When the City of Detroit’s employees and retirees approved a plan in late July to cut benefits to their pension as part of the bankruptcy proceedings, Emergency Manager Kevyn Orr lauded the deal as something that allowed the city to offer a “sustainable retirement plan” that is “fiscally sound.”
But some taxpayer advocates and a pension expert say the city missed a chance to provide a better solution to the longstanding problem with city pensions.
Detroit’s pension liabilities were a big reason the city ended up in bankruptcy, according to James Hohman, assistant director of fiscal policy at the Michigan-based Mackinac Center for Public Policy.
Orr estimates the city’s unfunded pension liability is $3.5 billion. And the problems that led to the multi-billion dollar liability can still be repeated because the city is keeping its defined-benefit pension plans, which means the city pays out an annual pension every year for the lifetime of the employee.
Hohman said Detroit doesn’t have the money to pay its debts, which created “a bad situation.”
“So it had to create this whole process to figure out who is going to take cuts,” Hohman said. “The better policy is to not get into this situation to begin with. They shouldn’t have to take cuts in the first place. They should convert to a defined-contribution plan where employees know the city will keep its promises. The city can’t underfund these benefits.”
Paying for Past Promises
Leon Drolet, chairman of the Michigan Taxpayers Alliance, said it is not surprising that the defined-benefit pension plans were not ended in favor of a defined-contribution 401(k)-type plan.
“Politicians have it both ways,” Drolet said. “They give labor unions benefits without raising taxes by making people pay for it in the future. Cities today are paying for the promises made by politicians decades ago.”
Drolet said politicians know public employee unions are very aggressive in local elections and pay close attention to what politicians do.
“It is usually in a politician’s best interests to collaborate with unions rather than negotiate,” Drolet said. “The moral of the story: Require any benefit promises to be paid up front today and ‘pay as you go.'”
Retirees and active employees who are in the city’s two public pension plans approved the deal that will clear the way for $816 in private and public funds to be used to “shore up” pensions and put the collection of the Detroit Institute of Arts in a protective trust, according to the city.
Overwhelming Backing for Deal
According to the city, 82 percent of the retirees and active employees in the Police and Fire Retirement System and 73 percent of retirees and active employees in the General Retiree System voted in favor of the plan that will reduce their monthly pensions by 4.5 percent and also eliminate cost of living increases.
“The voting shows strong support for the city’s plan to adjust its debts and for the investment necessary to provide essential services and put Detroit on secure financial footing,” Orr said in a press release.
Detroit moved its employees to a new, hybrid pension plan July 1. In a deal negotiated with the unions, current city employees who are part of the General Retirement System will contribute 4 percent of their salary. City employees who are part of the Police and Fire Retirement System will pay 6 percent. Police and Fire Retirement System members hired after June 30, 2014 contribute 8 percent.
“The city and its labor partners have come up with what we think is the best option to strengthen employee pensions so we can continue to meet future obligations in a financially responsible and sustainable manner,” Orr said in a press statement. “This new pension plan is the result of months of intense negotiation between the city, it’s unions and its retirees. The city’s intention all along was to create a sustainable retirement plan for its employees that is fiscally sound and continues to meet their needs.”
The city’s pensions were underfunded because investment returns were lower than projected, Hohman said. The pension funds also gave retirees and active workers “13th checks, ” or bonus payments each year. The Detroit Free Press reported the city’s General Retirement System board said in an affidavit during the bankruptcy proceedings that it gave out $756.2 million in excess earnings to active employees from 1985 to 2007. Retirees received another $195 million.