Report 2019-112 Recommendation 3 Responses

Report 2019-112: California State Lottery: The Lottery Has Not Ensured That It Maximizes Funding for Education (Release Date: February 2020)

Recommendation #3 To: Lottery Commission, California State

To ensure that it provides the maximum amount of funding to education in future fiscal years, the Lottery should do the following:

-By August 2020, determine the optimal amount of prize payouts that maximizes the funding for education.

-By August 2020, establish a policy to annually reconsider the optimal amount of prize payouts that maximizes funding for education.

-Use this optimal prize amount when setting its budgets, beginning with the budget for fiscal year 2021-22.

Annual Follow-Up Agency Response From October 2021

Pursuant to Lottery policy, in building the Lottery's budget for fiscal year 2021-22, the Director made a determination that prize payout levels across all games were in accordance with the optimal prize payout range recommended in the Lottery's most recent commissioned prize rate study. Specifically, the 2021-22 budget estimated prize expense to total 66.7 percent of total projected sales. This is within the range of 65 percent to 67 percent that was recommended as being optimal in the most recent prize rate study analysis.

California State Auditor's Assessment of Annual Follow-Up Status: Fully Implemented

1-Year Agency Response

3a: Encina Advisors, as an objective third party, was engaged to conduct the recommended analysis and issued a report in December 2020. The report's author, Dr. Justin Adams, was a partner in the firm Chang & Adams that conducted the prior study in 2010.

The study concluded that an overall prize payout from 65% - 67% maximized the Lottery's contributions to public education. The report details several reasons for establishing an optimal range rather than a single point. Based on data from the past ten years across the U. S. lottery jurisdictions, this study found an optimal payout rate that was higher than what was found in the 2010 analysis.

Reviewing the Lottery's audited financials, the Lottery has never exceeded the optimal prize payout through FY 2018-19 - the last year where audited figures were available. Although the audit of the Lottery's FY 2019-20 financials is not complete, the prize payout rate appears to be 66.5%, which is within the optimal range recommended.

3b: The Lottery now requires the Director to annually determine that prize payout levels across all games have been optimized for the coming fiscal year to ensure that funding for education is maximized.

3c: Pursuant to the new policy, in building the Lottery's budget for fiscal year 2021-22, the Director will make a determination that prize payout levels across all games are in accordance with the optimal prize payout range recommended in the Lottery's most recent commissioned prize rate study. This process will be repeated each budget cycle.

California State Auditor's Assessment of 1-Year Status: Partially Implemented

Although the Lottery addressed the first two components of our recommendation to determine the optimal amount of prize payouts that maximizes funding for education and establish a policy to annually reconsider this amount, the Lottery has not yet adopted its 2021-22 budget. Therefore, we cannot determine whether the Lottery has used the optimal prize payout amount when setting its budget.

6-Month Agency Response

3a:

Status of Implementation:

Not fully implemented.

Reason for not fully implemented:

After brief delays due to the COVID-19 pandemic and locating prospective vendors to conduct this study, the Request for Proposal was sent to four firms on June 19th with responses provided by three of these companies by the due date of July 7th. A contract with Encina Advisors has been executed with a scope that will help the Lottery determine the optimal prize payout rate that will maximize funding for education. Based on the project plan provided in their proposal and the date of our kickoff meeting, the final report will be delivered around October 5, 2020.

3b:

Status of Implementation:

Fully implemented.

The Lottery now has an approved policy requiring the Director to make a determination that prize payout levels across all games have been optimized for the coming fiscal year to ensure that funding for education is maximized annually.

3c:

Status of Implementation:

Not fully implemented.

Reason for not fully implemented:

The approved policy in Recommendation 3b requires the Lottery to utilize optimal prize payout levels in its development of its annual fiscal year budget. As stated above, this will be first employed when the Lottery develops its Fiscal Year 2021-22 budget.

California State Auditor's Assessment of 6-Month Status: Partially Implemented

To address the portion of our recommendation that the Lottery establish a policy to annually reconsider the optimal amount of prize payouts that maximize funding for education, the Lottery provided us a copy of its new policy requiring its director to make such a determination annually.

60-Day Agency Response

3a: Determine the optimal amount of prize payouts that maximizes the funding for education.

The development of the procurement document for a consultant has begun, and the identification of potential bidders has also begun. Given the COVID-19 emergency and its impact on Lottery operations, it is anticipated that responses to the solicitation document for procuring the consultant will be due sometime during the month of May 2020.

3b: Establish a policy to annually reconsider the optimal amount of prize payouts that maximizes funding for education.

Given higher priorities arising from maintaining Lottery operations during the COVID-19 health crisis, this policy has not yet been developed. Development of policy is expected by the 3rd quarter of CY 2020.

3c: Use optimal prize amount when setting budgets.

The recommended process will be incorporated into the policy noted in 3b above and will be first employed when developing the Lottery's Fiscal Year 2021-22 budget.

California State Auditor's Assessment of 60-Day Status: Pending

All Recommendations in 2019-112

Agency responses received are posted verbatim.