How a Bankrupt City’s Pension System Hit a Breaking Point

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Welcome back to Route Fifty’s Public Finance Update! I’m Liz Farmer and this is the second installment of my series on Chester, Pennsylvania’s bankruptcy. (Click here to read Part I.)

As with most—if not all—municipal bankruptcies, there’s a lot of blame being thrown around. But in Chester’s case, sentiments on all sides appear particularly caustic. So much so that for nearly two years, the receiver’s team has been working out of a sparsely furnished office a half-block away from City Hall. In courtroom testimony earlier this month, receiver Michael Doweary described being called the “N-word” during a verbal altercation with Mayor Thaddeus Kirkland. Doweary, meanwhile, has accused city officials of nepotism and fiscal malfeasance, if not outright corruption.

“It’s been rocky,” Councilmember William Morgan, who is also the city director of accounts and finance, told Route Fifty in a recent interview. “I do think there’s an opportunity—a small opportunity—for the relationship to get better but there has to be the want for that on both sides. And right now, I don't know that it’s there from all parties.”

A key driver of the conflict is around fiscal management and disclosure. Amid its budget troubles, the city has racked up $750,000 in Internal Revenue Service penalties related to unpaid payroll taxes, fell victim to a $400,000 phishing scam that wasn’t publicly disclosed for months, cycled through two chief financial officers in as many years and has failed to produce an audited financial report since 2018. But perhaps the most striking example of the problems surrounding the city’s bankruptcy is the discord—and conflicting information—around Chester’s underfunded police pension. 

Like other distressed cities, Chester has an outsized pension liability and annual pension bills that would take up a substantial portion of its budget if paid in full. But also like other cities, Chester hadn’t been paying its entire bill—called the Minimum Municipal Obligation (MMO) in Pennsylvania. In 2021, the city paid its full MMO for the first time since 2013 and it was a significant lift. The total it spent on pension and retiree health care costs that year—$14.6 million—took up 28% of its entire general fund.

But there’s a bigger problem: Due to accounting practices that inflated the plan’s assets and a dispute over what the city’s police pension formula actually is, no one really knows what Chester’s true unfunded liabilities are.

Hidden Pension Liabilities

The questions are mainly about Chester’s police pension, which is the largest of its three plans and accounts for more than three-quarters of the city’s $131 million in total unfunded liabilities. The most recent valuation for the police plan, from 2019, pegged assets at 34% of what is needed to cover total liabilities for about 140 retirees and 75 active members. 

But in reality, the plan has been perilously close to running out of money for years. Back in 2018, then-recovery coordinator Econsult Solutions, estimated the plan was actually 9.5% funded and had enough cash to cover about  12 months of payments. By the time Doweary arrived in 2020, his office estimated the plan was just 3% funded with three months of cash to cover payments. (The plan is now about 13% funded after the 2021 pension payment.)

The reason for the difference is that Chester’s pension system is counting its entire MMO bill—not its actual payment—as a “receivable.” Receivables can be counted toward the fund’s total assets. Sources interviewed for this story say this is a relatively common practice in cases where a payment needs to be slightly delayed for budget reasons but, for the purposes of the valuation, the full amount due is counted on the plan’s balance sheet.

But Chester has been doing this for years, counting money it hasn’t actually paid into its retirement system. It’s akin to paying the monthly minimum on a credit card bill, but failing to consider how all of the accumulated late fees and interest are adding to the overall amount due.

"It’s one thing if you’re expecting those contributions to be made up in a month or two, or even in the next fiscal year,” said Keith Brainard, research director for the National Association of State Retirement Administrators. “But we're looking at several fiscal years of underpayment, and the city does not appear to have the money.”

The state does have an enforcement mechanism, Act 205, to compel municipalities to make their full pension payments. But it was not employed despite Pennsylvania’s auditor general highlighting the issue.

A spokesman for the Pennsylvania Department of Community & Economic Development, which oversees distressed municipalities, said via email that normal procedures were followed, “but they were not developed for an issue of the magnitude found in Chester.”

Doweary’s chief of staff Vijay Kapoor has consulted with other fiscally distressed cities, including in Pennsylvania, and said this is a first for him. Act 205 also allows elected officials or any pension plan member to file a mandamus action to compel payment. “I have not experienced something like this where you have multiple years of nonpayment and every potential safeguard didn’t act,” he said.

A Benefits Dispute

A second unknown with Chester’s police pension debt is whether some retirees have been receiving the correct payments. Doweary’s office has cut the pensions of about 30 retired police officers after determining their benefits were miscalculated to be higher.

In 2009, the city pension board, as part of negotiations with the police union, changed the final salary calculation from which the payment amount is determined from an average of the last three years of an officer’s time on the job, to the last twelve months. The shorter time frame gave employees an opportunity to try to increase their final pension by working more overtime in their final year on staff.

The problem is, no one can find a signed copy of that agreement, nor was the formula change codified.

“The only collective bargaining agreement from that time showing the formula change is an unsigned draft agreement,” said Les Neri, former head of the Pennsylvania Fraternal Order of Police, who represents the union’s interests in the bankruptcy proceedings. “But after that point, all pensions were calculated based on the one-year formula. So there’s no doubt everyone believed that’s what the benefit was—the city didn’t just do this on its own.”

Still, the cuts were made after the receiver’s attorney conducted an extensive review and said in a December memorandum that he found no written agreement reflecting the change. He also “spoke to a number of individuals who could reasonably be expected to have knowledge of such an agreement—including the Act 47 Coordinator at the time—and no one had any such knowledge.”

Neri and others are challenging the cut-back payments in court. If they succeed, Chester’s reported police pension liabilities will go up.

A Symptom of the Problem

Between health care and pensions, Chester’s retiree liabilities account for more than three-quarters of the city’s $430 million in debt and will undoubtedly be a major focus of its restructuring. But some worry that right-sizing the city’s debt won’t fix more fundamental problems, like a shrinking tax base and a budget that relies heavily on a few major employers. 

"This case of Chester reminds me a bit of...Detroit and Stockton, California, where many fingers were pointed at the pension plan as the cause of their bankruptcies,” said Brainard. “Yes it’s an obligation, but to a large extent, the inability of those cities to fund their pensions was a result of other factors—chiefly economic."

Councilmember Morgan says the city has taken several steps to right its financial ship in recent years, including renegotiating police retirement and medical benefits.  He contends that local leaders just need more time to get the situation squared away.

But others say Chester’s pension woes are a symptom of a city ailing from deeper problems with poor management. Indeed, Doweary is seeking to overhaul the city’s management structure where council members and the mayor serve as department heads. Doweary is asking the state court judge overseeing receivership to approve, among other things, installing hired professionals to oversee departments. 

“What worries me is that people will see bankruptcy, wiping the debt clean, as solving the problem,” said Neri. “The problem is leaving the same people in charge. As long as they do that, things will continue the way that they did.”

Correction: This article was updated to note who receiver Michael Doweary is asking to approve, among other things, installing hired professionals to oversee city departments. It is a state court judge, not a bankruptcy judge.