market downturns and deteriorated fiscal conditions, and continue to face financial pressures.

The US Governmental Accounting Standards Board's new pension and other post-employment benefits (OPEB) accounting standards may bring additional challenges. Obligations are being recast in a way that will significantly increase the reported liability amounts on many balance sheets, and there are substantial additional financial statement disclosures. Government financial position and solvency issues may become more exposed, which can be particularly problematic for entities that are already in difficult situations. Pension and healthcare liabilities represent a significant claim on future revenues, which may influence credit ratings and increase the cost of issuing debt.

"A positive outcome from the accounting changes is an increased awareness of the liability to provide future employee benefits and what organisations need to do to prepare for that," said Anne P. Harty, CPA, the CFO for the city of Rock Hill, South Carolina. While some of the initial liability "sticker shock" has subsided, Harty said it is now more important to have a plan to address the future liability with thoughtful assumptions and realistic contributions. The plan should be reevaluated every few years, she said.

Greg Mennis is director for the Public Sector Retirement Systems Project at The Pew Charitable Trusts. He agrees that the accounting changes provide better and more consistent information on the cost of current benefits and sensitivity of liabilities to changes in rate of return. "The changes do cast a greater spotlight on fiscal challenges of states and cities, but most of that information is already available and understood by bond rating agencies and research organisations," he said. "Our focus is to help state and local policymakers think about the challenges from an economic and policy perspective going forward."

Mennis said that the level of reported unfunded pension liabilities in the aggregate for state and local systems is nearly as high as it has ever been ($1.78 trillion in the second quarter of 2017, according to Federal Reserve data). "There was a deterioration of fiscal position due to stock market downturns that has stabilised but not improved. Exposure from investment risk and financial market volatility is also as high as it has ever been, and the outlook for investment returns is expected to be substantially lower than historically," he said.

In addition, Mennis noted that fiscal health across states and cities varies considerably. "Some states are well-funded and have strategies to strengthen sustainability of their pension and OPEB systems going forward, but many states' [OPEB plans] are on a "'pay-as-you-go basis' and are strained," he said.

Steps CFOs can take

Prudent fiscal management can help governments of all sizes manage finances and avoid insolvency. Government finance leaders are in a unique situation because political leaders may largely dictate how their funds are collected and spent. Every jurisdiction is different in the challenges it faces and its goals for government services. Here are some strategies government CFOs can implement to ensure sustained long-term stability and growth:

Manage budgets: Many state and local governments are expecting lower rates of revenue growth and investment returns than they have seen historically. It is challenging to maintain the tax base and put infrastructure in place to be ready for recovery during recessionary times.

In Rock Hill, general operations are budgeted using a baseline budget with cost-of-living increases applied. Amounts above baseline must be submitted as "initiatives" that are evaluated and prioritised to make sure they are good additions overall. Department heads have been given more accountability and flexibility in managing their budgets. "There is more flexibility on managing the individual line items but severe compensation penalties when it comes to annual raises for exceeding the total budget," Harty said.

The city of Rock Hill implemented "gain sharing", a programme where employees can submit recommendations for cost savings; their suggestions are reviewed several times a year by a committee with representatives from all departments. The recommendations can include areas for significant change, such as changing electric components of city streetlights for easier assembly, and dollar awards can be significant.

Control labour costs: Governments are service organisations, so payroll is a significant budget component. "Position control is important, to provide citizens quality services they want at affordable cost," Harty said. In the past, Alfredo Riverol, CPA, CGMA, the CFO for the city of South Miami in Florida, had to address labour costs to make up revenue shortfalls. "From 2008 through 2010, assessed property values for real estate in Miami were so high but then collapsed, and 2010 was the first time we had layoffs," he said. At times, he has evaluated outsourcing for cost savings but has not done it. "It's not always about dollars and cents, because the dollars and cents would have clearly said outsourcing was the way to go," he said. "But it's about the services provided."

Control healthcare costs: The city of Rock Hill has reduced employee healthcare costs and increased productivity by offering employees an on-site clinic at work, run by a hospital, for basic healthcare needs at no cost to them. Police officers and firefighters can get their physicals there. Employees receive insurance discounts for managing their healthcare and meeting wellness and fitness goals. A health insurance committee with representatives from each department educates employees about the value of health insurance benefits and how to use the clinic.

Manage pension costs: States have little control over contribution rates for state retirement plans. Mennis suggests that government CFOs consider strategies to manage pension liabilities. These include strategies to increase funding; use more conservative assumptions (like assumed rate of return on plan investments and expected economic growth); and implement hybrid pension plans with a smaller defined benefit component and more individual savings accounts.

Certain state public pension systems have adopted stress-test reporting. Policymakers don't always have the information they need to understand implications of economic downturns and lower investment returns on pension plans' funded status. This analysis enables modelling of how public pension plan balance sheets will perform under different economic scenarios and provides a basis for deciding on changes in funding or benefits. "This is not just an academic exercise," Mennis said. "This information is actionable because it can be used to address real fiscal concerns and propose reform."

Manage revenues: In addition to cost control, CFOs can improve budgets through revenue enhancements. "Society is moving more to a user-based mentality, and [people] don't want to pay for something unless they use it," Harty said. "Of course, you can't do that with things like police and fire, but you can with building permits and park fees. We regularly look at our revenue sources and evaluate them to make sure they are competitive and affordable." For example, the city put a 2% hospitality tax in place on prepared meals and beverages and funded all sports- or tourism-related facilities with that tax. "That's a tax people have a choice about because people have a choice as to whether they eat out," said Harty.

The city of Rock Hill is included in an annual Cost of Public Services Survey of 29 cities. "We compare all our rates to other cities around us," Harty said. "We want to be in the middle, not the most or least expensive as it relates to taking care of our infrastructure." The city uses the survey results to inform elected officials during the budget process and to potentially justify increased rates.

The city of South Miami reevaluates fees for items such as permits and parking every budget cycle. "We do cost evaluations, working with the city manager and legislators, to make sure we are charging the right amount and assess the impact of changing fees as compared with the benefit of the service," Riverol said. "We have a very active downtown. You can't price parking too high, or people will not come downtown to shop and eat at our restaurants. There is a social benefit, not only dollars and cents. But you can't let businesses close and assessed values go down. It's all linked."

Refinance debt: CFOs should analyse outstanding debt and consider potential savings from refinancing. Some debt agreements have call provisions with early redemption penalties, which should be weighed (along with closing costs) against lower interest costs.

When interest rates dropped, between 2011 and 2014, Harty refinanced city debt, saving over $6 million. "With the new municipal adviser rules in place, financial managers are not calling anymore recommending when there is an opportunity to refinance, so CFOs really need to pay attention to this," Harty said. She hired a financial adviser to watch the market, and she was able to pay the adviser firm a low retainer with a larger fee if the city does a bond offering with the help of the adviser firm. CFOs may not have the staff or the time to do this, and this can be a small price to pay.

The city of South Miami implemented a plan over an eight-year period to eliminate all short-term bank debt and short-term capital leases, and also refinanced long-term bonds. "We evaluate interest rates on idle cash in invested funds as compared with the interest savings on using those funds to pay off debt," Riverol said.

Retain employees: An important strategy for stability in government organisations is having quality staff. Harty encourages government CFOs to communicate with their employees and educate them about the value of excellent health (and pension) benefits. "This is an area of focus, because with the economy picking up we are seeing some turnover and people going to the private sector for more money," she said. Rock Hill also keeps employees informed about things going on in the city through monthly newsletters. Hiring and retaining good employees is also an area of emphasis for Riverol. He recommends that CFOs find the best staff who understand accounting concepts, and invest in their success by providing ongoing training.

Evaluate projects: CFOs and finance departments can team with infrastructure project and economic development staff to identify opportunities and evaluate economic impacts. It is helpful for CFOs to be brought into the development project process early.

Cities may be mandated to undertake capital projects to provide infrastructure, such as water, roads, and sewers. Riverol works with his procurement office and provides needed analysis, and the city uses competitive bids to manage project budgets.

During the recession, the city of Rock Hill established public-private partnerships with construction companies that needed work. The companies built new buildings, infrastructure, and sports facilities at significant savings, including a velodrome cycling facility and BMX Olympic facility that generated millions of dollars in tourism revenues. The city established a partnership with a developer who had purchased 1,000 acres for development but could not build due to the economy; the developer agreed to donate 250 acres to the city in exchange for the city putting in amenities to help his development. "It was wildly successful," Harty said. "His business park is almost full, and his hundreds of homes exceed the average home values in the city. We were able to do unique things for the city, put construction workers to work when they were available, and got some excellent pricing."

Use tax incentives: Harty used new market federal tax credits in her partnership with the private developer to build the velodrome. There were restrictions on the type of project that qualified, and there were high legal costs, so the project cost had to be substantial enough to justify them. "It was complicated and a lot of work, but very worth it," Harty said. The incentives resulted in the project loan requiring interest-only payments for the first seven years, and 25% of the loan principal being forgiven.

Use outside advisers: Third-party advisers can be useful in areas where CFOs do not have professional resources internally. Riverol uses third-party advisers to develop economic impact studies for development in areas such as parks, police, and public works. He also uses a financial adviser whenever the city is considering paying off or refinancing debt. "When I'm doing something of financial consequence, I want to utilise special expertise and talk to the best," Riverol said. Harty and her finance department routinely evaluate the cost of different divisions, providing certain services in-house compared to contracting them out to third parties.

Maria L. Murphy (emailmariamurphy@gmail.com) is a freelance writer and editor based in Wilmington, North Carolina. To comment on this article or to suggest an idea for another article, contact Ken Tysiac, an FM magazine editorial director, at Kenneth.Tysiac@aicpa-cima.com.