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Council Introduces Plan to Modify DROP


The other shoe has finally DROP-ped.

As we predicted, Council today introduced legislation to reform the controversial DROP program. Their bill would lower the interest rate that participants earn and would require city workers to wait two more years before enrolling.

"The bill introduced today preserves DROP as an option," said Council President Anna Verna in a press release. "It is designed to eliminate its cost for all employees in currently open pension plans who are not yet eligible to retire. My colleagues and I believe this is the better approach, but we look forward to exploring the alternatives at the scheduled hearing on the bill."

The legislation will be reviewed at a June 6 hearing, along with legislation supported by Mayor Nutter to end DROP. But it's not clear if there are enough votes to end DROP.

City Hall sources said that under the Council plan, employees would not be able to enter DROP until two years after they hit retirement age - which varies by job. And the interest rate, now set at 4.5 percent, would be adjusted based on U.S. Treasury rates. The plan is also expected to include an option for employees to collect a lump sum upon retirement in exchange for lower pension payments.

Nutter has repeatedly called on Council to eliminate DROP. A study he commissioned from Boston College found that the program had cost $258 million since its inception in 1999. But a follow-up review by Council's consultant, Bolton Partners Inc., put the cost at $100 million.

DROP allows city employees to set a retirement date up to four years in the future, at which point they start accruing pension payments in an interest-bearing account while still on the payroll. When the employees retire, they collect a lump sum, then start receiving pension payments.

Public anger has been stoked in reaction to elected officials' participation in DROP - including a few who signed up for it, then ran for and won re-election, "retired" for a single day, collected six-figure DROP payments, then resumed collecting city paychecks. New elected officials cannot enter DROP.

Here's a press release from Council:

DROP Legislation Introduced

PHILADELPHIA, PA - City Council's Leadership today announced that proposed legislation concerning the City's Deferred Retirement Option Plan (DROP) will be introduced as planned at this morning's session of Council. A public hearing on this bill, and on Bill 100542 (Mayor Nutter's bill to eliminate DROP) will be scheduled shortly.

The attached bill overhauls the DROP program by directly addressing those elements that are responsible for its cost. It also avoids a costly one-time surge of last-minute applications that the Mayor's bill would trigger.

"I know there has been immense pressure to eliminate the DROP because of its cost," Council President Verna said. "The bill introduced today preserves DROP as an option. It is designed to eliminate its cost for all employees in currently open pension plans who are not yet eligible to retire. My colleagues and I believe this is the better approach, but we look forward to exploring the alternatives at the scheduled hearing on the bill."

Here are the key features of the attached bill:

• Employees would be required to work two years beyond their minimum retirement age before they could enter DROP. This change is designed to reverse and prevent the "change in behavior" that is responsible for most of the cost of DROP. For example, an employee in the "Y Plan" who could retire at age 60 would have to work until age 62 before enrolling in DROP.

• The interest rate earned by set-aside DROP payments would be calculated in a way designed to ensure that the Pension Fund either makes money or comes out even. The bill eliminates the 4.5 percent minimum interest payment that is now required. Instead, the interest rate would equal the interest rate being paid on one-year US

Treasury bonds – currently two-tenths of one percent. And if the rate increases in the future, the bill caps the rate so that it never exceeds half of the Pension Fund's assumed rate of return.

• "Grandfathered" Employees. Both the Mayor's bill and the attached bill allow employees who are currently eligible to enroll in DROP to sign up for the existing program. The bills differ, however, in their approach to this group of employees. For these employees, the Mayor's bill is likely to be more costly than the attached bill:

o The Mayor's bill: All employees who have applications to enroll in DROP pending at the time the bill takes effect could still enter DROP. The practical effect of this approach is that once the bill moved out of committee and seemed likely to be enacted, there would be a surge of applications by the thousands of employees eligible to enter the DROP. In fact, the Mayor's announcement on August 3, 2010 that he would be submitting this legislation already produced an initial surge: On just the five business days immediately following his announcement, the Board of Pensions received a total of 472 applications, as compared to the entire month of August 2009, when 82 applications were submitted. From August 4 through October 12, 2010, the Board of Pensions had received 1,188 Preliminary Applications.

o The attached bill: The same employees could enter the current DROP program, but instead of being forced to enroll now, they could enroll at a time of their choosing. This approach avoids the "run on the bank" that the Mayor's bill guarantees. And it gives those employees who would like to work beyond their minimum retirement age the opportunity to do so – thereby reducing the ultimate cost of their participation in DROP. This provision fulfills Council's October 2010 pledge to give eligible employees a "window of opportunity" to participate in DROP. Those employees who are DROP-eligible when the bill becomes law or within 90 days thereafter would be "grandfathered."

o Neither bill would affect employees who are currently enrolled in the DROP.

• Cost of DROP. The combination of delaying the entry date for DROP and reducing the interest on set-aside DROP payments will have the following effects for employees covered by the overhauled DROP program:

o For uniformed employees, the DROP has always been cost-neutral, primarily because the availability of DROP did not cause these employees to retire earlier than they did before the DROP program was enacted. The attached bill ensures that this potentially costly change of behavior will not occur in the future.

o For civilian employees covered by the new plan enacted in 1987 (Plan Y), the two-year delay should substantially eliminate the cost of DROP.

o For those remaining civilian employees covered by the old pre-1987 plan (Plan J) and who are under the retirement age of 55, the two-year delay requirement should reduce DROP costs to a one-time present value cost of between $15 million and $20 million. This cost will be substantially offset by the savings from the new interest rate formula, which would have saved between $1 million and $1.5 million annually if it had been in place for the last 10 years.

• Finally, the attached bill proposes a cost-neutral "partial lump sum" option for all City employees except those who enter the DROP: Upon retirement, an employee could choose to take up to three years of retirement benefits in a lump sum. This lump sum benefit would be completely offset by the employee taking a reduced monthly pension check for life, so as to guarantee that no new costs would be imposed on the City or Pension Fund. For employees not interested in DROP, this would provide a way for them to receive a lump sum at retirement that would be completely cost-neutral to the City and the Pension Fund.