November 2010
UC’s Top “Finance Guy” Seeks More Efficient Operations
Q&A with UC's CFO Peter Taylor
Peter Taylor is systemwide Chief Financial Officer of the University of California. A UCLA alum, he was a member of the Steering Committee of the President’s Task Force on Post-Employment Benefits and its Finance Work Team Lead. He is also in charge of developing more efficient systemwide business procedures.
Senate Source: How did your previous experiences in the financial sector and with the UC Alumni Association prepare you for the job of Chief Financial Officer at UC?
Peter Taylor: In the private sector, I worked with large private institutions, governments, and school districts with gigantic financial challenges, and helped them focus on how to increase revenue and cut costs. Obviously the private sector differs from the public sector, but there are some techniques that translate to what we do and how we do it. The fun part of my job has been thinking about how we can operate better and smarter on the administrative side of the house in order to free up money for the academic and teaching side of the house. My current job involves more consensus and coalition building as the academic environment is more freewheeling than the banking world in a lot of ways. For example, people are more apt to speak what is on their mind here than in the corporate culture.
I am also a longtime UCLA volunteer and donor. I was chair of UCLA’s scholarship programs, president of the UCLA alumni association, president of the UCLA Foundation Board of Directors, and chair of the African-American Admissions Task Force, which was focusing on how to increase the student pipeline, specifically recruitment and retention of African American kids. I also served as the UC alumni regent. All of those experiences have helped me understand more completely how UC works.
SS: The authors of the Dissenting Statement to the report of the Post-Employment Benefits Task Force say that benefits cuts are not a solution to UC’s budget problem. How do new tier options A, B, and C differ in their impacts on the operating budget?
Taylor: As a finance guy, I come at this from a cost point of view; other people have different perspectives. The current UC Retirement Plan is unsustainable. There are a lot of reasons why, but the bottom line is that we can no longer afford our current system. Option A will save UC about $20 Billion over 25 years; Option B and C will save between $12B and $13B over 25 years. That is a huge savings. We can debate whether it is enough and about what the new tier should be and look like, but I think it is important for the Regents to make a commitment to continue to provide quality benefits to UC faculty and staff, while also maintaining access to students, and the overall character and excellence of the University. In many ways, this speaks to the future character of the University itself, what we refer to internally as Size and Shape—who we are going to serve, and what we are going to do as a University in terms of our breadth and depth of research, enrollment, and our public face. All of these things need to be part of the discussion. Pension costs will rise and take a bigger share of the budget than they do now. But a new tier will help us manage the new fiscal reality without fundamentally damaging UC’s current character.
SS: Benefit reductions, in the form of increased employee contributions and reduced retiree health, amount to a pay cut for employees. What do you predict will be the balance between reduced benefits costs and increased salary costs?
Taylor: It is hard to predict right now. There is definitely a heightened sensitivity at UCOP about the importance of catching up UC’s cash compensation, in the form of base salaries, with the market for all employee cohorts from service workers to senior faculty. President Yudof is quite focused on this, and he has asked a number of us to think very aggressively about how we can get UC salaries back on the right track and provide at least marginal increases in the near term. I think everybody realizes that we cannot afford to let UC’s competitiveness slip any further. Cash compensation matters, particularly to younger employees and potential employees who may think less in terms of benefits 30 years in the future, even if those benefits are fabulous and make their total remuneration competitive, and more in terms of paying the rent and supporting a young family. It would not take as much money to bring people up to parity in terms of cash compensation as it would to fix the existing UCRP over the same multiple year period.
SS: Please explain your goals and objectives for restructuring UC debt and how it will help free up funds for other priorities.
Taylor: The University’s debt profile is heavily front-loaded, and we have a large number of bonds that will mature in the next 5-7 years. This is important because no other major corporate or government borrower has this kind of debt profile; all have back-loaded debt smoothed over 30 years. UC can afford to restructure a portion of its existing debt by pushing more of the debt principal further into the future. This will allow UC to take advantage of historically low interest rates, level its long-term debt profile, and give campuses more flexibility by creating more short-term borrowing capacity. Using the mortgage analogy, many homeowners would be happy with a 15-year mortgage, which costs less over time, but they are unable to afford the much higher monthly payments. In a sense, UC is in that situation. In fiscal year 2010-11 UC’s debt service will be about approximately $665M, declining to around $600 million in a few years. A substantial restructuring would smooth that out to between $550 and $575M over the next 30 years. Restructuring our debt in this way will take pressure off of all the fund sources that pay for the bonds – hospitals, dormitories, and parking garages, or indirect cost recovery. Our intention is to use some of the savings ($40 to $80 million per year) from this restructuring as part of the payment to UCRP’s Unfunded Actuarial Accrued Liability. This reallocation will have the benefit of not impacting any existing cash flows and of allowing UC to earn interest on these payments moving forward.
SS: How much would this restructuring cost UC over the long term?
Taylor: A crucial concept in finance is present value of dollars. One dollar 30 years from now will buy less than one dollar buys today. That is why it is strategically smart to push the debt principal further out into the future. It is a smart trade-off for UC to spend a few million dollars in today’s dollars to buy ourselves $75-100M in cash flow relief annually for the next 30 years. This will help get us through these difficult times.
SS: What should drive UC’s capital strategy? Is UC in danger of losing its public character by turning to financial strategies employed in the private sector?
Taylor: I treasure the fact that UC is a public university. Our record of serving low income populations is unparalleled, especially compared to our private competitors. I believe that this mission, and the academic plans of the campuses, should drive UC’s capital strategy. We are bringing various private sector techniques into our external finance strategy in order to free up cash that can be reinvested into the academic mission. I am also leading an effort to identify opportunities for increasing administrative efficiencies through economies of scale and strategic sourcing. The academic mission will benefit if we can save money by cutting better deals and being more aggressive in our procurement practices. For example, UC spends $4 billion per year on materials and supplies. Improving pricing by 10% could free up $400 million. Another example: UC has 11 different accounting and human resources systems, meaning that a huge amount of work is required to blend information from all campuses so they speak the same language. It would be much easier and more cost effective to have a single system. Finally, the University Controlled Insurance Program allows us to provide one blanket insurance policy for all of the construction projects on all campuses and medical centers. Negotiating insurance this way, instead of project by project, saved us 33% or $17 million in the first year, and we got a better policy to boot. As I see it, these efforts are consistent with the goal of preserving the public nature of UC at a time when the state is not in a position to fund us appropriately.
SS: The Academic Council recently recommended the University forego all non-essential campus construction projects. What is your view of this? How can campuses balance their aspirations for growth with the new fiscal reality?
Taylor: I have mixed reactions and concerns—some philosophical and some practical. There are approximately $2 billion worth of capital projects in the pipeline that have received Regents’ approval and need to be financed. On the practical level, 80% of buildings in the campuses’ five-year capital plans are self-financed, such as new dormitories, parking garages, student unions, etc. In the case of a dormitory, for example, unless the building goes up and students move in, the campus will not receive the revenue; thus, the expected future receipt of the cash doesn’t materialize unless we build the structure. The other 20% is largely from more flexible funding sources like indirect cost recovery. Restructuring UC debt will allow UC to finance these projects and capture low borrowing rates that might not be available in the future.
Philosophically, I am not sure it is the role of UCOP to tell campuses what aspirations they can and cannot have for future programs, services, and facilities. I believe that decisions about what kind of buildings to build should stem from local academic planning priorities. UCOP does, however, set guidelines for capital projects approval. We introduced the Debt Affordability Model last year to help campuses better assess their ability to assume debt to fund projects. If a campus wants to finance any capital project, they have to include an analysis of financial feasibility that takes into account operating costs, and identify a fund source to repay the obligation, for which UCOP establishes certain benchmarks. This model recognizes different revenue sources and growth rates among campuses, allowing them to model debt capacity to their specific situation with a greater sense of realism and prudence.
SS: Tell us more about how you see UCOP’s role vis-à-vis the campuses.
Taylor: UC campuses have a great tradition of autonomy where top-down mandates are not well received. I fully believe that this autonomy has helped make UC great, and we generally operate with that in mind. UCOP views its role as helping campuses meet their own identified capital needs and goals. But where do you draw the line? In my view, you draw it on things like the question of having one payroll system or 11 separate systems.
SS: What is your view of the Post-Employment Benefits process in terms of shared governance and faculty input?
Taylor: Without a doubt, the contributions of the faculty have been thoughtful, thorough, and timely throughout the process. Their insights have been enormously helpful to me and my staff both in the post-employment benefits work and in the Commission on the Future Funding Strategies Work Group, on which I served as an ex-officio member and led the staff team. Shared governance was new to me, and it is a slow process, but on something as big and complicated as benefits design, you have to make sure everybody has had an opportunity to think through, research, and synthesize all the possibilities and approaches. And then repeat the process.
SS: Please describe the Task Force’s proposal for using income from the Short Term Investment Pool (STIP) to fund the employer portion of UCRP contributions. What makes internal borrowing from STIP a good idea?
Taylor: STIP is similar to an enormous checking account where all University cash is invested in short term securities. There are over 76,000 STIP account holders in the UC system, and because we are an institution with a lot of revenue coming in every day, STIP maintains a consistent high balance. STIP funds are divided into restricted and unrestricted pots, each of which maintains an average balance of about $4B. An example of a restricted fund would be the proceeds of a bond deal before they are allocated to a campus construction project. The President’s PEB Task Force thinks that borrowing STIP income to fund UCRP is a good idea because we would essentially be borrowing from ourselves at a very low rate (between 2% and 3%) and investing in UCRP, where the assumed gain is 7.5%. If the President and Regents decide to go with the recommendation, we would first need to determine which of the restricted and unrestricted pool revenues could potentially be freed to fund benefits. We would also look campus by campus at how much cash each location needs to operate to see how much could be borrowed to be put into STIP, with a commitment from the Regents to pay principal and interest back to the STIP holder’s account. It will be a lot of work to set up the program, but we could absolutely get it done this fiscal year.
SS: You have been meeting with the US Department of Treasury to determine whether their rules would allow current employees to choose between having future service occur under a new UCRP tier or contributing at a higher rate to retain current plan provisions for future service accrual. If Treasury declines, would all UCRP incumbents be forced into the new tier?
Taylor: We think giving employees a choice about whether to stay in UCRP or move to the new tier is a good and fair practice, although there is no doubt that for many employees the new tier is going to be less expensive and less generous than the current UCRP. If the Treasury decides not to re-design the rule to allow this, existing employees would stay in UCRP at the contribution rate established in the final plan. They will not be forced into a new tier. In that case, the new tier would be only for new employees who begin service after July 1, 2013.
SS: It is probably not your place to speculate on the potential for generational resentment under a two tier system, but can you tell us how other institutions have dealt with perceptions by new hires that they are second-class citizens because their benefits are less than what their senior colleagues get?
Taylor: I take comfort in the fact that lots of other institutions – cities, counties, and states – have implemented a similar new tier system and have made it work. Part of the Task Force’s challenge was that the UC faculty cohort really works within a national and international marketplace, but the staff tends to work in a regional market. How do you design a system that addresses both those realities? Clearly faculty are the most important cohort in the institution. That is the group you have to protect first and foremost. Nevertheless, even though the Task Force did consider segmenting the faculty and staff into different tiers, it did not pursue this option.
SS: What do you say to faculty who are concerned about the potential privatization of the University?
Taylor: I do not see UC privatizing, and I would even bet money that it does not happen. Will we have to increase the number of out of state students? Yes, but at the 10% level, not the Michigan model of 35%. We will draw the line. We do great things for the State of California, and part of our challenge is getting more credit for doing them. In California, we are fortunate to have a mechanism through which people living in poverty today know that their children have an opportunity to improve their lot in life through the higher education system. This promise is the primary way we ensure that our democracy thrives in the long term. Part of our challenge is to drive that point home. It is not simply that we are providing graduates with a four year degree and then a job. There is a larger role we play in sustaining the democratic institution that allows everyone to thrive. We are that tunnel of opportunity for those who are not wealthy.