A report by PEW Charitable Trusts marks how Detroit can not only meet its pension obligations, but also how other troubled pension systems can learn from its actions to solve their own issues.
In its report, Pew projects funding levels under different scenarios and makes specific recommendations to the city’s pension system. The analysis attempts to determine whether the contribution policies proposed for Detroit’s legacy pension liabilities will be sufficient to pay promised benefits.
“This analysis is intended to help Detroit tailor its long-term policies to fully fund its pension promises,” said Greg Mennis, director of Pew’s public sector retirement systems project in a release. “If investment returns meet assumptions, Detroit’s contribution policies are likely to be sufficient. But the city still faces budget planning challenges—particularly if investment returns are lower than expected—that will require close attention.”
In 2013, Detroit became the largest US city in history to file for federal bankruptcy protection, with an estimated debt of $18 billion—$7.4 billion of which came from unfunded pension promises and retiree healthcare costs. By the following November, a deal known as the Plan of Adjustment (POA) was approved by a federal court to help dig the city out of its pension hole.
The deal cut pension and healthcare benefits as well as reduced the pension benefits for future retirees currently working. The POA saw several other extreme clawbacks, such as the elimination of retiree healthcare benefits for employees going forward and a freezing of Detroit’s two pension plans. Additional measures included temporary reductions for city pension contributions, new governance structures that would oversee the frozen plans, and the creation of two new pension plans for current and future employees.
Detroit then set extra funds aside each year that the POA required to meet the pension costs and to make the ongoing budget allocation for pensions in 2024 a smaller incremental increase. In 2017, the city proposed a trust fund be established for the annual deposits, which the state-appointed Financial Review Commission approved. The deposits are estimated to grow to roughly $377 million by 2023. A portion of the Retiree Protection Trust fund’s balance will go towards pensions promised until the fund runs out.
However, this will only meet one-third of the obligations to the frozen plan over the decade, racking up more unfunded pension debt along the way.
The recommendations outlined in the report suggest that officials in Detroit consider closely coordinating decision-making with the investment committees of the two retirement systems.
“Such collaboration is essential because the POA gives the committees the authority to determine the amount of funding required annually from the city,” said the report. “Decisions that will have a significant impact on Detroit’s overall budget.”
Pew also suggests the city clarify provisions of cost-sharing features in the new pension plans that require higher employee contributions and adjustments to benefits if investments underperform.
“The features were included to reduce the risk of unplanned city costs, but the guidance for their application in its current form is ambiguous,” said Pew.
Other suggestions made in the report include monitoring cash flow and planning for long-term liquidity issues, and measuring and managing administrative costs, which have been relatively high compared to other cities of comparable size.
The report added that Detroit’s short- and long-term funding choices for its legacy plans could provide helpful insights for other cities and municipalities in the US that have implemented new pension plans for recent hires.
“Although the scale of Detroit’s bankruptcy is unique” said the report, “officials in cities and states across the country grappling with similar, if less acute, fiscal challenges can apply the lessons of the city’s experience.”