Deal puts pension funds on stronger footing
Michael Van Overbeke wants to stress one point when it comes to the role of city pensions in Detroit's bankruptcy: The problem was the city's inability to make its scheduled pension payments, not the performance of the pension funds themselves.
"The retirement system themselves were some of the best-funded systems in the state and even the country at the time the city went into bankruptcy," said Overbeke, general counsel for the city's General Retirement System. "The concern was that because of the decline of the tax base, the city could no longer afford to make its contributions."
Critics of public pensions in general argue the pensions simply were too generous — so generous as to be unsustainable — and that, specifically the Detroit pension funds had experienced a series of missteps that included systematically overpaying benefits, mismanagement, poor investments and outright fraud.
That ranged from a $26 million loss the pension funds took on an Alabama-based airline and a $20,000 trip to a conference in Dubai, to outright corruption. Jeffrey Beasley, the Kilpatrick-administration treasurer who sat on the boards of both the police and firefighters pension fund and the general retirement fund, is now on trial for corruption with former Detroit pension trustee Paul Stewart and pension fund lawyer Ronald Zajac, charged with taking bribes. Three people already have pleaded guilty in the case.
A bigger concern was that the pension funds also overpaid benefits, including more than $1.2 billion in annual bonuses, or "13th checks," issued to retirees from 1985 to 2008 before the city outlawed the practice. The city's general retirement system also overpaid interest on annuity savings plans, to the extent that the city will now reclaim $239 million from retirees. The total of those overpayments is as much as the city borrowed in the controversial casino tax financing deal that many blame for tipping the city into bankruptcy.
According to representatives for city retirees, however, those issues already were in the past.
"The stuff that everyone complains about is pretty far back in the past. Everything has been relatively well-run in the past four or five years," said Carole Neville, an attorney representing the Official Committee of Retirees in the bankruptcy. "Each of the pension plans could actually have paid out the benefits unreduced for eight to 10 years."
The problem was that after that, they would have been broke.
In June 2013, just one month before the city declared bankruptcy, Emergency Manager Kevyn Orr reported that the city would miss $100 million in pension payments. And while the city had earlier estimated that it needed to cover an accumulated shortfall of $640 million in pension promises, new calculations by Orr and his consultants pegged the city's pension gap at $3.5 billion.
That yawning spread became a huge bone of contention in the city's bankruptcy, focusing on the assumed rate of profit the funds would make on their investments. But one thing was certain: The city couldn't afford to make its scheduled pension payments, and without those contributions, the pension plans were doomed.
It was the city's desperate attempt to keep up with its pension payments in years past that ultimately led to the bankruptcy. That came in the form of payments owed on a complex 2005 deal created by the corrupt Kilpatrick administration that leveraged Detroit's casino tax revenue to plug a $1.4 billion hole in the funds. Payments on those investments, called certificates of participation, totaled nearly $40 million due in June 2013, a payment the city missed because it was very nearly out of cash.
Now, the city emerges from bankruptcy with its pension obligations significantly cut, in hopes that future payments to the plans will be in line with the city's expected tax income.
"The real long-term issue for the pension funds is merely a process of adjusting debt to what is sustainable and affordable going forward," said James Spiotto, an attorney and bankruptcy expert with Chapman and Cutler in Chicago. "It's a recognition of reality, because the city can only pay what it can pay."
Between now and 2024, the city will make no payments to the pension funds, which have been frozen. The funds themselves, however, will collect $428.5 million from the Detroit Water and Sewerage Department, as part of its spin-off into a regional water authority, $56 million from a settlement with some general-obligation bondholders and $816 million from contributions from foundations, the state and the Detroit Institute of Arts that are part of the "grand bargain" that protected the institute's art and won retiree approval for the city's bankruptcy exit plan.
The city also has escaped $4.3 billion in retirement health care benefits, in exchange for a payment of $450 million to two voluntary employee benefits trusts, or VEBAs, one for general city employees and one for police officers and firefighters.
The $7.8 billion in savings comes at the expense of current retirees, who'll see their pensions cut and healthcare benefits reduced. General retirement system workers will take a cut of 4.5 percent to their benefits while there was no pension payment cut for police and firefighters, who can't collect Social Security or Medicare benefits. General system retirees also lost annual cost-of-living increases, which the city estimated would amount to a 13 percent cut over the duration of their retirement. Police and firefighters cut their cost-of-living increases in half, which the city estimated to be the equivalent of an 18 percent benefit cut during their retirement period.
In addition, more than 16,000 workers who participated in the city's annuity savings plan will have to return the $239 million in excess interest that was found to have been wrongly paid to them. Retirees can either pay back the amount in a one-time payment or take a reduction to their annuity payouts that will be capped at 15.5 percent per month. Added to the pension cuts, general system retirees with savings plans would face a pension reduction of up to 20 percent, not counting the loss of the cost-of-living increase.
The exit plan allows for the restoration of pension benefits if the funds' investments perform better than expected. And both pension funds will get new independent committees to oversee and manage the investments.
For active employees, the city has established two new "hybrid" pension plans, where workers contribute 4 percent to 8 percent of their pay, with the city contributing, as well. The city will contribute to the new pension plan while payments to the old, frozen plans are suspended until 2023. Active employees also will get a new retirement benefits plan, while active police officers and firefighters will join the VEBA.
With the city's emergence from bankruptcy, retirees will be taking cuts now, while the city gets nearly a decade of breathing room from making pension payments to rebuild city services and, it is hoped, attract new taxpaying residents and businesses. In the best-case scenario, the pension funds will perform well and the city flourishes, which could lead to the restoration of some or all of the pension cuts. In the worst case, retirees will struggle to afford medical care and watch inflation erode their pensions over the years.
"The way this has worked out, we've kept the plans alive and we've given the retirees a good shot at health care," said Carole Neville of the retirees committee. "Forty years from now, there'll be a pension plan."