Candidates ignore city's biggest issue: Pensions

With less than a month before the May 19 primary, the six Democrats running for mayor have yet to talk about the $5.7 billion dark cloud that threatens to snuff out their campaign promises of universal prekindergarten, cuts in the wage tax, and other costly pledges.

That cloud looming over the candidates' plans, the city's unfunded pension liability, has been there for decades, and it grows with every passing year.

"The municipal pension crisis - and it is a crisis - is the No. 1 issue for the future of the city," said Comcast executive vice president David L. Cohen, who served as chief of staff to Ed Rendell when Rendell was mayor.

Pension costs currently consume 15 percent of the city's $3.9 billion general fund budget - that's $577 million off the top before any of the city's other obligations are considered. The pension fund also takes in $110 million from other city sources, including airport and water fees, for a total of $687 million.

In 2010, the fund took $557.2 million. In 2020, when the mayor elected this fall will be finishing his or her first term, the fund's take will be $770 million.

Those dollars add up.

"For every dollar we put toward pensions, it's $1 less to spend on schools . . . pick your favorite issue," said David Thornburgh, chief executive of the good-government group Committee of Seventy.

Unlike funding for Philadelphia's schools, the biggest topic of the mayoral campaign, pensions are entirely in the city's control.

Where the Philadelphia School District depends on Harrisburg for about half of its budget, every penny that goes into the pension comes from the city and its workers. The state legislature has nothing to do with it.

And when the fund comes up short, the obligation to make up the difference is wholly the city's.

Like similar pension crises elsewhere, Philadelphia's woes are the result of previous administrations' increasing retirees' benefits without regard to the bottom line, and investments that went south.

If Philadelphia's pension fund were healthy, it would have $10.5 billion available. That factors in the city's 30,000 beneficiaries, the 27,000 current employees in the pipeline to receive a pension, and how long they will live after retiring.

But the fund has only $4.8 billion, leaving a $5.7 billion hole that gives Philadelphia the second-worst-funded pension system among large cities, according to a Pennsylvania Intergovernmental Cooperation Authority report published Jan. 20. Only Chicago's system is worse, said PICA, the agency that oversees the city's finances.

The way the pension fund is supposed to work is simple: The city and its workers contribute to a fund that is then invested. Between the constant contributions and returns on investments, enough revenue is produced to pay its obligations.

In Philadelphia, that has not been the case.

The city has been dealing with shortfalls - due to insufficient money going in or bad investments - since at least the 1960s.

One fix, a $1.3 billion 30-year bond issued in 1999 to bring the pension's funded liability up to 76 percent, has resulted in recurring yearly costs that will not end until 2029. Currently, the fund has to pay about $134.7 million a year to cover the bond.

How much the city and the workers contribute to the fund is negotiated with every new contract. Of late, the city has tried to get unions to contribute more into the fund.

This year, the city will put in $92.2 million (6.3 percent of wages), $131 million in bond payment, and an additional $463.8 million into the system. The workers will contribute 3.3 percent of their pay, $49.3 million.

The 30,000 beneficiaries receive an average of $20,036 a year. The range of payouts, however, is wide: Monthly pension payments currently go from a low of $6.15 to a high of $12,703.

Next year, 2015-16, the city's share will go down to 5.6 percent of wages, and the workers will pay more, 3.8 percent.

Meanwhile, the deficit keeps growing.

When Mayor Nutter took office in 2008, the pension plan was 55 percent funded. When he leaves in January, it will be 46 percent funded.

And the outlook from there is even more grim. "Increasing government contribution will bankrupt the city," Cohen said.

The pension fund, experts say, has two structural problems. One is erasing the $5.7 billion deficit. The second is coming up with a fix so the fund always has enough money to cover benefits.

Candidates Lynne M. Abraham and Nelson A. Diaz have proposed changing the way the pension is managed.

James F. Kenney would negotiate with the unions.

Anthony Hardy Williams would inject the pension with funds from leasing city assets, including the airport and the Water Department.

Doug Oliver would explore selling city assets.

T. Milton Street Sr. said he would "hire the best minds" to examine the issue.

None of these solutions is enough, Cohen said, calling them "Band-Aid solutions."

"Steps like reducing minimum pension payment, saying you'll improve efficiency of fund managers . . . people should be getting tired of those excuses," he said.

The city has three options for dealing with the pension deficit: increasing the city's contribution, increasing the workers' contribution, and decreasing benefits.

But increasing the city's contribution could dip into the wallet that pays for basic services, such as police, fire, and trash collection.

And increasing employees' contributions alone does not produce significant results.

The other option is to do nothing. If the city makes minimum payments and gets an average 7.8 percent return on investment, the fund could be fully funded by 2039, according to the latest actuary analysis. But that's a big if.

"Between here and there, there are a lot of risks, and it's going to be a continuing large burden on our general fund," said Rob Dubow, the city's finance director. "So, anything we can do to kind of attack that burden is essential for our fiscal health."

Local and national experts suggest moving from a traditional pension plan for new employees to a defined contribution plan, like a 401(k), in which the city would match a percentage of what employees put in.

"Defined pensions are a dinosaur," said Thornburgh, who was executive director of the Fels Institute of Government before taking over the Committee of Seventy.

Cohen agreed and said that the city cannot sustain the cost of defined benefits.

"Eventually it's the only solution I know of," Cohen said of moving to a 401(k) model. "At some point this all breaks."

The Nutter administration has created Plan 10, a hybrid model of a pension and a 401(k), but the unions balked. So, for most city workers, including new hires, Plan 10 is optional.

Union leaders say they have sacrificed wage increases and other benefits to keep the defined pension plan and prefer to keep it that way.

The next Philadelphia mayor will be "battling against the odds" in addressing the pension crisis, said Richard C. Dreyfuss, a fellow at the Manhattan Institute's Center for State and Local Leadership with an expertise in public pensions. "Over the next 10 years, they are going to have an increased risk of insolvency," Dreyfuss said.

Dreyfuss and other pension experts said Philadelphia should get rid of any bonus or special retirement packages.

One such bonus is Kenney's doing. As a councilman in 2007, he sponsored a bill that did away with a safeguard that required the fund to be at least 76.7 percent solvent before bonuses could be paid. Retirees receive a bonus if the pension fund's investments do better than the previous five years in a row.

This spring, the fund will pay out $62 million in bonuses to its beneficiaries. "Here you have a city [pension fund] that is 46 percent funded. . . . Are you nuts?" Pat O'Keefe, a bankruptcy expert in Detroit, said of Philadelphia's bonuses. Detroit's bankruptcy, he added, was due in part to the "13th check," a similar pension bonus program.

In a recent interview, Kenney defended his bill and said that as mayor, he would not reverse it.

He said he believes the widow of a firefighter who does not receive Social Security deserves to get a cost-of-living adjustment via a pension bonus.

"The money managers benefit when the fund over-performs," so why can't retirees? Kenney said.

The other pension perk that has been criticized by experts is the Deferred Retirement Option Plan, which has cost the pension $258 million from 2000 through 2008, according to a 2010 study commissioned by Nutter.

But whether the mayoral candidates would try to eliminate DROP remains to be seen. The campaign has hardly touched on that issue - or on pensions in general.

Phil Goldsmith, a managing director under Mayor John F. Street, said that the candidates are not talking about pensions because the voters, especially the millennials, are not demanding it.

Millennials, Goldsmith said, "who have more skin in the game . . . it's the farthest thing from their mind because they aren't thinking about retiring."

Below is a summary of the Democratic mayoral candidates' plans for dealing with Philadelphia's pension crisis:

Lynne M. Abraham: "We would get rid of the high-priced financial people the city hires who are betting that the market is going to make a return greater than the market ever returns," she said. Fund managers were paid $31.5 million last year. Abraham would also get rid of the pension bonuses.

Nelson A. Diaz: "We can increase funding levels to 60 to 65 percent by management reform," he said. He wants the city's fund managers to have more experience.

James F. Kenney: "The bulk of pension reform has to come from labor contract negotiations," he said. He declined to specify what he would seek in those negotiations.

Doug Oliver: "The city needs to grow itself out of the [pension] problem by encouraging younger Philadelphians to stay in Philadelphia in order to increase the tax base, and by exploring all options including the sale of city assets to slowly solve our pension issues."

Anthony Hardy Williams: He would look to lease or privately manage city assets such as the airport and Water Department. "We would put those one- time pots of money toward our pension responsibility, therefore reducing the responsibility of the general fund to pay for it." He also wants to establish a municipal bank and use interest proceeds to alleviate city finances and the pension fund.

T. Milton Street Sr.: He would hire pension experts to suggest a solution.

More on the candidates' positions on Philadelphia's pension crisis and six other important issues at Philly.com's Next Mayor website: nextmayor.philly.com

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