Don't DROP It

(August 2010)

Philadelphia's Deferred Retirement Option Plan (DROP) has once again landed on the front pages with the release of a city-commissioned report from a consultant that claims the program has increased city pension costs by $258 million over a decade.  While that number sounds extreme, considering our pension fund is underfunded by billions, it is literally a DROP in the bucket of a much larger problem.  The impact of DROP on the city's annual budget is much more complicated and unsettled.  Predictably, there are calls from the Mayor to do away with the program, but such a reactionary response betrays a lack of managerial skill and a lack of a reformer's will.  Used correctly, the tool of DROP could save the city millions and allow the city to best configure its workforce to respond to the challenges that confront us.

"Every great cause begins as a movement, becomes a business, and eventually degenerates into a racket.”  Eric Hoffer wrote that about mass movements, but he surely could have been writing about Philadelphia because that sentiment seems to nicely capture much of what goes wrong in our city.  The DROP program was initiated to be a management tool to improve service delivery and save taxpayer dollars, but it quickly became an expensive perk that was then perverted and abused by elected and appointed officials.

DROP Begins As A Movement

In a city where rationalizing the size of the workforce is a major challenge and where long-term planning is often sacrificed for the need to deal with today's crisis, DROP was presented as a management tool that could help the city plan and save.  

DROP is a retirement-incentive program introduced in Philadelphia in October 1999, modeled on similar programs in other cities.  One compelling reason to create the program is to keep the more-experienced employee, especially in the uniformed forces, from leaving the payroll and leaving the city without effective agency leadership.  By encouraging workers to commit to staying on the job for a period, DROP helps retain institutional knowledge and gives the city the managerial certainty to accomplish succession planning, reconfigure organizational personnel, and/or reduce payroll expenses.  Knowing that a valued employee would be retained for a number of years, agency leaders could train that employee's (lower-salaried) replacement and evaluate ways to reduce top-heavy management by replacing, for example, three departing employees with two promoted employees.

Here's how it works.  The employees who elect to participate in the DROP make a commitment to retire no later than four years after entering the program.  While the workers remain employees of the city, they (and the city) stop making contributions to the pension system so their take-home pay increases and the city saves money.  In addition, the employees no longer accrue any additional service credit for pension purposes so the long-term value of the employees' pension does not increase as it otherwise would with continued service.  While enrolled in the DROP, the still-employed workers receive a pension payment that is deposited into an escrow account that is guaranteed to earn at least 4.5-percent interest annually.  When the employees ultimately retire, they receive a lump-sum check for all the accrued pension payments as well as the interest earned.

DROP Turns Into A Business

It is easy to see why employees would want to enter the DROP as it essentially allows them to increase take-home pay while working (by eliminating employee pension contributions) and, at the same time, start accruing pension payments, which are guaranteed to grow at a 4.5-percent interest rate.

It is also easy to see why the city would want to utilize the DROP program as it reduces costs in the short run by eliminating city pension contributions for participants, gives the city the predictability to plan to reduce the size of the city workforce in the future, and generates long-term gains when pension funds grow at historical rates.

As long as our pension-fund investments earn a return of more than 4.5-percent, our employees' behavior doesn't change radically in response to the DROP incentive, and our leaders are prepared to use the DROP tool to manage the size of the city workforce, the program is a can't-lose proposition.

Oops.  Things certainly change.

It didn't take long for employees to recognize that if they were thinking of retiring anyway, DROP could generate a nice benefit for sticking around for a few years.  The change in behavior encouraging some to retire earlier has increased pension costs.  Also, with the underperforming economy, pension funds certainly did not earn more than 4.5-percent interest in recent years and keeping that 4.5-percent interest promise has been costly in many years.  When the DROP originated, the stock market was performing well and the fund enjoyed returns of 11 percent in fiscal year 1999 and 9.5 percent in fiscal year 2000.  When the stock market started to decline, the fund absorbed losses of -5.5 percent and -5.2 percent in fiscal year 2001 and fiscal year 2002, respectively.  We all know what has happened in the most-recent years.

Even with that cost, the city could have taken advantage of the program to make major strides in reducing the costs associated with the city workforce.  But, the city never responded with a comprehensive plan to use the tool of DROP to make dramatic changes to the size and configuration of the city workforce.  While the city workforce did drop from a recent high of 24,500 in Fiscal Year 2003 to 22,900 in Fiscal Year 2005, the numbers have not changed much in the five years since and the city employs about 22,500 workers today.  While nearly 7,000 workers have already left city employ through DROP and more than 2,000 are currently enrolled in the program, the city has made almost no change to the size of the overall workforce in recent years.

DROP Degenerates Into A Racket

Of course, there could never be a program that presents a benefit without someone looking to pervert that benefit into something shady.  So it is with DROP.  First, city officials decided to allow certain employees to enter the DROP program, collect the DROP payout, and return to the payroll.  This was obviously never the purpose of DROP and any excuses that some employees are too valuable to let go fly in the face of the mechanics of the program, which create the certainty of a four-year window when employees' replacements should be trained to take over.

Then, a few elected officials decided that they would like a piece of the DROP action.  Certainly, nobody could make the case that DROP should apply to elected officials and, happily, state lawmakers recently ended elected officials' eligibility for the program.  Still, many elected officials who are already in the program have or are looking to run for re-election and then return to office after having “retired” to take advantage of the DROP payment.

While the cases of retired-but-retained officials and elected-office holders entering DROP are few compared to the scope of the overall program, they have become emblematic of what taxpayers see as the greed and excess of those who run Philadelphia.  Unfortunately, because these actions have been so repulsive and so inexcusable, they have made the program an easy target for muckrakers who use it to demonstrate the city's dysfunctional civic culture.

Stop it?  DROP it?

Give a child a hammer, they say, and all the world becomes a nail.  So it is with this tool.  If DROP is seen as a tool to increase individual wealth, then it will be a benefit to be protected by the city's bargaining units, a perk to be extended to high officials, and a scam to be exploited by scoundrels.  However, if DROP is used as a tool to create effective succession planning and workforce management, then it can be used to help configure city agencies to efficiently serve the citizenry.

My father always told me that it's the poor craftsman who blames his tools.  If one is hitting his thumb instead of the nail, it is not the hammer's fault.  Hit the nail on the head and it works quite well.

Rather than drop DROP altogether and lose the possibility of being able to use this tool effectively, the city should make two minor changes to the mechanics of the program and one major change in mindset of administration officials to make it work for Philadelphia.

First, rather than a guaranteed return of 4.5 percent, DROP participants should earn a much-smaller guaranteed return of, say, 1.0 percent plus a variable rate of return tied to the performance of the pension fund.  This way, the pension fund is not devastated during slow-growth periods and DROP participants can share in the benefit when the investments perform well.

Second, the city must shut, lock, and bolt the door after employees enter DROP and ultimately leave city service.  No more retiring and rehiring.  No more post-DROP consulting arrangements.  No more wink-and-nod shenanigans.  Every time the program is misused, it becomes harder and harder to justify its proper use.

Finally, and most important, the city must use the tool of DROP much more effectively.  Informed with the certainty created by the DROP participants' timetable for retirement, the city should reassess workforce planning to best manage our organizational approach toward fulfilling agency missions.  We should use the tool of DROP to ensure that we have a lean management structure overseeing a workforce that is deployed effectively to meet the needs of the citizenry.

If the city could use the tool of DROP to replace the more than 2,000 current DROP enrollees in a way that eliminates 500 positions, the city could save up to $50 million each year in salary and benefits costs.

It is not about doing more with less.  It is about doing what we should be doing most efficiently.

In a city where approximately 60 percent of the budget goes toward employee compensation, our central challenge is finding ways to maximize the competence and productivity of our workforce.  We need to use every tool in our toolbox to achieve those goals.

So, mend it, don't end it.  Fix it, don't nix it.  Improve it, don't remove it.

We have a managerial tool in our hands, if we DROP it, we may never get a chance to put it to good use.