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How to save Philadelphia's pension fund

Empty pension pot on wooden background
Peter Dazeley | Getty Images

The rising cost of public pensions continues to stretch the finances of many American cities.

Moody's estimates U.S. municipalities have run up more than $2 trillion dollars in unfunded liabilities.

Philadelphia, for instance, now has a funding gap of $5.71 billion, or less than half of what it owes its 64,000 current and future pensioners.

The situation has gotten so bad that even the city's fiscal watchdog thinks this is the worst performing pension in the entire country.

Read MorePhiladelphia's "quiet crisis"

Appearing on CNBC's "Power Lunch" on Wednesday, Rob Dubow, director of finance of the City of Philadelphia and chairman of the city's pension fund board, said the situation is "very bad."

"The health of the municipal pension fund is one of the greatest financial challenges facing our city. One particular challenge is that the number of retirees exceeds the number of current employees paying into the fund, and that is a huge drain on our budget," said Dubow.

The challenge, he said, is when a pension plan comes up short, more funds get diverted away from residential services like fire and police departments or garbage collection.

But Dubow is convinced they will find a way out, in part by aggressively cutting manager and hedge fund fees.

"We reduced our exposure to hedge funds by a couple of million dollars," Dubow said. "We also have tried to be more defensive, putting more of our assets into cash and fixed income, to help weather the storm. But that also means we don't get the returns we want. So it's a process, and it will still take a while to solve."

Other measures on the table include working across the aisle with city politicians and unions.

"Mayor Jim Kenney, who took office earlier this year, will work with the city's council and unions on ways to improve the health of the fund. And the mayor's representatives on the pension board are already working with the other members of the board to reduce fees," said Dubow.

Founded in 1915, the Public Employees Retirement System provides benefits to police, fire and civilian workers of the city of Philadelphia through the administration of 18 separate plans.

In addition, the Board of Pensions administers a pension plan for the employees of quasi-public agencies (the Philadelphia Parking Authority, the Philadelphia Municipal Authority and the Philadelphia Housing Development Corporation.

Its last public performance report showed that as of December 31, 2015, the fund had a market value of $4,182,443,197.

During the same period, the total actuarial liability was $10.52 billion, and the unfunded actuarial liability was $5.71 billion.