Why a sale of PGW makes sense

Olivia S. Mitchell

directs the Pension Research Council and is a professor of insurance/risk management and business economics/policy at the Wharton School of the University of Pennsylvania

Philadelphia's unfunded city pension obligation is enormous: Morningstar estimates that $7,000 per household is required to fill the hole. And without some urgently needed extra cash, the city's pension fund is likely to run empty in less than five years. This is why Mayor Nutter's recent deal to sell Philadelphia Gas Works to UIL Holdings, a diversified energy company, is a much-needed boon for the city's ailing pension system.

There are many other good reasons to favor the PGW sale, including the grim reality that old pipes pose a severe threat to the city's safety and health. A PGW worker was killed and six others injured when a 71-year-old cast-iron pipe exploded in 2011, and the utility reported almost 5,500 leaks in 2012. Yet current management has stated that it would take 88 years to replace the old pipes, because there's no money to speed up the process. The city cannot access the capital markets for this purpose. By contrast, a new owner would be able to borrow in the capital market and rapidly accelerate sorely needed repairs.

PGW is unique in that it is the nation's oldest and largest city-owned public utility. But why should a city own a gas works? Indeed, its ownership posed extreme risk to the city's budget when the utility almost collapsed in the late 1990s and early 2000s, having to be bailed out with large loans. So now that the utility can garner a competitive bid of $1.9 billion from UIL, the city should jump at the chance for a propitious, and profitable, sale. And while some worry out loud that utility rates may rise post-sale, UIL has committed to a freeze though 2018. Without the sale, rates will head up even sooner, as PGW has filed for a rate increase effective in 2017.

To my mind, however, the key argument in favor of the deal is that it will pump about $500 million into Philadelphia's municipal pension fund. That revenue, plus additional contributions made possible by the sale, will bring greater security to retiree promises than we've seen in decades. Already, Philadelphia pays more for pension contributions (21 percent of operating expenses) than for debt service (6 percent). And if we permit the pension shortfalls to keep growing, there would be much less money to spend on education, libraries, parks, public safety, and fixing sidewalks and potholes (and after last winter, those potholes seem much deeper and bigger than usual).

The city's pension shortfalls also drive up the city's cost of borrowing. When deciding how much risk a bond issue poses to investors, Fitch Ratings, Moody's Investors Service, and Standard & Poor's all look closely at the relationship between a city's pension promises and its assets to back them. For instance, both Omaha and Atlanta's bond ratings were recently revised in light of pension developments. Underfunded city pensions were cited as a key concern in April in a Philadelphia municipal bond offering, and the plan to sell PGW was hailed as a useful way to "alleviate potential future funding strains."

The PGW sale is part of a larger national trend to sell and lease public assets. Dallas sold its zoo to a private firm, after which the facility thrived. Ontario, Canada, is thinking of selling its city Power Corp. Even the Italian city of Venice recently tried to sell a 16th-century convent on the island of Murano. In the wake of the financial and economic crisis of the last six years, city budgets desperately need all the help they can get.

City Council must recognize that if the PGW sale does not go through, lawmakers would need to implement several painful reforms. Current examples abound: Chicago Mayor Rahm Emanuel has promised that millions of dollars more in new property and income taxes will be needed to keep his city's pensions afloat. Omaha recently levied a restaurant tax to help pay for city pensions. In California, underfunded public pensions have prompted city bankruptcies from Stockton to San Bernadino to Vallejo.

The PGW sale offers Philadelphia a win-win opportunity, by making the city safer and shoring up the pension fund at the same time.