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How will a new mayor handle Philadelphia’s biggest expense — pension funding — especially with a threat of recession?

The city's largest expense is "locked into" the budget, its leader insists.

One thing we’re not hearing much about in this spring’s now five-way race for mayor is the city budget’s largest single expense: pension funding for 30,000 former city workers and their survivors.
One thing we’re not hearing much about in this spring’s now five-way race for mayor is the city budget’s largest single expense: pension funding for 30,000 former city workers and their survivors.Read moreTom Gralish / Staff Photographer

More police! Better schools! Safer rec centers!

One thing we’re not hearing much about in this spring’s election race for mayor is the city budget’s largest single expense: pension funding for 30,000 former city workers and their survivors.

Philadelphia’s underfunded pensions in past times were a drag on the city’s fiscal reputation, lowering its credit rating to the worst among U.S. big cities and raising costs for the borrowing that funds city projects.

Since 2016, Mayor Jim Kenney’s first year in office, the city has begun to close the financial gap between what it expects to have to pay current and future pensioners — currently $12 billion — and the investments designed to pay the pensions — now $7 billion, up from less than $5 billion seven years back.

That’s because the city has been paying more than its state-mandated minimum into the pension plan — a total of $846 million this year, more than it spends on police, transit, parks, prisons, public health, debt, or anything else. By comparison, it spent $1.9 billion a year on pay for active-duty workers.

Put another way, the city puts about 44 cents into the pension plan for every $1 it pays active employees. That’s a lot more than most private employers pay for retirements. (As city finance director Rob Dubow points out, pensions are part of workers’ promised compensation, no matter how they are funded.)

Pension funding eats up 15% of the city budget, up from 12% when Kenney took over. Higher funding, along with stock-market gains, helped raise the pension’s ratio of assets (what the city has set aside to pay future pensions) to liabilities (what it expects to owe current and future retirees) from a sparse 40% in its weakest years to a healthier 60%, according to a yearly report released last week by actuaries at Cheiron Inc. in Washington, D.C., for the pension board.

If the city keeps putting aside roughly that much money over the next two mayoral terms — and if investment markets recover — the city hopes it will have enough to pay all future pensions by 2033. If the city succeeds, the minimum annual city payment to the plan would then drop to around $200 million a year under state rules.

What could go wrong? The stock market fell and bonds plunged as the Federal Reserve boosted interest rates last year, and the economy seems headed toward recession. Separately, the end of federal pandemic stimulus grants will make it harder for the city to fund future programs.

The city is now at a kind of financial crossroads, according to a report Thursday by Cora Bruemmer, an analyst at Standard & Poor’s, the bond-rating service.

Noting that Philadelphia has made progress in recent years, Bruemmer laid odds at a cautious “one in three chance” that through its first year under the next mayor, Philadelphia will continue to spend within its means. If it does, she said, analysts will raise its bond rating and cut borrowing costs.

But she warned that the city’s credit rating will drop and its borrowing costs rise “if the city is unable to continue to fund its pensions” at the current high level, or if other spending gets out of control.

City pension investments lost 6.5% of their value in the fiscal year ended June 30 — slightly better than New Jersey’s state pension plan, slightly worse than Pennsylvania’s, and far below its annual budget target of gaining 7.4%.

That loss won’t immediately cost taxpayers very much, since pension rules call for “smoothing” the results over several years. But additional years of losses like 2021 would force the city to pay much more than current projections.

Under Kenney, the city agreed to give the pensions more than state guidelines require — an extra $92 million last year, a projected $107 million this year — to help close the pension deficit in the years ahead.

The next mayor might be tempted to look at ways to divert some of that money elsewhere to meet emergencies. Actual pension checks, guaranteed by law, wouldn’t be affected — but a delay in financing would push their future cost far higher, a familiar tactic for fiscally stressed politicians.

But stripping the pension of its extra funding won’t be easy. “Those things are now locked in,” said Francis Bielli, the city pension board’s executive director.

He noted that part of the money directed to the pensions comes from the extra 2% Philadelphia shoppers pay in state sales taxes — money split with the city’s public schools, which could be diverted to other uses only by changing state law, Bielli said. The rest was negotiated in collective bargaining union labor contracts with city workers’ unions and can’t be changed without the unions’ agreement.

Why have city officials in recent years worked so hard to keep the pension plan solvent after earlier decades of underfunding?

To avoid a tough choice. When Pennsylvania cities let pension assets fall below 40% of liabilities, state officials have a history of pressuring cities to give up control of their pension plans and contracts, or selling city assets to raise cash.

Pittsburgh sold its parking meters and Harrisburg its parking garages. Officials in Chester, Delaware County, want to sell the city-owned regional water system over opposition from customers who worry that for-profit owners will boost rates.

Philadelphia has taken desperate steps to raise pension cash before. Taxpayers are still paying for the disastrous 1999 city pension bond issue, an expensive gamble that pumped $1 billion into venture capital and other risky bets connected with the boom, which dissipated in the 2001 stock market collapse.

City Council has since fought off proposals to sell Philadelphia Gas Works, a scheme justified by some supporters as a way to fund pensions.

During the financial crisis of 2008, Mayor Michael Nutter won a one-time delay on pension contributions — always an option if the economy gets really ugly and vital services must still be paid for.

Nobody currently in city government has advocated sacrificing pension solvency, selling assets, or anything other than maintaining the current high funding levels, Dubow said. The goal is that in not so many years, retirement funding will equal future need, and the annual cost will drop, freeing hundreds of millions of dollars in yearly spending.

No matter who’s mayor.

And especially if investment markets happen to cooperate.