Palo Alto's process for administering health benefits to city workers and retirees is riddled with errors and suffers from insufficient monitoring, according to a critical report from the Office of the City Auditor.

City Auditor Jim Pelletier found, among other things, that the city's retiree reimbursements were not accurately calculated; that the billing from the California Public Employees' Retirement System (CalPERS) was not adequately monitored; and that the city has not effectively administered its contract with a consultant charged with verifying the city's health expenditures. The report concluded that the city's Human Resources Department needs to improve its internal controls over health benefits to ensure that health premiums, administrative fees and retiree reimbursements are calculated and paid accurately.

The audit focused on health payments made by the city between September 2011 and October 2012 and found that the city has been overpaying for retiree reimbursement. In reviewing CalPERS bills in October 2012, the audit found that the city made overpayments totaling $12,585 and underpayments totaling $3,434, resulting in a net overpayment to retirees of $8,151. The report also notes that 64 retirees were either overpaid or underpaid by $10 or more. The report notes that the Human Resources Department "did not have a clear, documented methodology to determine the reimbursement amount."

The sheer complexity of tallying the reimbursement amounts appears to be a major factor in many the errors uncovered by the audit. The city's program covers 855 active employees and their 1,526 dependents in addition to 871 retirees and their 627 dependents. Each of the city's labor groups is governed by its own health care contract, with varying tiers based on seniority. The fact that the system is administered by a colossal entity based in Sacramento and that CalPERS routinely makes errors and revisions to its billing further muddies the process, the report states.

The report cites the Human Resources Department's (HRD) view that "there are so many billing errors and subsequent corrections made by CalPERS that they would not be able to review the entire billing and keep track of all deductions made for each retiree."

"For this reason, there were cases where HRD was aware that the retiree was receiving overpayment but no actions were taken because they assumed the overpayment was due to a CalPERS error and the error would be corrected by CalPERS in the future," the audit states. "These discrepancies were neither documented nor tracked."

It didn't help that the city's eligibility criteria for retiree health benefits was "not clearly defined and documented," according to the audit. The city has a document called Tier Matrix, which defines retiree health tiers for each employee group and each tier within the group. The audit's review of the Tier Matrix found that the document "was inaccurate and incomplete." While there was no evidence to conclude that the inaccuracy resulted in a "material difference," the audit states: "Adequate documentation and clear communication of eligibility criteria would help to prevent any inaccuracies in future actuarial valuations." The audit recommends making the Tier Matrix available to all stakeholders and enhancing current procedures to ensure that the document is "maintained accurately, completely and in an organized manner."

The audit also found that CalPERS used "inconsistent and inaccurate" methodology to calculate the employer share of health care costs for retirees. Auditors reviewed 832 records and found that the employer share was different from expected amount in 55 of these records, resulting in $5,513 in overbilling. Much of this was related to retirees from two employee groups -- the Palo Alto Police Officers Association and Fire Chiefs Association. When reached by the auditor's office, CalPERS "confirmed that most of their formulas set up to calculate the employer share were incorrect" and stated that they will correct these errors as soon as clear written instruction is provided by the city.

The auditor's office reviewed CalPERS billing for December 2012 and found numerous errors. Of the 91 retirees from PAPOA and FCA, 42 were still being billed incorrectly -- an error rate of 46 percent.

The audit calls for better monitoring of CalPERS billing for accuracy. Currently, such a review only occurs for retroactive transactions associated with retirees. The audit recommends that the city conduct monthly reviews of CalPERS billing and reconcile these bills with city records.

The audit also criticizes the city's contract with the firm Employee Benefit Specialists, which the city hired in August 2011 and charged with reviewing, calculating and processing health care reimbursements. The review found that the firm "was not providing all services required in the contract." Specifically, the firm did not perform calculations of reimbursements using formulas provided by the city and did not reconcile monthly disbursements. Employee Benefit Specialists claimed that it could not perform the latter function because "CalPERS would not provide them with the necessary data to perform these services."

The audit concluded that the city did not adequately monitor the contract and recommended a review of the contract and monitoring procedures to ensure terms remain adequate.

The city's health care expenditures have emerged as a hot topic over the last four years, as the City Council embarked on a series of reforms, including greater cost-sharing by employees, aimed at containing the swelling costs. The city's health premiums for active employees have been rising steadily over the past decade, going from $9.1 million in 2005 to $13.2 million in 2012, according to the audit.

The council's health care reforms, which began in 2008, have been extremely contentious, prompting a wave of retirements by city employees. Last year, the city reached new agreements with its police and firefighter unions that require employees in both labor groups to foot some of the costs for health care. The city remains at an impasse, however, with its largest police union, the Palo Alto Police Officers Association, over a proposal to extend the cost-sharing provision for health care to retirees.

The council is scheduled to hold a hearing on employee health care costs in January.

In her response to the audit, Chief People Officer Kathryn Shen wrote that the Human Resources Department staff is "committed to addressing the deficiencies and improving the reconciliation methodology for this complex process." She noted that CalPERS has recently implemented a new billing system and is "still struggling to find corrections to the various errors."

"This has complicated the reimbursement process requiring substantial adjustments," Shen wrote. "Fortunately, most overpayments can be recovered by withholding or reducing future reimbursements. Careful reviewing the reimbursement reports will be key to addressing the issues found in the audit. Staff will also continue to find solutions to streamline this reimbursement process."