Philadelphia Gas Works, the municipal utility that serves 500,000 mostly residential customers, yesterday requested a $42.5 million rate increase that would boost residential bills 6.5 percent.

PGW says it needs the increase chiefly to change the way it pays for health obligations for retirees. PGW says the new funding mechanism would save $180 million in the long run and contribute to PGW's efforts to repair its near-junk credit rating and lower its borrowing costs.

The utility's proposal would create a long-term fund to pay retirement benefits that are now being paid out of current operations. The rate increase would be front-loaded: The utility proposes to annually reduce the $42.5 million increase to $7 million by 2015.

A separate filing yesterday with the Pennsylvania Public Utilities Commission would allow PGW to recover the costs of a five-year $54 million energy-conservation effort that would benefit 85,000 residential and business customers. PGW estimates that the average residential customer would pay about $5.64 a year for five years to support the program.

"All of the changes we have asked the PUC to approve are designed to continue our recent progress and to reduce customer costs," chief executive Thomas Knudsen said in a statement. "For example, investing in our conservation plan now will ultimately allow our customers to enjoy savings of about $60 million."

The PUC has until the end of August to hold hearings and rule on the request.

PGW calculated the increase would add about $8.54 to the average monthly bill of $131.48. But it said rates would be lower than they were a year ago because natural-gas commodity costs - which PGW passes through to customers - have declined.

The filing comes a year after the PUC granted a $60 million emergency rate increase so PGW could avert costly debt refinancing and credit downgrade amid the national market meltdown. At the time, regulators ordered PGW to return by the end of 2009 to file a formal rate increase. Yesterday's filing also seeks to make last year's emergency boost permanent.

PGW says its income is so lean that its owner, the city government, has forgiven the utility's annual $18 million dividend until PGW regains its financial footing. But PGW's critics say the utility's collection efforts come at the expense of low-income customers.

They point to statistics the state released this week showing that PGW, long considered a soft touch by customers, reported a big increase in terminations this year.

The PUC reported that 17,037 Pennsylvania households began the winter with their heat-related utility service cut off, an 18.5 percent increase over last year. Almost one out of every two of those households were PGW customers.

"PGW has an unreasonable reconnection policy that makes it virtually impossible for customers to get their service restored," said Jonathan M. Stein, general counsel of Community Legal Services Inc.

But Steven M. Hershey, PGW's vice president for regulatory and external affairs, said the utility was forced to take a hard stand because 90 percent of the customers who agreed to reduced-payment plans broke their agreements within a year. Their arrearages are paid by other PGW customers - about 20 percent of current rates cover low-income subsidies.

PGW said that reductions in the number of low-income customers getting federal energy grants this year also contributed to snug finances. PGW's revenue from the federal grants is off $9 million this year.

Contact staff writer Andrew Maykuth at 215-854-2947 or amaykuth@phillynews.com.