The Perfect Storm

For Mayor Street (right), the pension-fund debacle has become a campaign issue, thanks to Republican challenger Sam Katz. Photo By: Michael T. Regan

A combination of unexpected economic factors met to create the city’s looming fiscal calamity.

by Ralph Cipriano

When city Finance Director Janice Davis talks about the negative forces battering the municipal pension fund, she likens the situation to The Perfect Storm.

Davis is talking about declining stock market revenues, rising pension-bond payments that taxpayers are obligated to make and the experimental DROP (Deferred Retirement Option Plan) pension giveaway program.

Today, the DROP is expected to bleed the pension fund of up to $461 million in cash bonuses to be paid to city workers during the next four years. "You get a hit when you can least take it," Davis said of a program that the mayor has already announced plans to kill.

Under the DROP, the city pays out lump-sum cash payments to veteran employees, in addition to their regular salaries and pensions, to entice them into staying at their jobs. But for city taxpayers, Davis' storm has a price. Their contributions to fund city pensions are projected to rise from a total of $222.8 million in fiscal year 2004 to a total of $378.9 million by 2008, according to city records. That's an increase of $156.1 million over five years, or an expected jump of 70 percent. (These figures represent both taxpayer contributions to the pension fund and debt service owed on pension bonds.)

The increase leaves city officials with only two choices, Davis said. "It's going to require that we find other places in the budget to cut, [or pray for] more robust growth in the economy," Davis says. Another finance department official said decisions about potential cuts have not yet been made.

For Mayor Street, the pension-fund debacle has become a campaign issue. Republican challenger Sam Katz charged last week that city officials are compounding a "pension fund crisis" by continuing to rely on past earnings projections now considered unrealistic.

"I remember the movie," Katz said, picking up on Davis's reference to the

2000 George Clooney film about a fishing boat tragedy off the shore of Nova Scotia

. "They could have turned around, but they decided to keep going."

Getting back to the point, Katz continued that "the best thing to do in all of these situations is to totally disclose the truth. Not to sugarcoat it with numbers that are totally unrealistic on the surface." He’s referring to a July 1, 2000 actuary’s report on the pension fund that, when released 10 months later, estimated the progress of the municipal pension fund across the next two decades.

That report based projections on an expected annual increase in investment income of 9 percent but it was written in better times, when the city was earning robust investment returns, like 23.7 percent in 1999, Davis said. While the pension fund lost at least 5 percent on investments in both 2001 and 2002, the city hasn’t revised annual earnings estimates, leaving a growing funding gap between the projected value of the pension fund and the amount that taxpayers will be obligated to pay.

According to the actuarial costs based on July 2000 projections, the city pension fund -- boosted by expected annual earnings of 9 percent -- was supposed to swell to $5.48 billion this year. Instead, the city pension fund is only at $3.8 billion and taxpayers will have to make up the difference. The future doesn’t look brighter either.

Katz said the first thing the city needs to do is revise its actuarial report and substitute a more realistic earnings projection, say 6 percent. Davis agrees that a 9-percent earnings estimate is "very aggressive," and "should probably be adjusted downward." But, she adds, now is not the time.

Redoing the city pension plan and plugging in a lower earnings projection would "be exacerbating a bad situation," she said, because it would necessitate plugging in even higher numbers for taxpayers annual contributions to the pension fund.

"In theory, he (Katz) is right," Davis said, "but this would not be a good time to do it because you’re attempting to balance your budget, which is already having a problem."

The city’s pension problems began five years ago when city officials, under former Mayor Ed Rendell’s direction, took out a $1.25-billion pension obligation note to boost the funding of the pension plan from 50 cents for every dollar owed to pensioners to 75 cents on the dollar.

That pension obligation note was taken out at the height of the bond market -- when interest rates were high -- and the proceeds were invested in the stock market, which promptly tanked. Now the funding level has drifted back to 50 cents on the dollar.

Taxpayer payments on the bonds, issued at 6.55-percent interest, have continued to rise from $12 million in 1999 to $63 million this year, and the trend will continue. Over the next five years, the bond payments that the city is obligated to make will jump from $66.8 million to $91.6 million.

Davis, however, rejected Katz’s characterization that the city was having a pension-fund crisis. "It’s something to be concerned about," she said, adding that it’s "a situation that every public entity is grappling with. … If it’s a crisis, it’s a crisis across all governments."

Meanwhile, one former city official blames Rendell for the city’s current pension problems, as well as the media. Bennett Levin, a former commissioner of the city’s Department of Licenses and Inspections under Rendell, was one of the earliest DROP critics.

"This was typical Ed," Levin said of the 1999 decisions to issue the billion-dollar pension note and kick off the DROP program. "He (Rendell) killed two birds with one stone," Levin said, referring to the fact that Ballard Spahr Andrews & Ingersoll -- the law firm of both Rendell and his former mayoral chief of staff David L. Cohen -- was one of many firms to benefit, receiving $250,000 in bond fees. "And at the same time, [Rendell] maintained the aura of having busted the unions but bought back their favor by giving them a staggering bonus that was never part of any collective bargaining unit."

Responding to Levin’s claims, Rendell spokesman Chuck Ardo said that at the time the DROP was instituted, Rendell and other city leaders consulted with actuaries and other financial experts and were advised that the DROP was supposed to be cost neutral to the city. But the program didn’t work because of an unforeseen and precipitous drop in the stock market, Ardo said. For critics to attack Rendell and other city officials is "unfair and raises questions about the motives of those who are asking the questions," he continued.

Levin also was critical of the city's paper of record, The Philadelphia Inquirer, which has devoted little coverage to the DROP plan in the past four years, except to summarize a July 24 City Paper cover story -- without mentioning CP.

"This is a perfect example of what happens when the mainstream press is in the hip pocket of the mayor and his chief of staff," Levin said. "There’s no checks and balances, there’s no real hardcore reporting and the public ultimately pays the bill."

When asked for comment, Amanda Bennett, newly appointed editor of the Inquirer, replied in an e-mail, "I would say that hard reporting that holds institutions accountable is something that I really value and that this is just one of many stories that we all wish we could be more aggressive on."