Council Increases Reserve Fund Threshold

Council Increases Reserve Fund Threshold
Photo by Chris Parypa

OCEAN CITY – After months of debate, resort officials this week approved a proposed budget redirection plan that includes, among other things, increasing the minimum threshold for reserve fund balance from 15% to 17%.

In the weeks since fiscal year 2023 budget deliberations, City Manager Terry McGean, Budget Manager Jennie Knapp and Finance Director Chuck Bireley have been working on a proposal to address the town’s unrestricted fund balance and direct it in such a way as to prepare for disaster, other unforeseen circumstances or revenue shortfalls.

For years, the town’s stated policy has been to maintain a reserve fund balance of 15% of the general operating budget. The reserve fund balance is a rainy-day fund of sorts to cover potential storm damage or other disasters, pension investment return shortfalls or other dips in revenue sources. The reserve fund balance is also used for certain pay-as-you-go capital projects.

There has been talk in recent months about increasing the minimum reserve fund threshold from 15% to 20%, and following budget talks earlier this spring, the Mayor and Council directed staff to explore the options. In reality, the minimum 15% threshold is largely a paper one as fund balance has soared to over 30% in recent years to over $28 million.

However, that figure is somewhat deceptive because portions of the reserve fund balance are directed at other costs. For example, at the outset of the presentation on Tuesday, McGean pointed out while the fund balance at the end of the last fiscal year was over $28 million, the actual balance at the 15% reserve policy was more like $14 million. The overall balance is reduced by $1.1 million for the Ocean City Development Corporation (OCDC) parking lot fund, the fire apparatus fund at $1.5 million and a $1.5 million transfer to the capital reserve fund.

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McGean explained there are factors to consider when deciding on the minimum threshold for the reserve fund balance.

“There are three major threats to fund balance,” he said. “The return on investment in the pension fund is one concern. The current operating budget includes $3 million in one-time federal COVID grants. There is also the impact of a natural disaster or just a bad summer to consider.”

In terms of the return on investment in the pension fund, the town, through its financial advisors, make investments using pension funds based on an average return of 7%. In some years, the investment return exceeds the 7%, while in other years it falls short of the expectation. If the investment return falls short, the town must make an investment in the pension fund to make up the difference.

“Typically, what happens is, we look each year at the return on investment in the pension fund,” said McGean. “We based the budget on an average 7% return. If it exceeds 7%, it reduces our contribution to the pension plan. It’s just a snapshot in time. If it happened today, we would have to make a contribution to the pension plan.”

For that reason, the plan presented on Tuesday recommended setting aside $2.5 million from the reserve fund balance to cover a potential shortfall in the pension fund. Councilman John Gehrig said when there are times when the pension investment return exceeds 7%, the difference should be returned to the pension fund as a cushion against future shortfalls.

“We’re going to have periods when we’re above the 7% or below the 7%,” he said. “When we’re above, I always think it should stay in the pension fund.”

The plan presented this week also calls for setting aside $1.9 million in unspent federal American Rescue Plan Act (ARPA) funds to cover increases in salaries and benefits for employees in the coming fiscal year. The town received millions of dollars in federal COVID-related ARPA funds and there is a balance in that account of $1.9 million.

The plan also includes a larger contribution to the capital reserve fund (CRF). Last year, the Mayor and Council created the CRF as a source to fund ongoing capital projects such as street paving, canal dredging and the like. The initial contribution to the CRF was $3 million as seed money, with a plan to add $1.5 million in each out year.

McGean said the plan presented on Tuesday recommended increasing the fiscal year 2023 contribution to $3 million from fund balance. The current CRF balance is around $1.6 million, and upping the contribution to $3 million would leave a balance of $4.6 million.

McGean said there are several critical capital projects on the horizon that could be funded by an expanded CRF. He said those projects, which include repaving the Inlet lot, Caine Woods traffic calming measures, the OCDC police department project, a new police substation and a new floor at the transfer station, could be re-evaluated after the summer when the picture becomes clearer on anticipated room tax and other revenue sources.

“That would essentially allow us to do two years’ worth of projects in the next year,” he said. “The first thing is addressing the threats we perceive to fund balance and the second is to start adding these other projects.”

Finally, the plan presented on Tuesday includes increasing the minimum reserve fund balance from the current 15% to 17%. Again, there has been considerable discussion about raising it to 20%, but McGean said the proposed 17% figure represented a conservative compromise.

“The reserve policy should be increased from 15% to 17%,” he said. “This increases our ability to cover lost revenue and additional expenses due to a disaster. Since theoretically the financial impact of these events will increase as the city budget increases, it makes sense to tie the reserve amount to the budget.”

McGean said all of the measures proposed in the plan would actually reduce the town’s unassigned fund balance considerably.

“The result of these actions will reduce the unassigned fund balance from $10.4 million to $2.7 million,” he said. “Should revenues or pension performance exceed expectations, any additional unassigned fund balance should be used for other capital projects.”

Council Secretary Tony DeLuca praised McGean, Knapp and Bireley for the well-thought-out plan that was presented.

“We assigned you this project,” he said. “You took all of this information and put together a very solid strategic plan.”

McGean said the plan as proposed represented a fiscally-responsible way for the town to prepare for peaks and valleys during its budget cycles.

“The perfect word is smoothing,” he said. “This allows us to smooth that out as we rebound from COVID and as we look to grow room tax, parking or other revenue sources. When we have a valley, we will be prepared for that.”

Councilman Mark Paddack agreed the plan as presented was conservative and prepared for any eventuality.

“I know there was a lot of ambiguity and you have been very prudent with this plan,” he said. “You’ve done the threat assessment homework. I feel comfortable with this proposal to protect the Town of Ocean City and its taxpayers. This is conservative, responsible and prudent.”

Councilman Lloyd Martin said the information presented in the plan painted a more accurate picture of the level of reserve fund balance.

“This shows the public exactly why we have this fund balance and what we use it for,” he said. “It shows we’re not just hoarding funds. This is very responsible. It looks like we have $28 million, but it’s more like $15 million because some of it is dedicated to doing these important things.”

After considerable debate, the council voted 6-1 to approve the plan as presented, including increasing the minimum reserve fund balance threshold from 15% to 17%. The lone dissenting vote was Councilman Peter Buas, who voiced concern about setting aside too much money for recurring liabilities.

About The Author: Shawn Soper

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Shawn Soper has been with The Dispatch since 2000. He began as a staff writer covering various local government beats and general stories. His current positions include managing editor and sports editor. Growing up in Baltimore before moving to Ocean City full time three decades ago, Soper graduated from Loch Raven High School in 1981 and from Towson University in 1985 with degrees in mass communications with a journalism concentration and history.