Detroit pension-fund practices compel Orr to call for freeze

9/27/2013

DETROIT — Detroit’s municipal pension fund made undisclosed payments for decades to retirees, active workers, and others above and beyond normal benefits, costing the city billions, according to an outside actuary hired to examine the payments.

The payments included bonuses to retirees, supplements to workers not yet retired, and cash to the families of workers who died too young to get a pension, according to a report by the actuary and other sources.

How much each person received is not known.

But records suggest the trustees approving the payments did not discriminate; nearly everybody in the plan got them. Most trustees on Detroit’s two pension boards represent organized labor, and for years they could outvote anyone who challenged the payments.

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Since June, Detroit’s auditor general and inspector general have examined the pension system for possible fraud or misfeasance. They released findings Thursday.

Detroit Emergency Manager Kevyn Orr wants to freeze the pension system for public workers in light of evidence it was operated in an unsound manner for many years, contributing to the city’s financial downfall. Details were outlined in a memo provided by Tina Bassett, a spokesman for the trustees of Detroit’s General Retirement System.

The memo said the city’s defined-benefit pension plan would be closed to new members as of Dec. 31.

Further benefit accruals would be halted on that date for workers vested in the plan, but they would keep the pensions they had earned. That type of freeze is legal and fairly common in the private sector.

The Detroit pension freeze also would halt payments of other nonpension benefits that have been made for many years, including distributions to active workers.

Retirees also no longer would receive yearly cost-of-living adjustments.

Current workers would be shifted into new defined-contribution plans, similar to 401(k) plans, which would comply with the requirements of the Internal Revenue Code.

Ms. Bassett said the trustees did not support the proposed freeze and saw it as a sign of bad faith on the part of the city and the law firm advising it in its municipal bankruptcy case, Jones Day.

She also said she thought the outside actuary’s analysis, which concluded the extra payments had cost the city nearly $2 billion over 23 years, was “not being fully straight with what happened.”

She said the trustees administered benefits that had been negotiated by the city and its unions and they had established an internal account to set aside “excess earnings” that would cover the cost.

She said it was appropriate for retirees to benefit from market upturns because they had paid into the pension fund, so their own contributions had generated part of the investment gains.

“People were having a hard time, living hand-to-mouth, and we thought we would give them some extra,” she said.

Of all the nonpension payments, she said, 54 percent went to active workers, 14 percent went to retirees, and 32 percent went to the city, which used its share to lower its annual contributions to the fund.

The excess payments were often made near the end of the year, when recipients needed money for the holidays, or to heat their homes.

Detroit has nearly 12,000 retired general workers, who last year received pensions of $19,213 a year on average — hardly enough to drive a large U.S. city into bankruptcy.

But the total excess payments in some years ran to more than $100 million, a crushing expense for a city in decline.

In some years, the actuary found, Detroit poured more than twice the amount into the pension fund than it would have had to contribute had it paid only the specified pension benefits. Even then the city’s contributions were not enough.

So much money had been drained from the pension fund that by 2005, Detroit no longer could replenish it from its dwindling tax revenues. Instead, the city turned to the public bond markets, borrowed $1.44 billion, and used that to fill the hole.

Even that didn’t work. In June, Detroit failed to make a $39.7 million interest payment on that borrowing — the first default of what was soon to become the biggest municipal bankruptcy case in U.S. history.

When Detroit turned to the bond market in 2005, it acknowledged it needed cash for its pension fund but did not explain its history of paying out more than the plan’s legitimate benefits, including the bonuses, known as “13th checks.”

Nor did the city describe the pension fund’s distributions to active workers, or note a 1998 shift to a 401(k)-style plan had been blocked and turned into a death benefit.

Finally, in 2011, the city hired the outside actuary to get a handle on where all the money was going. The pension system’s regular actuaries, with the firm of Gabriel Roeder Smith, would not provide the information because they worked for the plan trustees, not the city.

The outside actuary, Joseph Esuchanko, concluded the various nonpension payments had cost the city nearly $2 billion from 1985 to 2008. The trustees began making the payments before 1985, but it seems he could not get data for earlier years.

His calculations included only the extra payments by Detroit’s pension fund for general workers. Detroit has a second pension fund, for police and firefighters, which also made excess payments. But Mr. Esuchanko could not get the data he needed to calculate those.

When he reported his findings, city council voted to halt all payments except legitimate pensions, as described in plan documents.

The police and firefighters’ plan trustees appear to have discontinued the practice earlier.

An investment banker advising Detroit, Charles M. Moore, has said the trustees of the general pension plan were “effectively robbing” the fund when they diverted its assets.

He criticized the transfer of money from the pooled pension trust fund to a group of individual accounts for workers who had not yet retired. “Hundreds of millions of dollars of plan assets intended to support the city’s traditional defined-benefit pension arrangements were converted,” he wrote, “to provide a windfall to the annuity savings accounts of active employees outside of the defined-benefit pension plan.”