Moral Hazards: Philadelphia’s Ongoing Pension Crisis

How did Philadelphia end up as one of the poorest, least-educated, highest-taxed and most violent cities in the country? Blame 40 years of political cowardice—and 34,966 ex-city workers who are still collecting fat government pensions.

Early on the morning of June 13, 1984, John Keyser and eight other­ firemen entered a burning rowhome on the 2000 block of Tulip Street in Fishtown, in search of an old woman supposedly­ trapped on the second floor.

The smoke was thick, and there was garbage and clutter all over the place, so the going was slow. Keyser remembers crawling over a motorcycle in the kitchen. He was approaching the staircase when, with no warning, the house caved in. The floor gave way beneath him, he tumbled into the basement, and multiple stories’ worth of plaster, wooden beams and junk came crashing down on top of the firefighters. Keyser and seven others survived. Fifteen-year veteran Joseph Konrad didn’t.

That, Keyser says, was probably the closest call of his 34 years of fighting fires in the City of Philadelphia. He retired in 2008, satisfied with his career, but happy to end it at the age of 55. “If someone’s hanging out a third-floor window in a burning building, do you really want it to be a 65-year-old guy that goes and gets her?” says Keyser. His family’s financial security was assured, thanks to the city’s pension system. Keyser is paid just shy of $50,000 a year. He’ll get that check for the rest of his life.

And really, who would begrudge him a comfortable retirement? Here’s a man who literally risked his life for the residents of Philadelphia. It seems eminently fair that Keyser is paid enough in retirement to afford a handsome Cape Cod two blocks from Burlholme Park in the Northeast. His condo in Ocean City, Maryland? Well, that’s more than a typical taxpayer can manage. But it’s no palace, and it’s hard to argue that he didn’t earn it.

But there’s a problem. While John Keyser on his own may seem worth every cent, he was just one of the 1,407 municipal employees who retired from the City of Philadelphia in 2008. Each of them is owed a lifelong pension. In all, there are 34,966 city pensioners now receiving monthly checks.

And together, John Keyser and the 34,965 other retirees are making beggars of City Hall.

PHILADELPHIANS HAVE LEARNED through bitter experience to expect less and less of their city government. Year after year, more services are cut than expanded. Libraries are subjected to commonplace “emergency closings” due to staff shortages. Mechanical leaf collection is gone; street repaving and pothole repairs are completed on slower schedules. Even for that much, we pay more. Three years running, planned tax cuts have been scotched, and rates were raised on other levies, like property, parking and sales taxes. Increasingly, Philadelphia has a government that demands more from its citizens even as it gives them less.

What’s to blame? The causes are complex, and include everything from generational poverty and white flight to the Great Recession. But more than anything else, it’s Philadelphia’s dull, maddeningly complex and immutable pension system that has sapped the strength of city government. There is no single greater drain on the city’s capacity—to fight crime, to fund education, to clean the streets or to cut taxes—than pensions.

Philadelphia’s pension fund—the $4.7 billion pot that writes pension checks for retirees—has only half as much money as it needs to be self-sustaining. That’s a dangerously low funding level, one of the worst in the nation. Left on its own, the fund would be insolvent by 2015. But the city won’t—and legally can’t—let that happen, so it writes massive checks each year to cover the pension benefits the fund can’t.

This year and next, Philadelphia will spend 18 percent of its total budget paying for pensions. Those payments—$630 million­ this year, $660 million next year—are non-negotiable. (The state constitution forbids cities from shorting pensioners.) And they are devastating for a city with so many other needs.

Let’s start with tax relief. With $630 million, the onerous city wage and net profits tax could be cut in half. Or you could eliminate the business privilege and city sales taxes altogether. Either option would, overnight, make Philadelphia—long regarded as one of the most hostile business locales in the nation—financially competitive with any city in America. That means jobs, and in the long run, the sort of prosperity that has eluded Philadelphia for more than 50 years.

Perhaps you think it would be wiser to invest the money in city services. With $630 million, the city could just about double the departmental budgets for the police, the Free Library and Parks and Recreation. Imagine: more cops per capita than any big city in the nation; a library system to rival those of ultra-educated cities like Seattle and San Francisco; a Fairmount Park to be proud of, every bit the equal of Golden Gate or Central Park.

Another option: Increase spending on capital projects by a factor of five. Stop babbling about redeveloping the Delaware waterfront and just do it. Those comparisons likening the Ben Franklin Parkway to the Champs-Élysées are embarrassing, but $630 million (in one year alone) sure would narrow the gap.

But because of the pension problem, such investments are utterly out of reach. “We can’t do any of it as long as we have these obligations that essentially strangle us,” says City Councilman and mayoral aspirant Bill Green.

If the failures of the past are any indication, Philadelphia won’t be able to escape its fate. Not because there aren’t solutions, but because to date, the system has proved unable to enact them. Union workers could start contributing more to the fund. New city employees could be steered into 401(k)-type plans. Limits could be placed on the egregiously generous pension benefits for elected officials. City Council could kill DROP, the costly pension perk that so outraged the public last year. Bigger fixes, which would have a more immediate impact, include selling off core city infrastructure—like the Gas Works and the Water Department—and putting the proceeds into the pension fund.

None of the solutions are easy. Each is fraught with political risk and loaded with very real consequences. The alternative, though, is to limp along indefinitely, a diminished city, in hock to the past.

SITTING IN HIS usual booth at the Palm Restaurant in Center City, former labor consultant and City Council candidate Bill Rubin munches a lobster salad and explains the abiding appeal of pensions for a unionized workforce. “The last thing our people want is to be involved in anything where the market dictates to them what their retirement earnings are,” Rubin says. For public employees, a pension is the ultimate security blanket, and they have no intention of letting go, not now and not in the future: “They know if they work for a certain number of years, they’ll get a set dollar figure for the rest of their lives and not have to worry about whether IBM is up or down.”

Outside the comfy embrace of government employment, of course, that type of security is an anachronism. In the private sector, people change jobs and even careers so frequently that a retirement funded by a single employer has become an alien concept, particularly in white-collar settings. (Today, fewer than 20 percent of private-sector workers have pensions.) For earlier generations, though, a pension plan was a standard perk, in government and out. Six out of every 10 Americans were covered by a pension plan in the 1960s, and the social consensus was that pensions were a clear good.

And indeed, when run responsibly, pension systems can provide comfortable retirements without sinking the companies or governments that manage them. Pensions are funded through a combination of employee and employer contributions, which are pooled into one big fund and invested in the markets. Investment profits are plowed back into the fund, and pensioners generally get a fixed benefit—usually a percentage of their former salary—from the day they retire until the day they die.

Public-employee pension plans started out simply enough, first covering only retired police officers and firefighters. By 1916, most big cities offered pensions for all their workers. In those days, the Philadelphia benefit was capped at half an employee’s final salary. Given the modest salaries of the time, a city’s liabilities were relatively contained.

All that changed when municipal workers won the legal right to form bargaining units in the late 1950s and early ’60s. Here in Philadelphia, unions and politicians alike immediately recognized the clout that organizations comprising thousands of city workers could wield at the polls, and that power inevitably spread to the negotiating table.

Public-sector unions have a special kind of leverage. Unions in the private sector—the Auto Workers or United Steelworkers, say—can’t win better wages and pension benefits simply by putting political pressure on the local mayor. Nor could those unions vote out their boss, the company CEO. Municipal unions, on the other hand, can do both. In their heyday, the leaders of public-sector unions could walk into the mayor’s office and give its occupant a stark choice: Accede to our contract demands, or our members will punish you and your allies at the polls. If that didn’t work, strikes were threatened. “One word from me and the traffic lights don’t work, the bridges don’t open, the trash isn’t collected and the heat in all the city buildings is cut off,” legendary Philadelphia labor leader Earl Stout said in 1975, amid contract talks with Mayor Frank Rizzo.

Rizzo caved, just as James Tate had before him. Under those two mayors, the city’s newly formed municipal unions won full control over city-funded health insurance plans, beefy salary hikes and, of course, major concessions on pensions. For the politicians, pension give-ins represented the ultimate Wimpy option, as in “I’ll gladly pay you Tuesday for a hamburger today.” The promises Tate and Rizzo made had almost no impact on their administrations. The deals made sense for the unions as well, who knew that once pension benefits are granted, they can’t be revoked.

Consider the example of John Keyser. Barely 20 years old when he was hired in 1974, Keyser was actually eligible to retire, with full pension benefits, the year he turned 45. (Plenty of cops and firefighters have done exactly that: worked for 25 years, got a lifelong pension, and then began a second career, with a second income.) By staying on the payroll until he was 55, Keyser was able to retire with a bigger pension, one roughly equal to 88 percent of his average salary during his years on the city payroll.

Keyser was also enrolled in DROP, the pension program that pays retirees large lump-sum amounts the day they leave city service. As a well-paid firefighter, Keyser had a hefty DROP payout: about $200,000. “I feel blessed and lucky that I’m able to collect this,” Keyser says. “I know lots of guys who don’t have any pensions.” He should feel lucky. If Keyser lives to 75.3 years old—the average for an American male—the City of Philadelphia will have paid him a minimum of $1.2 million in retirement. If Keyser, who’s a healthy man, makes it to 85, that figure swells to $1.7 million.

Now consider the fact that there are more than 12,000 former firefighters and police personnel and their beneficiaries receiving city pension payments under the Tate/Rizzo plan, and it becomes easier to understand why the city can’t afford to keep its libraries open on a dependable schedule.

ECONOMISTS HAVE A term for situations in which people and institutions throw caution to the wind because they won’t be held responsible for the consequences: moral hazards. For Tate and Rizzo, guaranteeing Keyser and thousands like him $1.2 million retirements was easy. It didn’t put a meaningful dent in their budgets, after all. Why, the bill wouldn’t come due for years and years. “The four-year life cycle of an elected official and the 30-year life cycle of a municipal employee do create some inherent traps,” says Sam Katz, chairman of the Pennsylvania Intergovernmental Cooperation Authority (PICA), the state agency that oversees the city’s long-term financial planning.

In 1987, the city scaled its pension benefits back a bit, and they’re now largely in line with what’s offered to municipal workers in other cities. But those reforms only applied to workers hired after 1987, so virtually all pensioners currently receiving checks are covered by the Tate/Rizzo plan. And even now, our city workers contribute less to their pensions than those in most other big cities.

Reasonable people can disagree about the salary and health-care concessions made to the unions in the 1960s and ’70s. In a Democratic stronghold like Philadelphia, the majority view is that it’s right and proper to compensate city workers—whom we ask to keep the city safe, clean and functioning­—with a solid middle-class salary and a benefits­ package­ befitting the importance of their work. The true offense, the sin that hobbled Philadelphia for decades, was making extravagant promises on behalf of future generations without socking away the funds to pay for those commitments down the line. And Tate and Rizzo were hardly the last or only offenders.

Later mayors compounded the sin by short-changing the city’s contributions to the pension fund and experimenting with complex high-stakes financial maneuvers that only set the city back further. On Rendell’s watch, the city sold $1.29 billion in bonds and put the cash into the pension fund, betting that it could make more money in the markets than it would owe in interest on the bond. The bet was a loser. The city has paid more in interest on the bonds than it has earned investing the money.

Then, in 2003, Mayor Street dealt the pension fund a massive blow, reducing the city’s contribution to the already-depleted fund to the lowest level permitted by state law. The economy was going through a bit of a rough patch back then, and Street preferred to use the cash to limit layoffs and fund his priorities. Owing no doubt to the arcane nature of pensions, Street’s decision received scant attention from the press. Which may help explain why even when the city’s budget picture improved, Street continued to pay the lowest amount possible, a practice continued by Mayor Nutter.

This decades-long string of disastrous decisions has been compounded by a few factors outside of political control, most notably the 2008 stock market crash, which cost the city’s pension fund $1.23 billion. Then there are sheer demographics: The city’s workforce is old, so there are a ton of looming retirees about to enter the pension system.

To be sure, the unions own a chunk of the blame. Their intransigence on pension benefits helped create the mess, and their unwillingness to bend since Nutter became mayor is particularly galling, given both the city’s self-evident financial fragility and the recent hardships endured by so many private-sector workers.

But it’s naïve to expect union leaders to do anything other than negotiate the best possible deals for their members. What’s more, even with the generous benefits, City Hall could have avoided the crisis by socking away more money over time. “They stopped putting money in the pot,” says Rubin, the union consultant who is also a former vice chairman and union representative to the city’s pension board. “So the question is, what did they do with the money? If it was spent on great investments, wonderful. But you can’t complain to the unions about the money you have to pay now. It’s not their fault you didn’t pay it before.”

MORE THAN ANY mayor before him, Nutter has labored to get a grip on the city’s pension disaster. Too bad he has so little to show for it.

For nearly two years, the Nutter administration has tried but failed to get rid of DROP, the perk that pays sizeable lump-sum payments to retiring employees, on top of their annual pension payments, at a cost to the pension fund of somewhere between $9 million and $22 million a year.

For four years, Nutter has tried but failed to negotiate contracts with the city’s blue- and white-collar unions—AFSCME District Councils 33 and 47—that would set the city on a path toward a sane pension system. The one deal he did sign with those unions, a 12-month accord at the beginning of his first term, accomplished nothing on pensions. In retrospect, given Nutter’s enormous popularity his first year in office and seeming political leverage at the time, that looms as a critical mistake. Ever since, DC 33 and DC 47 employees have worked without contracts, under the terms of their old deals.

And for four months, Nutter tried but failed to put together a pension bond offering so vast that it made Rendell’s risky bid look like Little League. That setback turned out to be a propitious one: If the Nutter administration had gotten the bond deal together, the 2008 stock market collapse would have had a truly catastrophic effect on the city’s finances.

Yet for all the shortcomings, pension hawks say Nutter has done better by the pension system than his predecessors. The city’s pension board, comprised of administration and union appointees plus the City Controller, has cleaned house internally, severing questionable deals with politically connected investment advisers and lowering the presumed rate of return on its investments (a prudent measure that makes it less likely the fund will fall short of its investment goals). Nutter—with the firm hand of the state legislature stiffening his spine—managed to get through the 2008-’09 economic crisis without stiffing the pension fund too badly. (The city did defer pension­ payments for two years, but has been paying back those skipped payments, with interest.) And the Mayor has lightened the pension fund’s long-term load somewhat by keeping­ the city’s workforce lean: There are 2,500 fewer pension-eligible workers on the city payroll now than in 2008.

What Nutter is most proud of, though, are contracts with the city’s fire and police unions. Those contracts, reached through arbitration in 2009 and 2010, included a one-point bump in the retirement contributions of all future cops and fire personnel (from five percent to six percent of each paycheck), and a new hybrid retirement plan—part pension,­ part 401(k) equivalent—that will apply only to fresh recruits. “We’re the only city in the United States of America that has a hybrid pension plan for uniformed police officers. And we have the same for firefighters,” Nutter recently boasted to reporters in City Hall, shortly after presenting his budget address to an audience packed with hostile union members in February.

That’s not quite true, actually; Atlanta also has a hybrid plan. But even if it were, Nutter tends to leave out a critical fact: The hybrid plan is optional, not mandatory. And to date, not a single new cop or firefighter has enrolled in it. Not one. “Just because no one is participating yet doesn’t mean no one will in the future,” says Nutter’s finance director, Rob Dubow. But that may be wishful thinking, given that union bosses are actively discouraging new hires from signing on.

In March, though, Nutter scored a real victory, albeit over a very small union: the 2,000-member Local 159, which represents corrections personnel. Unlike the arbitrated police and fire contracts, this deal creates a mandatory hybrid pension plan for new corrections workers. If Nutter successfully makes that deal the blueprint for future contracts with bigger unions, he will have achieved something significant, something that would put Philadelphia on better financial footing for decades to come.

But that’s a big “if.” Given the absence of major pension concessions from the larger unions, Councilman Green says, the past four years have been about “kicking the can down the road,” and enacting pension reforms that sound good but don’t achieve much. The next mayoral race, Green predicts, will turn on one question: “Are we actually going to address our real problems? Are people going to vote for somebody who tells them what has to happen to fix the situation?”

Green’s resolute rhetoric is inspiring, which makes it all the more disappointing that he himself has chickened out when presented with opportunities to make even modest reforms to the pension system. Instead of embracing Nutter’s bid last year to terminate DROP, Green sided with the Council majority that opted to preserve the program (which is beloved by the unions) while tweaking it around the edges. And when Nutter asked Council to approve an ordinance that would have increased pension contributions and created a hybrid plan for the city’s non-union workforce, Green again declined to support the Mayor. Here was a pension reform the city could have enacted on its own; union consent wasn’t necessary. And Council, including Green, balked. “It’s meaningless,” says Green, when pressed on his votes. “I want us to focus on steak, and not claim victories that are sizzle.” As though it would have been simply “sizzle” for the city to lead by example and create a sane pension system for non-union workers.

The point isn’t to harp on Green’s pension hypocrisy, but rather to highlight the fact that even politicians who plainly understand the stakes are prone to wilting on pensions. Indeed, in terms both of policy and perception, City Council—in partnership with the rest of the city’s political elite—has done massive damage to the fund’s stability and overall public support for public-employee pensions.

In recent years, a glut of Council members and other high-level city officials have retired and collected DROP payouts on top of lifetime pension benefits that are astronomically large in a city where the median household income is just $36,251. Mayor Street will get $116,387 a year for life, on top of the $451,626 DROP windfall he collected the day he retired. Recently retired Council president Anna Verna now receives $130,707 a year, in addition to her jaw-dropping $567,000 DROP bonus.

The massive payouts are due in part to the fact that elected officials are paid a lot more than an average trash hauler. But back in 1987, when they were paring back pension benefits for union workers, the city’s elected leaders also created a special, particularly generous pension class just for themselves.

It has been revealing over the past few years to watch City Council debate the fate of DROP. On its own, the program is no mortal threat to the pension fund. But DROP—which was never intended for politicians—was so badly abused by Council members and other elites that it became the symbol of the political class’s sense of entitlement.

Even so—even with public pique maxed out—Council sided with the unions, voting 14-3 to preserve the program, modifying it only slightly. Nutter vetoed the bill. Council overrode him, unanimously: Damn the consequences for the pension fund, and to hell with public opinion.

BEFORE HE WAS a member of Nutter’s administration, Dubow, the city finance director, liked to compare the city’s pension problem to the Blob, the gelatinous star of the 1950s sci-fi film that enveloped its victims. “It just keeps consuming more and more and more,” Dubow once said, “and eventually you will find everything’s gone, the town’s been eaten and destroyed.”

He issued that warning five years ago. And sure enough, the Blob—the annual city pension payment—has grown by 32 percent since then. But the town is still here. Battered, yes, but still standing. And that, really, is part of the problem. In contrast to Philadelphia’s 1991 fiscal crisis, the city’s underfunded pension plan is unlikely to create a moment dire enough to force the public and City Hall to prioritize the problem. Philadelphia is in no real danger of declaring bankruptcy over its pension obligations. The city won’t suddenly cut pensioners off; the state constitution forbids it. Unlike in 1991, there’s no short-term risk that City Hall will start bouncing checks.

The pension crisis is better understood as a long-term hardship, an enormous fiscal weight to be borne for years to come, a stone heavy enough to prevent Philadelphia from doing what other cities seem to pull off with such frequency: a Millennium Park, a renovated High Line, a waterfront worth visiting. This year, for instance, Nutter’s budget calls for $99 million in new City Hall spending. It’s a pittance, really, in a $3.6 billion budget, but a welcome one for city departments that have been cut back three years running. The only problem is that the city’s voracious pensioners have already spoken for $75 million of the new spending. What’s left behind, $24 million, isn’t even enough to keep up with inflation.

What’s the way out? In the short term, the options are limited. The only way to reduce pension payments immediately is to see what the municipal scrapyard is offering. How much would the private sector pay for the Philadelphia Gas Works? How much for the Water Department? Is there a way to sell off the Parking Authority’s lucrative airport garages? Perhaps we could even sell the Parking Authority itself (a deal that would require state blessing).

The idea is that the city would cash in whatever assets it could and sink the proceeds into the pension fund. That, in turn, would lower what the city has to pay into the fund each year. The trouble is, such sales are extraordinarily complicated, and it’s not even clear how much the city would net. Selling off PGW could yield as much as $350 million, according to a recent report. Or, the same report said, the transaction could yield next to nothing.

Long-term, the fixes are obvious, provided our political leaders can find the spine to face down the unions. The city needs to shift to 401(k)-type plans, or greatly increase employee contributions to the pension fund. Sane policy requires reforms that would prevent overtime spiking and other tricky maneuvers designed to inflate lifetime pension payments. The city must kill DROP, and tie cost-of-living increases for retirees to a predictable formula, since City Council can’t be trusted to stand up to political pressure. It must keep its workforce lean. And above all, it has to stop shorting the fund: Pay what must be paid, so that someday the Blob can be beaten back.

Sam Katz, the former mayoral candidate and current chairman of PICA, has put together a short presentation for business leaders and politicians that endeavors to explain just how daunting the pension problem has become. It’s got clip art, and a few comics thrown in to keep people awake, but the message is as serious as it is depressing. He’s titled it “The Pension Crisis: Here Today, Here Tomorrow.”

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