Tough Times Call for Creative Funding Alternatives
Poor returns on pension investments, runaway healthcare costs, and reduced shared revenue have forced most state and local agencies to make the hard choices between what is needed and what can be afforded. Handcuffed with tax-levy caps and unfunded, mandated programs, many agencies are scrambling to find alternative funding methods and looking for ways to reduce costs.
Historically, when the time arrives to assess community programs and agency needs, one of the first to fall victim to cuts has been equipment and vehicle replacement. While the philosophy that “we can make it last one more year,” may certainly hold true, it too comes at a price. The impact of deferring vehicle/equipment replacement goes far beyond capital budget cost. Keeping these units past their economical life adds expenses to the agency’s operating budgets and profoundly impacts the productivity of the fleet division and customer departments. As vehicles and equipment age, much like everything in life, the likelihood for breakdowns and repairs increases.
To effectively deliver critical services and maintain established levels of service, such as snowplowing, park maintenance, and police and fire response, the agency must guarantee that good dependable vehicles and equipment are available to the service providers.
Replacement Fund Offers Option
To save fleets from budget amputation during hard economic times, public agencies can consider alternative funding methods, including leasing, using operating funds to purchase smaller, cheaper vehicles (under $50,000), and co-operative purchasing. Establishing a vehicle replacement fund, however, might be the best long-term solution. A vehicle/equipment replacement fund works on the premise that no vehicle or piece of equipment will be purchased or replaced until the money to do so is in hand, in short, an accrual process. With such a program, departments make annual payments (replacement fees) from their operating budgets to a replacement fund for each unit assigned to the department. The replacement charge is equal to the acquisition cost, amortized over the estimated useful life of the asset, plus insurance and an inflationary factor.
In rare instances when a decision is made to defer replacement of a specific piece due to low utilization, exceptional condition, etc., thus keeping it beyond its useful life, the using department is not charged additional annual payments, since sufficient replacement money has already been collected. The money is then held and invested as funds to replace the unit in the future. Public agencies around the country, including the city of Ames, Iowa, and Waukesha County, Wis., have already implemented similar replacement fund programs. Paul Hinderacker, City of Ames fleet services director, has worked with this type of program for many years and notes that its benefits include “greatly helping improve productivity in our department.” Implementing a replacement fund program may require some buy-in from end users and elected officials, since replacement charges may directly affect operating budgets. However, the impact of assessing a department an annual charge for future equipment replacements must be weighed against the agency’s desire to reduce additional bond funding and eliminate long-term debt service for capital purchases. In some cases, seed money may be required to help kick-start the program. “Instead of seed money, we chose to double the replacement fee in the program’s first few years in order to get it off the ground,” says Hinderacker.
Timely Replacements Assured
One substantial benefit of such a funding mechanism is that end-users are assured timely replacement of vehicles and equipment, thus reducing higher future expenses associated with older, less reliable vehicles and equipment; a benefit also realized by the entire agency and taxpayer. The program may affect departments that rely on tax levy. However, that impact must be viewed from a global perspective, since the overall benefit to the agency is eliminating competition for funds and/or the need for additional bond debt plus interest, which ultimately are still paid with tax levy and/or other revenue sources.
Language may be required via ordinance to allow the agency to adopt an accrual program similar to a contingency fund or to establish a trust fund or enterprise account. In developing governance policies for these programs, it is important to include specific language guarding against fund diversion to cover other budget shortfalls, particularly during tough times. A reasonable depreciation/lifecycle schedule is also crucial, since it serves as the basis for the accrual of funds to replace units.
The immediate benefits of adopting a vehicle/equipment replacement fund are numerous:
• Reduces competition for limited funds (a contest fleets usually lose!) For agencies that bond for vehicles/equipment replacement, the program reduces bond money amounts required and may free up funds for other capital projects.
• Allows interest to be earned on accrued money versus paying interest on borrowed funds. The interest earned may be credited to the replacement account to cover shortfalls due to cost increases or replacement piece upgrades (usually limited to 10 percent of originally estimated cost). Earnings can also be used to cover overhead cost thus lowering vehicle/equipment rates (as does the city of Ames).
• Eliminates arbitrage penalties. Savings realized from better-than-anticipated pricing are noted as residual and banked in the replacement account to cover shortfalls. These savings may also be credited back to the using department. Enough residual may also be realized to fund new additional pieces in the future, thus reducing the annual replacement charges to departments.
• Allows full vehicle and equipment replacement on a timely basis, since the replacement process is not driven by how much the agency can afford in any given year.
• Reduces the amount of parts and labor dollars needed to repair older vehicles/equipment that ultimately equates to sunk cost.
• Ensures disposition of vehicles and equipment before they are deemed “scrap,” allowing maximum resale value.
Other ways to help build the vehicle/equipment replacement fund include the use of fleet-generated revenues such as auction profits and insurance proceeds. Often these unpredictable revenue sources are anticipated and projected in operating budgets, a practice that should be avoided. Instead, any revenue realized from these areas should be reinvested in the replacement fund, thus reducing the need for supplemental funding. Replacement fund programs also can be implemented to replace other commodities with an expected useful life, such as computers. Obviously, many factors may determine the feasibility and practicality of implementing replacement fund programs including vehicle ownership, the equipment charge-back process, seed money availability, and ultimately, the philosophy of the authorizing environment. However, creating a fund that, in essence, serves as the piggy bank for future asset replacement makes fiscal sense; especially at a time when the public is adamantly opposed to additional tax increases and generally disenchanted with the overall cost of government.
FOR MORE INFORMATION: George Torres is director of fleet management for Milwaukee County, Wis. He is also an assistant professor at Cardinal Stritch University and an adjunct instructor for Ottawa University. He can be reached at [email protected]