Tucson is preparing to withdraw $25 million from its self-insurance reserve fund to help offset an $80 million shortfall in this year's budget, despite warnings from its financial advisers that depleting the fund could leave the city with no way to pay a big legal judgment.
The self-insurance fund, used to pay lawsuits and workers-compensation claims, has been operating at an increasing deficit since 2001 because city departments haven't been putting enough money in to cover their losses.
By the end of the last budget year the deficit was at $17 million — something Deputy City Manager Mike Letcher said top city officials didn't know because nobody told them.
The $25 million is collateral required by the state to make sure the city can pay any claims. Withdrawing it is legal as long as the city replaces it with some other guarantee it can pay its obligations.
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But the move would boost the deficit to $42 million, which is so large it could trigger an outside audit, according to e-mails obtained by the Arizona Daily Star.
Frank Abeyta, former finance director, warned that emptying the fund was inappropriate just before he abruptly quit in January.
In his first interview since quitting, Abeyta said "it's pretty evident" why he opposed the transfer, declining to comment further.
Lee Schiffel, assistant professor of accounting at Valparaiso University in Indiana, said the transfer would definitely catch the attention of the city's auditors and could lead to a downgrade of the city's credit rating.
The move comes at a time when the city is preparing to restructure hundreds of millions of dollars in debt to save an estimated $10 million a year in interest.
"I think they're going to have serious questions from their auditors," Schiffel said. "It wouldn't concern me so much if they hadn't run a deficit in that fund for so long. I don't know what assurances they could give me that they could turn this around."
The $25 million reserve, which includes a Treasury bond and cash, fulfills a state requirement for being self-insured.
If the money is transferred, the city is required to buy a surety bond to guarantee payment in case it defaults on a liability claim.
The surety bond would cost $500,000 a year. Taxpayers would also lose the annual earnings from the Treasury bond if it's traded in, which have averaged $685,000 annually over the past two years.
The bond would not cover any city losses. It would just guarantee creditors payment if the city can't pay. If the surety company has to make good on that guarantee, the city would have to pay it back, said Risk Manager Joel Peterson.
A surety is just a promise to pay if the city doesn't, he said. "The surety would pay it for us and then they would come after us for it. We do have to repay them." No final decision
Letcher said the city would transfer the $25 million only if it would not increase the self-insurance fund's deficit — something that both experts and other city officials say is impossible.
"It's a proposal. No decisions have been made," Letcher said.
But Interim Finance Director Silvia Amparano said the city applied to its insurance broker, the Mahoney Group, for a surety bond this week. She said the city doesn't know what company would underwrite the surety bond, adding the broker would help find interested companies.
Abeyta moved from Flagstaff in October to become interim finance director, and was made permanent finance chief in early December. But he quit Jan. 30, giving no notice or explanation.
E-mails show on the day he quit he told another city employee to stop Rio Nuevo payments to the University of Arizona for work on a new science center, adding in the e-mail that City Manager Mike Hein said he "would rather not know what discrepancies we find in payments to U of A."
Hein said an agreement with the UA requires the city to pay the bills.
Also that day, he e-mailed Letcher about Finance Department projections showing the city running out of cash to pay its bills in December. Letcher said the city has cash-flow issues, but they are resolvable.
Abeyta also opposed the transfer of the Treasury bond and cash-out of the self-insurance fund. He wrote to Letcher two weeks before leaving, stating, "I don't believe this would be an appropriate use of funds."
Abeyta repeatedly declined to talk specifically about why he quit. He said it's something for the city to resolve, and since he is no longer there he doesn't want to be involved. He said others may not agree with the concerns he had.
However, he said, "There's enough information to resolve it," adding, "people could see it for themselves."
"There were a number of issues that I saw, but I don't want to comment," Abeyta said. "That's the position I'm taking at this time."
Letcher said the city initially stopped looking at the transfer after Abeyta's opposition but resurrected the idea after he left. He said it's possible the city could cash in only a portion of the $25 million to ensure there is enough in its rainy-day fund. Fund in deficit since 2001
The city's self-insurance fund has run deficits since 2001, several city officials said.
In 2008, the fund had an operating loss of $5.6 million, Peterson said, because the city did not charge departments enough to offset the cost of claims and workers compensation.
A portion of the current $17 million deficit includes funding for future liabilities the city knows it will owe but which haven't come due yet. But last year's losses contribute to a negative cash balance of more than $11 million.
The transfer, boosting the self-insurance deficit to $42 million, could open the city up to a "management-audit finding by external auditors due to the long-term nature of the fund balance deficit," according to an e-mail written by Joyce Garland, a city finance manager. Garland said the city would need to come up with a plan to address the deficit.
Government accounting expert Charlie Francis said freeing up cash to balance current deficits is often a good strategy. But Francis also said he is concerned about the self-insurance fund's long-term deficit.
Letcher said the City Manager's Office didn't know about the seven-year self-insurance fund deficit until Abeyta pointed it out. "Up to that point in time nobody in finance came forward and said we had a deficit."
He said the city is developing a long-term plan to address the self-insurance deficit but didn't give specifics.
"It took a long time to build this deficit. It's going to take a long time to get out," Letcher said. "We want to take care of it."
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