Undisclosed pension payments cost Detroit billions

9/25/2013

Detroit’s municipal pension fund made undisclosed payments for decades to retirees, active workers and others above and beyond normal benefits, costing the struggling city billions of dollars, 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 outside actuary and other sources.

How much each person received is not known, because payments were not disclosed in the annual reports of the fund.

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 great American city into bankruptcy. But the total excess payments in some years ran to more than $100 million, a crushing expense for a city in steep decline. In some years, the outside 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.

And even then, the city’s contributions were not enough. So much money had been drained from the pension fund that by 2005 Detroit could no longer 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.

Detroit said that making the interest payment would have consumed more than 90 percent of its available cash. And besides, the hole in its pension fund was growing again, and it needed a further $200 million for that.

When Detroit turned to the bond market in 2005, it acknowledged that it needed cash for its pension fund but did not explain its long history of paying out more than the plan’s legitimate benefits, including the bonuses, known as “13th checks,” which were reported this month by The Detroit Free Press. Nor did the city describe the pension fund’s distributions to active workers, or note that a 1998 shift to a 401(k)-style plan had been blocked and turned instead into a death benefit. In its most recent annual valuation of the fund, the plan’s actuary said it was still trying to determine the “effect of future retroactive transfers to the 1998 defined contribution plan,” without mentioning that it had not been carried out.

All of these things eroded the financial health of the pension system, but neither the magnitude of the harm nor its effect on the city’s own finances was disclosed to investors. German banks were big buyers of Detroit’s pension debt; now they are complaining that they were told it was sovereign debt.

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 that the various nonpension payments had cost the struggling city nearly $2 billion from 1985 to 2008, because the city had to constantly replenish the money, with interest. The trustees began making the payments even before 1985, but it appears that Esuchanko 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 officers and firefighters, which also made excess payments in the past. But Esuchanko could not get the data he needed to calculate those either.

When Esuchanko reported his findings, Detroit’s 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.

Detroit’s pension trustees and their lawyers were unavailable Wednesday to comment on the extra payments.

Joseph Harris, who served as Detroit’s independent auditor general from 1995 to 2005, said the payments had been approved by the pension board of trustees, and it would have been useless for the city to have tried to stop them during his term.

“It was like dandelions,” he said. “You just accept them. They were there, something you’ve seen all your life.”

When asked on what legal authority the trustees had made the payments, Harris said, “My understanding was, it had to be approved by city council, and council was under the belief that the money was there — that the pension funds were earning the money, with the consideration that in bad times the city would be making up the difference. I hate to say that. Ultimately the fund has to be funded by the taxpayers.”