Appendix C: Financial Policies

Introduction

The City of Somerville has an important responsibility to carefully account for public funds, to manage municipal finances wisely, and to plan and provide for the adequate funding of services desired by the public and as required by laws, rules, or regulations, including the provision and maintenance of public facilities and improvements. The budget and financial goals and policies in this document are intended to establish guidelines for the continued financial strength and stability of the City of Somerville. Sound Financial Condition may be defined as:

• Cash Solvency – the ability to pay bills in a timely fashion.

• Budgetary Solvency – the ability to balance the budget annually.

• Long-Term Solvency – the ability to pay future costs.

• Service Level Solvency – the ability to provide needed and desired services.

• Public Confidence – the ability to garner public support for decisions that promote financial stability.

It is equally important that the City maintain flexibility in its finances to ensure that the City is in a position to react and respond to changes in the economy and new service challenges without measurable financial stress.

Goals

Goals are broad, timeless statements of the financial position the City seeks to attain. The financial goals for the City of Somerville are:

• To provide full value to the residents and business owners of Somerville for each tax dollar by delivering quality services efficiently and on a cost-effective basis.

• To preserve the quality of life of Somerville residents by providing and maintaining adequate financial resources necessary to sustain a sufficient level of municipal services, and to respond to changes in the economy, the priorities of governmental and non-governmental organizations, and other changes that may affect financial well-being.

• To maintain and improve the City’s excellent Aa2 (Moody’s) and AA+ (S&P) credit ratings.

• To employ balanced and fair revenue policies that provide adequate funding for desired programs.

• To maintain appropriate financial capacity for present and future needs.

• To promote sound financial management by providing accurate and timely information on the City’s financial condition.

• To ensure the legal use of financial resources through an eff ective system of internal controls.

Operating Budget Strategy

• Balanced Budget. The annual operating budgets will be appropriated on a balanced basis, where operating revenues (estimated revenues) are used to fund operating expenditures/expenses (appropriations).

• Operating revenues include property taxes, motor vehicle excises, charges for services, interest earnings, license and permit fees, fines and forfeitures, regularly recurring governmental aid, and transfers in from other funds established for operating purposes.

• Operating expenditures/expenses include salaries and wages, employee benefits, equipment and improvements, depreciation (proprietary funds only), materials, supplies, contractual costs and debt service.

• Nothing in this policy shall prohibit the use of operating revenues for capital expenditures/expenses.

• To the extent possible, one-time revenues that are not required by law or agreement to be expended for a particular purpose will only be used for capital purposes, augmenting of City reserves or emergency expenditures/expense.

• The Finance Director will annually estimate the costs of the City’s obligations for providing benefits for City and Somerville Public School employees as part of the preparation of the annual operating budget.

• The operating budget will only be subsidized by the Rainy Day Stabilization Fund in emergency situations, and then for only a limited time.

Revenue Policy

• The Finance Director is responsible for estimating revenues for the upcoming fiscal year. The Finance Department will consult with other officials of the City as well as state officials and others with knowledge of state and local finance.

• Revenue forecasts for local receipts and state aid shall be conservative, using generally accepted forecasting techniques and appropriate data. Revenue deficits will be avoided at all costs. To avoid any potential for such a deficit, estimates for local receipts will generally not exceed 105% of the prior year’s actual collections.

• Each year and whenever appropriate, existing revenues will be re-examined and possible new sources of revenues will be explored to ensure all revenue potential is maximized. All fees are reviewed and periodically updated, as necessary.

• The City will strive to be informed and aware of all grants and other aid that may be available. All potential grants and other aid shall be carefully examined for matching requirements (both dollar and level-of-effort) and restrictive covenants, to ensure that participation in such grants will be beneficial and cost-effective.

• Each year and whenever appropriate, intergovernmental revenues will be reviewed to determine their short and long-term stability and to minimize the impact of any adverse changes. Intergovernmental revenues shall be used as legally prescribed or otherwise set forth by policy.

• A balance will be sought in the revenue structure between elastic and inelastic revenues, to minimize any adverse effects caused by inflationary or economic changes.

• One-time revenues will be used for capital improvements, additions to reserves or as legally restricted to a specific purpose.

• The City will carefully and routinely monitor all amounts due the City. An aggressive policy of collection will be followed for all receivables, including property taxes.

• User charges and fees will be set to recover approximately 100% of total direct and indirect costs.

Expenditure/Expense Policy

• Expenditures/expenses and purchase commitments will be made in a form and process that is legal, appropriate, funded, authorized and sufficiently documented.

• The balances in appropriation accounts will be monitored regularly to ensure that the total of expenditures/expenses and purchase commitments in any account do not exceed the authorized budget for that account.

• Requests for competitive bids, proposals, formal and informal quotes, and other methods of seeking and encouraging vendor competition will be obtained as required by law.

• Arrangements will be encouraged with other governments, private individuals, and firms, to contract out or cooperatively deliver services, in a manner that reduces cost and/or improves efficiency and effectiveness while maintaining service quality.

• The full direct and indirect costs will be calculated for any service provided for a fee or charge, or where there is a potential for the reimbursement of such costs.

• All appropriations shall lapse at the close of the fiscal year to the extent that they shall not have been expended or encumbered.

Risk Management Policy

The City will maintain an effective risk management program that provides adequate coverage, minimizes losses, and reduces costs.

• The City will annually work with the City’s insurance carrier to update all listings of City owned assets and the value of such covered assets.

• As the City is self-insured for several of the benefits programs it offers, the City will conservatively budget for its Workers Compensation, Unemployment Compensation, and Health Insurance Programs, as follows:

• Workers Compensation will be budgeted at least 110% of the average annual claims for the prior three years.

• Unemployment Compensation will be budgeted at 110% of the average annual claims for the prior three years.

• Health Insurance will be budgeted at the full premium amount set by the GIC and will assume that all vacant positions will enroll in the most popular health insurance plan.

Reserves Policy

Stabilization Funds

• The City of Somerville shall maintain Stabilization Funds to provide the reserves that are required to protect the financial condition of the City.

• It shall be the goal of the City to achieve and maintain a balance in the Stabilization Funds of no less than 10% of the operating budget but in no case less than 5% of the operating budget.

• Interest earned on Stabilization Fund balances will be retained in the Stabilization Funds.

• The Stabilization Funds should be used to provide for temporary financing for unanticipated or unforeseen extraordinary needs of an emergency nature; for example, costs related to a natural disaster or calamity, an unexpected liability created by Federal or State legislation, immediate public safety or health needs, opportunities to achieve long-term cost savings, or planned capital investments and related debt service.

• Withdrawals from the Stabilization Fund will only be made by a two-thirds vote of the City Council, only if the balances exceed the 5% target and will not draw the balance below that point.

• To the extent possible, the Stabilization Funds will not be used to fund recurring budget items.

• In order to replenish the Stabilization Funds, in the year immediately following any withdrawal, an amount at least equivalent to the withdrawal should be deposited into the fund. Said funding should come from Free Cash or revenues. If Free Cash or revenue is insuff icient to replenish the Stabilization Funds in the immediately following fiscal year then the replenishment should occur as soon as Free Cash or revenue is available, and no further withdrawal should occur until the funds have been replenished.

• The Capital Stabilization Fund is used to defray the cost of pay-as-you go new equipment, planning studies, building repairs/maintenance, capital improvements to land and buildings, and related debt service, to the extent that these costs may be funded by the Fund’s balance. It is the goal of the City to maintain a minimum unreserved fund balance of $2 million in the Capital Stabilization Fund.

• The Rainy Day Stabilization Fund is maintained for unanticipated or unforeseen needs of an extraordinary nature.

Free Cash

Free Cash is a revenue source that results from the calculation, as of July 1, of the community’s remaining, unrestricted funds from its operations of the previous fiscal year based on the balance sheet as of June 30. It typically includes actual receipts in excess of revenue estimates and unspent amounts in departmental budget line items for the year just ended, plus unexpended free cash from the previous year.

• Given that Free Cash is a one-time revenue source, it should not be used to fund any personnel, program, or initiative that would require expenditures in subsequent fiscal years. Free Cash should be restricted to paying one-time expenditures, non-recurring, unforeseen expenditures, funding capital projects, or replenishing other reserves.

• It is the City’s policy to reduce and then eliminate its use of free cash as a revenue source for the ensuing year’s budget.

• It is the City’s policy to use Free Cash to enhance reserves (Capital Stabilization, Salary and Wage Stabilization, Green Line Extension Stabilization, OPEB Trust, etc.); fund non-recurring, unforeseen expenditures, and/or provide funding for additional capital projects.

• The target goal for the City is to generate between 3-5% of the annual appropriated budget in free cash. At no time should unappropriated free cash be less than .5 % nor more than 7.5% of the annual appropriated budget.

• Free Cash shall not be depleted in any particular year in order to enable the following year’s calculation to begin with a positive balance.

• To meet the target goal of 3-5% Free Cash, the City will orchestrate conservative revenue projections and departmental appropriations to produce excess income and departmental turnbacks.

• The City will endeavor to apportion a minimum of 30% of its yearly free cash certification to the Capital Investment Plan.

Capital Budgeting and Planning Policy

• The City will update and readopt annually a five-year capital improvement plan (“CIP”), including the upcoming annual capital improvement budget and a four year projection of capital needs and expenditures which details the estimated cost, description and anticipated funding sources for capital projects.

• The first year of the five year CIP will be the basis of formal fiscal year appropriation request.

• The capital improvement budget and plan will generally address those capital assets with a value of more than $50,000 and a useful life of over five (5) years.

• Capital Items costing less than $50,000 each need not be included in the CIP and should be funded in the annual operating budget.

• Capital Items costing more than $50,000 but less than $250,000, including improvements of a scheduled and recurring nature, such as safety equipment and vehicles, may be funded from available funds: free cash, grants, unexpended bond proceeds of a like purpose, etc. unless they are improvements to buildings.

• Improvements to buildings and capital items costing more than $250,000, such as large vehicles and roofs, roads and sidewalks, should be paid by borrowing. The debt service for that borrowing would be paid from the operating budget until the maturity of the bonds.

• Very large building and utility infrastructure projects, such as new, replacement or improvements to buildings costing $4,000,000 or more, may be funded by borrowing paid for from debt exclusions, city reserves, or use of District Improvement Financing. The City will continue to maintain Stabilization Funds for such a purpose.

• The City will emphasize preventive maintenance as a cost-eff ective approach to infrastructure maintenance. Exhausted capital goods will be replaced as necessary.

• Lease-purchase agreements may be authorized to allow the City to take advantage of special conditions or circumstances, where the terms are advantageous to the City.

• Short-Term debt may be used to provide necessary cash flow prior to bond sales, in order to start capital projects on optimal construction or acquisition schedules before determinate costs can be ascertained. The City, when possible and economic, will use cash on hand to fund projects until bonds are issued.

• The scheduling of bond issues will be arranged to provide the necessary on-going funds for each capital project.

• Proceeds from the sale of municipal property shall be dedicated to capital improvement financing.

Debt Management Service

General Fund Debt Service

• A limit on debt service costs as a percentage of the City’s annual budget is especially important because of Proposition 2 ½ constraints on the City budget. At the same time, the community’s regular and wellstructured use of long-term debt signifies the municipality’s commitment to maintaining and improving its infrastructure.

• The City will observe a debt service “ceiling” of 10% for non-excluded debt service, meaning that annual debt service payable on non-excluded bonded debt should not exceed 10% of the annual operating budget. The City’s current target is not to exceed 7% of the annual operating budget. The City also designates a debt service “floor” of 2% as a continued expression of support for continued investment in capital infrastructure.

• Long-term debt will be issued only for objects or purposes authorized by state law under Chapter 44, section 7 and 8.

• Short-term debt may be issued to finance current operating expenditures only in the event of extreme financial emergency.

• Debt maturity will not exceed the lesser of: the useful life (as established by the City Treasurer-Collector), or the period of probable usefulness (as defined in Massachusetts State Local Finance Law), of the object or purpose so financed, whichever is shorter.

• The City will maintain good communications with bond rating agencies, bond counsel, banks, financial advisors and others involved in debt issuance and management.

• The City will attempt to maintain a long-term debt schedule so that at least 50 percent of outstanding principal will be paid within ten years.

• The City will continually pursue opportunities to acquire capital by means other than conventional borrowing, such as grants, and low-or-zero interest loans from state agencies such as the Massachusetts Water Pollution Abatement Trust (MWPAT), Massachusetts School Building Authority (MSBA) or the Massachusetts Water Resources Authority (MWRA).

Enterprise Fund Debt Service

• Water and Sewer Enterprise Debt Service should not exceed 30% of water and sewer operating revenues. This benchmark recognizes the capital intensive nature of the Water and Sewer Enterprise Funds.

• The City maintains a Water and Sewer Stabilization Fund for Water and Sewer Capital Projects. The City endeavors to appropriate a minimum of 60% of Water/Sewer Retained Earnings to the Water/Sewer Stabilization Fund on an annual basis.

Protection of Credit Rating Policy

• The City will not rely on reserves to sustain operating deficits. Use of such reserves will be limited to helping the City deal with short-term or emerging financial stress, but then the City will either reduce spending to within the limits of recurring revenues, or seek approval for additional revenues from the voters of the City.

• The City will not defer current costs to a future date. This includes costs such as pension costs or benefits costs.

• The City will analyze the full-life costs of multi-year decisions. For example, acquiring or construction of new buildings will be conducted with an assessment of the operating costs of the building. Lease agreements will be conducted with an assessment of future budgets and the ability to make annual payments. Labor agreements will be negotiated with an analysis of the full costs associated with the terms of the agreement.

Investment Policy

1. The Investment of General Funds, Special Revenue, and Enterprise Funds.

A. Scope

This section applies only to short term operating funds, general funds, special revenue, enterprise funds, bond proceeds and capital project funds. Section two will deal with trust funds and other special circumstance such as stabilization, and section three will deal with Other Post Employee Benefits (OPEB) Funds.

B. Objectives

Massachusetts General Laws, Chapter 44, section 55B requires the Treasurer to invest all public funds except those required to be kept uninvested for purposes of immediate distribution. Funds should be kept in interest bearing until such time these funds need to be disbursed. The state law further requires that invested funds are to be placed at the highest possible rate of return reasonably available, taking account of safety, liquidity and yield. Therefore, these guidelines are intended to further the objective of securing the highest return that is consistent with safety of principal while meeting daily cash requirements for the operation of the City.

• Safety of principal is the foremost objective of the investment program. Investments shall be undertaken in a manner that seeks to ensure the preservation of capital though the mitigation of credit and interest rate risk. These risks shall be mitigated by the diversification and prudent selection of investments instruments and choice of Massachusetts based financial institution. To further diversify credit risk no one institution should contain more than 25% of the City’s working Capital, unless the capital is fully collerized or insured through either the FHLB SIF or DIF.

• Liquidity is the next most important objective of the investment program. The overall investment portfolio shall remain sufficiently liquid to meet all operating requirements that may be reasonably anticipated. Since all possible cash demands cannot be anticipated, the Treasurer shall carry out investment activities that assume a reasonable high demand on capital so that no forfeiture of accrued interest or other penalty of capital arises.

• Yield is the third, and last, objective. Investments shall be untaken so as to achieve a fair market average rate of return, taking into account safety and liquidity constraints as well as legal and policy requirement parameters.

The Treasurer may invest in the following instruments:

• Massachusetts State pooled fund: No more than 30% of the City’s working capital(pool is liquid)

• The Massachusetts Municipal Depository Trust (MMDT), an investment pool of state, local, county, and other independent governmental authorities, is under the auspices of the State Treasurer and currently managed by Federated Investment. It invests in Bankers Acceptances, Commercial Paper of High quality, Bank Certificates of Deposit (CD’s), Repurchase Agreements (Repos), and U.S. Treasury Obligations. It has Federal Deposit Insurance Corporation (F.D.I.C.) pass-through insurance on the C.D.’s and takes

delivery on the Repos and Treasuries. Under Government Accounting Standards Board Regulation (GASB III), it is not considered an uncollateralized product.

• U.S. Treasuries that will be held to maturity: 25% (up to a three year maturity from date of purchase).

• U.S. Agency obligations that will be held to maturity. 25% (up to three years from date of purchase).

• Bank Accounts and CD’s (Up to three years) must be fully collateralized or insured through another source, Depository Insurance Fund (DIF) or Shared Insurance Fund (SIF), further examination of a financial institution should take place periodically during the duration of the obligation.

• Unsecured Deposits of any kind such as other checking, savings, money market, or CD’s accounts at Banks that do not fit into the above categories. These investments are subject to the following limitations: No more than 5% of and institutions assets and no more than 5% of the City’s Cash. This amount may be increased for not more than 30 days during times of heavy collection or in anticipation of large payments that will be made within 30 days. Significant contact, reserseach, diversity and other forms of examination should be used to closely monitor the institutions credit worthless.

• Money Market Mutual Funds that are registered with the Securities and Exchange Commission that have received the highest possible rating from at least one nationally recognized statistical rating organization and as otherwise referenced in M.G.L. Chap 44 Section 55.

The City will manage credit risk several ways. There will be no limit to the amount of US Treasury and Agency Obligations which both of these carry AAA rating. However it’s noted in the policy that no more than 50% should be utilized in this category for liquidity needs. The City may also invest in MMDT up to 50% of its Cash. The City may also pace funds in banking institutions as stated in section C of this policy.

Custodial Risk

The custodial credit risk from deposits is the risk that, in the event of the failure of a depository financial institution, a government will not be able to recover deposits or will not be able to recover collateral securities that are in the possession of an outside party.

The City will review the firm’s financial statements at least annually and the character and background of the Sale Representative. The intent of this qualification is to limit the City’s expose to only those institutions with a proven financial strength, Capital adequacy of the firm, and overall affirmative reputation in the municipal industry.

Further all securities not held directly by the City, will be held in the City’s name and tax identification number by a third party custodian approved by the Treasurer and evidenced by safekeeping receipts showing individual numbers for each security.

Concentration of credit risk

Concentration of credit risk is the risk of loss attributed to the magnitude of government investments in a single issuer. The City will minimize Concentration of Credit Risk Dy diversifying the investment portfolio so that the impact of potential losses from any one type of security or issuer will be minimized.

Interest Rate Risk

Interest rate risk is the risk that changes in interest rates will adversely affect the fair value of an investment. The City will manage interest rate risk by managing the various durations in the account.

Foreign Currency Risk

The City will not invest in any instrument exposed to foreign currency risk.

Authorization

The Treasurer has authority to invest municipality funds, subject to the statutes of the Commonwealth of Massachusetts G.L. Chap 44, Section 55,55A & 55B as amended.

Ethics

The Treasurer (and the Assistant Treasurer) shall refrain from any personal activity that may conflict with the proper execution of the invest program or which could impair or appear ability to make impartial investment decisions. Said individuals shall disclose to the Finance Director and the Town Clerk any material financial interest in financial institutions that do business with the City. They should also disclose any large personal financial investments positions or loans that could be related to the performance of the City’s investments.

Relationship with Financial institutions

Financial institutions should be selected first and foremost with regard to safety. Broker should be recognized, reputable dealers and members of FINRA.

The Treasurer will require any brokerage houses and broker/dealers wishing to do business with the City to supply the following information to the Treasurer:

Audited Financial Statements

• If acting as an investment Advisor their updated Form ADV upon request

• Proof of National Association of Security Dealers Certification

• A statement that the dealer has read the City’s investment Policy and will comply with it on an annual basis.

• Proof of credit worthiness and 10 years in business and minimum of $10 Million in Capital.

• Restrictions. Chapter 44, Section 55 set forth the several restrictions that the Treasurer must be aware of when making investment selections.

• The Treasurer shall not at any time have on deposit in a bank or Trust company an amount exceeding 50% of the capital and surplus of such bank or Trust company, or banking company, unless satisfactory security is given to it by such bank or trust company, or banking company for such excess.

• The Treasurer will not make a deposit in any bank, trust company or banking company that he/she is associated as an officer or employee or has been the same for any time during the three years immediately preceding the date of such deposit.

Legal References

Massachusetts General Laws Chapter 44, Section 55, 55A, and 55b

II. The Investment of Trust Funds, Stabilization Funds and Community Preservation Act Funds

This section of the policy applies only to funds that could be invested long term, i.e. trust funds, stabilization funds and community preservation act funds.

A. Scope

This policy applies to all accounts that are designed as Trust Funds, Stabilization Funds, and Community Preservation Funds. In addition the Town has placed the Stabilization money in this account.

All accounts will be maintained separately receiving their proportionate interest and any realized and unrealized gains or losses. The account will be established as a pooled investment portfolio unless otherwise stated. Any additional accounts will be maintained in this same manner.

B. Authority

Massachusetts General Law Chapter 44, section 54 pertains to the investment of Trust Funds. All trust funds shall fall under the control of the City Treasurer unless otherwise provided or directed by the donor.

C. Objective

Massachusetts General Laws, Chapter 44, section 55B requires the City Treasurer to invest all public funds except those required to be kept uninvested for purposed of immediate distribution.This section also requires that invested funds are to be placed at the highest possible rate of interest reasonably available, taking account of safety, liquidity and yield. Therefore, these guidelines are intended to further the objective of securing the highest return that is consistent with safety of principal while meeting the daily cash requirements for the operation of the entity’s business.

Safety of principal is the foremost objective of the investment programs. Investments shall be undertaken in a manner that seeks to ensure the preservation of capital through the mitigation of credit risk and interest rate risk. These risks shall be mitigated by the diversification and prudent selection of investment instruments, and choice of depository. Credit risk is the risk of loss due to the failure of the security issuer or backer. Interest rate risk that the market value of the security will fall due to changes in general interest rates.

Liquidity is the next most important objective. The overall investment portfolio shall remain suff iciently liquid to meet all operating requirements that may be reasonably anticipated. Since all possible cash demands cannot be anticipated, the treasurer shall carry out investment activities in a manner that provides for meeting unusual cash demands without the liquidation of investments that could result in forfeiture of accrued interest earnings, and loss of principal in some cases.

Yield is the third, and last, objective. Investments shall be untaken so as to achieve a fair market average rate of return, taking into account safety and liquidity constraints as well as all legal requirements.

D. Investment instruments

M.G.L. Chapter 44 section 54 states that money should be deposited into savings bank, trust companies incorporated under the laws of the commonwealth, banking companies incorporated under the laws of the Commonwealth which are members of the Federal Deposit Insurance Corporation, or national banks, or invested in participation units in a combined investment fund under section thirty-eight A of chapter twenty-nine, or in a paid-up shares and accounts of and in co-operative banks, or in shares of savings and loan associations or in share or savings deposits of federal savings and loan associations doing business in the commonwealth.

Additionally the City may invest such funds in securities, other than mortgages or collateral loans, which are legal for the investment of funds of savings banks under the laws of the commonwealth; provided, that not more than fifteen company stocks, nor shall more than one and one-half percent of such funds be invested in the stock of any one bank or insurance company. See attached the Commonwealth of Massachusetts List of Legal Investments

The Treasurer may invest in the following instruments:

• U.S. Treasuries that maybe sold prior to maturity: Unlimited amounts (With no limit to the length of maturity from date of purchase)

• U.S. Agency obligations that may be sold prior to maturity. Unlimited amounts (With no limit to the length of maturity from date of purchase)

• Bank accounts or Certificates of Deposit, hitherto termed C.D.’s Unlimited amounts (With no limit to the length of maturity from date of purchase) which is fully collateralized through a third party agreement.

E. Standards of Care

The standard of prudence to be used by the Treasurer shall be the “prudent Person” standard and shall be applied in the context of managing an overall portfolio. The Treasurer acting in accordance with written procedures, and this investment policy, and exercising due diligence shall be relieved of personal responsibility for an individual security credit risk or market price changes, provided the purchase and sale of securities is carried out in accordance with the terms of this policy.

Diversification

Diversification should be interpreted in two ways: in terms of maturity as well as instrument type and issuer. The diversification concept should include prohibition against over concentration of maturities as well as concentration in a specific institution, with the exception of US Treasury Obligations or investments fully collateralized by US Treasuries or Agencies.

Ethics

The Treasurer (and the Assistant Treasurer) shall refrain from any personal activity that may conflict with the proper execution of the invest program or which could impair or appear ability to make impartial investment decisions. Said individuals shall disclose to the Finance Director and the Town Clerk any material financial interest in financial institutions that do business with the City. They should also disclose any large personal financial investments positions or loans that could be related to the performance of the City’s investments.

Relationship with Financial Institutions

Financial institutions should be selected first and foremost with regard to safety. Broker should be recognized, reputable dealers and members of FINRA.

The Treasurer will require any brokerage houses and broker/dealers wishing to do business with the City to supply the following information to the Treasurer:

• Audited Financial Statements

• If acting as an investment Advisor their updated Form ADV upon request

• Proof of National Association of Security Dealers Certification

• A statement that the dealer has read the City’s investment Policy and will comply with it on an annual basis

• Proof of credit worthiness and 10 years in business and minimum of $10 Million in Capital.

Bank accounts and C.D.’s (With no limit to the length of maturity from date of purchase), fully insured by F.D.I.C. and in some cases also Depository Insurance Fund of Massachusetts (D.I.F.) & (SIF): $250,000 the maximum allowable insurable amount all bank accounts and C.D.’s in one institution are considered in the aggregate to receive the $250,000 maximum allowable insurance coverage.

Unsecured bank deposits of any kind such as other checking, savings, money market, or Certificates of Deposit accounts at Banks that do not fit the above categories. These investments are subject to the following limitations: These investments will be limited to no more that 5% of an institution’s assets and no more than 20% of a municipality’s cash. This percentage may be increase for not more than 30 days during times of heavy collection or in anticipation of large payments that will be made by the Town in the near

future. These payments maybe for such items as debt service payment or regional school assessments. Their credit worthiness will be tracked by research, or other bank credit worthiness reporting systems. They will be diversified as much as possible. C.D.’s will be purchased with no limit to the length of maturity from the date of purchase and will be reviewed frequently.

Common and preferred stock that are listed in the List of Legal Investments.

Investment Funds that are listed in the List of Legal Investments.

All other items not separately identified here that are listed in the List of Legal Investments.

Risk Tolerance

Credit Risk

Credit risk is the risk that an issuer or other counterparty to an investment will not fulfill its obligations. The City will manage credit risk several ways. There will be no limit to the amount of United States Treasury and agency obligations which both of these types of investments carry an AAA rating. In regards to other investments the City will only purchase investment grade securities with a high

concentration in securities rated A and above. The City may invest in the Massachusetts Municipal Depository Trust (MMDT) with no limit to the amount of funds places in the fund. The City may place funds in banking institutions as stated in the Section C of this policy.

Custodial Risk

The custodial credit risk for deposits is the risk that, in the event of the failure of a depository financial institution, a government will not be able to recover deposits or will not be able to recover collateral securities that are in the possession of an outside party. The custodial credit risk for investments is the risk that, in the event of the failure of the counterparty to a transaction, a government will not be able to recover the value of investment of collateral securities that are in the possession of an outside party. The City will review the firm’s financial statements and the background of the sales representative. The intent of this qualification is to limit the City’s exposure to only those institutions with a proven financial strength, Capital adequacy of the firm, and overall affirmative reputation in the municipal industry. Further all securities not held directly by the City, will be held in the City’s name and tax identification number by a third party custodian approved by the Treasurer and evidenced by safekeeping receipts showing individual CUSIP numbers for each security.

Concentration of Credit Risk

Concentration of credit risk is the risk of loss attributed to the magnitude of a government’s investment in a single issuer. The City will minimize Concentration of Credit Risk by diversifying the investment portfolio so that the impact of potential losses from any one type of security or issuer will be minimized.

Interest Rate Risk

Interest rate risk is the risk that changes in interest rates will adversely affect the fair value of an investment. The City will manage interest rate risk by managing duration in the account.

Foreign Currency Risk

Foreign currency risk is the risk that changes in the exchange rates will adversely affect the fair value of an investment or a deposit. The City will not invest in any instrument exposed to foreign currency risk.

III. The Investment of OPEB Funds

A. Purpose

The primary purpose of this Investment Policy Statement (IPS) is to provide a clear understanding between the City of Somerville and Rockland Trust, the designated Investment Manager, regarding the objectives, goals, risk tolerance, and investment guidelines established for the OPEB (Other Post-Employment Benefits) Trust Fund. The secondary purpose is to describe for the Office of Treasurer & Collector of Taxes, the public, and staff the underlying logic and philosophy supporting this Statement.

B. Scope

This IPS applies to all funds that are separately designated as long-term OPEB funds. The account will be established as a pooled investment portfolio unless otherwise stated. Any additional contributions to the account will be maintained in the same manner.

C. Authority

Massachusetts General Law Chapter 32B, section 20 allows a city, City, district, county or municipal lighting plant to set up a special trust fund, the Other Post-Employment Benefits (OPEB) Liability Trust Fund. The City of Somerville Treasurer/Collector is the Custodian of the fund. Investment of fund monies by the custodian must be consistent with the prudent person standard set forth in Massachusetts General Law Chapter 203C for private trust funds. Interest earned on the investment of fund monies belongs to the fund.

D. Introduction

Creating an investment policy is the most critical phase of the entire investment process. The effects from a properly drafted vs. ineffective investment policy statement can be more important than the effects of good or poor investment management. To be successful, an investment policy needs to be appropriate for its setting and intended purpose. The policy needs to match the needs of the anticipated requests or periodic disbursements to the financial assets most likely to meet those cash flow needs. The best way to minimize investment risk is to match, as closely as possible, the timing of future liabilities with the timing of future cash flows from the portfolio assets. Furthermore, with regards to OPEB liabilities, the policy needs to stipulate those permitted investments most likely able, over the long term, to approximate the rate of return, or discount rate, targeted by the City’s actuarial study. Under GASB 45, the discount rate should be the long term expected yield on the investments that are expected to be used to pay benefits as they

come due. These would be plan investments for a funded plan or a weighted average of expected plan and employer investments for a plan that is partially funded. Investments within an OPEB Trust Fund will closely approximate pension fund-type investments securities.

The policy statement is also designed to withstand “trustee risk” — the possibility that, at some stress point (most frequently an extreme decline in the stock or bond markets), those who oversee the funds may react in a manner detrimental to the long-term health of the Trust Funds.

E. Objective

OPEB funds are long-term investments. Given a stated discount rate target, this long-term approach enables the City to purchase long-term assets, such as equities, which tend to have high returns over many years but whose price volatility precludes their use by those with shorter time horizons. By keeping our long-term focus in mind at all times, we hope to weather the periodic bad times.

We expect this long term view to provide us with better results than will be earned by those who pick short term investments or who abandon ship during turbulent times. We also expect that equities will serve as a hedge against eroding Trust fund values due to long term inflationary trends.

We expect the stock market to provide greater total returns than the bond market does. We make this statement in a long-term sense, knowing that both economies and markets suffer periodic (but normally brief) declines, and knowing that there have been periods when cash and bonds outperform stocks.

We expect the relationship between the economy, the stock market, and inflation that has been in existence for the past 70 years to continue. We expect the American economy to show modest real growth over full business cycles, after allowance for occasional recessions. We expect stock prices to grow slightly faster than inflation, although the naturally volatile nature of the stock market will make such growth invisible except when observed over longer periods of time. We expect cash dividends from stocks also to grow

slightly faster than inflation, and to fluctuate much less than stock prices do.

We expect continued inflation. Its timing and severity we cannot predict, but we believe it will be of sufficient magnitude that to ignore it would threaten our ability to meet our long-term objectives. Our definition of risk is not always the common one. Most investors define investment risk in terms of the volatility of short-term total returns. This definition is appropriate for funds with a very short-term time horizon, but inappropriate for quasi-perpetual funds such as the OPEB Trust Fund. Our managed funds bear three potential kinds of risk. One comes from any mismatch between the natural cash flows out of the Trust Fund (the amount requisitioned from the Trust Funds and the cash flows coming in (from contributions, dividends and interest). A second source of risk is the possibility that the assets in the funds do not perform the way the investment manager(s) or we expect them to. The third form of risk is that of reacting inappropriately at a volatile period, most likely after a severe market decline. We hope to minimize these

risks to as great a degree as is possible without harming the Trust Fund’s long-term objectives. Market value fluctuations are of secondary importance unless individual assets have permanently impaired values and must be liquidated to preserve remaining value.

F. Strategy

The contracted Investment Manager(s) will utilize the following investment guidelines in terms of asset allocation. This policy is subject to review and amendment at any time.

0 – 10% Cash and cash equivalents – normalized at 5%. Cash will be maintained to provide periodic cash distributions. Cash will not normally be held as a strategic investment asset, although the Investment Manager may seek to allow cash to build to the maximum level in times of market uncertainty.

0 – 20% Alternative Investments – normalized at 10%. Alternative Investment strategies include, but are not limited to, investment vehicles with the following objectives: market-neutral, absolute return, global macro, long/short, commodities, managed futures and arbitrage.

30 – 50% Fixed Income - normalized at 40%. To ensure appropriate diversification and to minimize default risk, the Trust Fund will invest primarily in high-quality taxable bonds, notes, and other credits through mutual funds, exchange-traded funds (ETFs) or individual bonds. Lower-quality bonds may be held through mutual fund or ETF ownership. The overall goal of the fixed-income portion of the portfolio is to provide returns competitive with, and price volatility similar to, the Barclays (Lehman Brothers) Aggregate Bond Index. The fixed income allocation exists to provide income and to dampen the volatility from the fund’s equity holdings.

30 – 70% Equities – normalized at 50%. The sub-categories and their respective allocation ranges are guidelines and may be modified. They are as follows:

1) 40-60% - normalized at 50% (of the equity allocation) in U.S. Large Cap;

2) 15-25% - normalized at 20% - in International Developed Countries (all markets caps);

3) 10-15% - normalized at 12.5% - in U.S. Mid Cap;

4) 5-15% - normalized at 10% - in U.S. Small Cap;

5) 5-10% - normalized at 7.5% - in International Emerging Markets.

Adequate diversification and risk controls must be maintained within each sub-category. An appropriate benchmark for the overall asset class of equities, as well as each sub-strategy, will be determined and agreed upon between the City and the Investment Manager(s).

G. Investment Instruments

M.G.L. Chapter 203C: section 1 known as the Massachusetts Prudent Investor Act, states that a custodian shall invest and manage trust assets as a prudent investor would, considering the purposes, terms, and other circumstances of the trust, including those set forth in subsection c. In satisfying this standard, the custodian shall exercise reasonable care, skill, and caution. A custodian’s investment and management decisions respecting individual assets shall be considered in the context of the trust portfolio as a part of an overall investment strategy reasonably suited to the funds.

Among circumstances that a custodian shall consider in investing and managing trust fund assets are such of the following as are relevant to the trust fund or its beneficiaries: 1) general economic conditions; 2) the possible effect of inflation or deflation; 3) the role that each investment or course of action plays within the overall portfolio; 4) the expected total return from income and appreciation of capital: 5) other resources of the beneficiaries; 6) needs for liquidity, regularity of income, and preservation or appreciation of capital. A custodian shall make a reasonable effort to verify facts relevant to the investment and management of

trust fund assets. A custodian may invest in any kind of property or type of investment consistent with the standards of this chapter. A custodian, who has special skills or expertise, shall have a duty to use such special skills or expertise. A custodian shall reasonably diversify the investments of the Trust Funds unless, under the circumstances, it is prudent not to do so.

The Treasurer may invest in the following instruments:

• U.S. Treasuries that may be sold prior to maturity: Unlimited amounts (With no limit to the length of maturity from date of purchase)

• U.S. Agency obligations that may be sold prior to maturity: Unlimited amounts (With no limit to the length of maturity from date of purchase)

• Bank accounts or Certificates of Deposit (“CDs”): Unlimited amounts (With no limit to the length of maturity from date of purchase), which is fully collateralized through a third party agreement.

• Bank accounts and CDs: (With no limit to the length of maturity from date of purchase) fully insured by F.D.I.C. and in some cases also Depository Insurance Fund of Massachusetts (D.I.F.): All bank accounts and CDs in one institution are considered in the aggregate to receive the insurance coverage limit.

• Money market mutual funds.

• Fixed-income mutual funds and exchange-traded funds (ETFs).

• Preferred stock: securities must be investment grade at the time of purchase.

• Common stock.

• Equity mutual funds and exchange-traded funds (ETFs).

• Alternative investment-oriented mutual funds. Leveraged (i.e. 2x or 3x) investment strategies are not permitted.

H. Diversification

Equity

The equity portion of the portfolio should consist of a diversified mix of investments (individual equities, mutual funds and exchange-traded funds) suitable to achieve the objective of capital appreciation. Individual equity holdings in any one company should not exceed 5% of the market value of the portfolio. Equity holdings may be selected from the New York and American Stock Exchange or the NASDAQ markets. Securities may be in U.S. companies, or foreign companies purchased as American Depository Receipts (ADR’s). Funds may be invested in securities convertible into equities or preferred stock.

No funds may be invested in real estate, private placements or letter stock, the Investment Advisor shall not engage in margin transactions, short sales or any other such specialized investment vehicles. The manager of a specific mutual fund and exchange-traded fund, however, may engage in short sales as part of an overall investment strategy. The selection of individual equities will be at the discretion of the Investment Advisor. OPEB funds may be invested in the State Retiree Benefits Trust Fund (SRBTF) and are therefore exempt from having to comply with the activity described in the beginning of this paragraph.

Fixed Income

Investments in fixed income securities will be made principally for income and capital preservation. Selection should be made from liquid, investment grade corporate debt, convertible debt and obligations of the United States Government and its agencies. Lower-quality investments may only be held through diversified vehicles, such as mutual funds or exchange-traded funds.

Securities of a single corporate issuer (excluding the United States Government and its Agencies) will not exceed 5% of the portfolio market value. Investments in U.S. Government debt will not include agencies that are not permitted under Massachusetts General Laws (i.e. Sallie Mae (SLMA) or Ginnie Mae (GNMA) obligations).

No more than 15% of the portfolio’s total market value will be invested in convertible securities.

Individual corporate debt and preferred stock issues must be rated BBB or better, as defined by Moody’s and/or Standard & Poor’s Rating Agency.

There shall be no direct investments in real estate, mortgages, collateral or non-collateral loans, private placements, fixed income or interest rate futures, and no engagement in any other specialized fixed income ventures. The manager of a specific mutual fund and exchange-traded fund, however, may engage in fixed income and interest rate futures as part of an overall investment strategy.

Diversification should be interpreted in two ways: in terms of maturity as well as instrument type and issuer. The diversification concept should include prohibition against over concentration of maturities, as well as concentration in a specific institution, with the exception of U.S. Treasury obligations or investments fully collateralized by U.S. Treasuries or agencies.

J. Supervision

• The Treasurer will meet with the investment manager(s) as frequently as quarterly to monitor the performance of the funds and the investment manager(s) compliance with these guidelines. The Treasurer will receive and review portfolio management reports quarterly.

• The Treasurer will review this Investment Policy Statement at least once a year to ensure that it remains appropriate and complete.

• The Treasurer has the option to put the management of funds out for bid periodically, and shall consider such option not less frequently than every five years, through a request for information, request for proposal, or similar process as required by law or City policy

The City will follow the policies as outlined in this policy statement.