Public Pensions, Once Off Limits, Face Budget Cuts

[begingri]

The struggles of Detroit, of course, are extreme. The report by the arbitrator, Thomas W. Brookover, noted that although the city’s unemployment rate was officially 28 percent, there was evidence that less than 37 percent of the city’s residents were actually working. The population had crashed. Property tax revenues were dwindling. Detroit had drained its rainy day fund, reduced overtime, offered property-tax amnesty, sold public assets, borrowed money, allowed casinos to set up shop — and still its deficits kept growing.

The average pension for retired police officers in Detroit is not especially rich: it is $28,501 a year. But with more than twice as many retirees as active workers, Mr. Brookover wrote, the costs of paying for the pensions “threaten both the city’s fiscal viability, as well as its wherewithal to provide public safety for its citizens.”

Detroit’s efforts to cover those costs through aggressive investing have not helped. In a 2010 report, an auditor warned that $103 million of alternative investments were unaccounted for. The city’s bets have included Tradewinds Airlines, which went bankrupt for the third time in 2008, and a luxury hotel in Detroit. The Securities and Exchange Commission is investigating.

The city initially sought to freeze its pension fund immediately, which is almost unheard of in the public sector. The arbitrator rejected that proposal, but agreed that the city could reduce the rate at which lieutenants and sergeants earn pension benefits from 2.5 percent of their salary per year to 2.1 percent. Although rare, the reduction is not particularly large, given the magnitude of Detroit’s problems. The arbitrator did not try to find a solution to the fund’s imbalance.

Michigan’s new Republican governor, Rick Snyder, has taken a carrot-and-stick approach to the state’s troubled cities. The carrot: He scrapped the old way of distributing state aid, and wants to make aid contingent on having cities adopt “best practices,” which he says should include reducing the rate at which workers earn pension benefits. The stick: A new law allowing the state to appoint fiscal managers with broad powers over distressed local governments.
Mayor Dave Bing of Detroit referred to both carrot and stick in his budget address this month, when he spoke of the need to reduce pensions for current workers, and to move away from traditional pension plans to those more like 401[[k)’s for “at a minimum all new hires.”

“If we are unable or unwilling to make these changes, an emergency financial manager will be appointed by the state to make them for us,” he said. “It’s that simple.”

http://www.nytimes.com/2011/04/26/us...emc=rss&src=ig

[Packman41]

"Detroit’s efforts to cover those costs through aggressive investing have not helped. In a 2010 report, an auditor warned that $103 million of alternative investments were unaccounted for. The city’s bets have included Tradewinds Airlines, which went bankrupt for the third time in 2008, and a luxury hotel in Detroit. The Securities and Exchange Commission is investigating."

They cannot account for $103 million of alternative investments?

"Aggressive investing" with pension fund assets is an oxymoron

What luxury hotel did the funds invest in during the last few years?

[Mikeg]

What luxury hotel did the funds invest in during the last few years?

According to this 2009 Freep article, the Police & Fire pension fund invested $5.2M in stock of the Atheneum back in 1992. They have since received only $200k in dividend payments and have written down the value of their investment to $2M.

"Aggressive investing" with pension fund assets is an oxymoron

Yeah, they should invest in something safe like a new condo development in Shelby Twp.!

[Ray1936]

Hi ho, hi ho, it's back to work I go..........

[Locke09]

This arbitration ruling came on April 5th. Does anyone recall reading about this in one of the local papers? All of their reporting makes it seem as if the Mayor hasn't gotten or isn't getting any concessions from City employees.

At least the NY Times piece was fairly balanced, not blaming everything on employees but noting that promises were made to lure people into public service, while at the same time acknowledging the difficulties government bodies are having keeping those promises with loss of population and lower property tax revenues.

And I loved the phrase "pension envy".

[Fnemecek]

According to this 2009 Freep article, the Police & Fire pension fund invested $5.2M in stock of the Atheneum back in 1992.

The also loaned money to the Westin Book Cadillac. I believe that's the deal the report refers to, rather than the one from 19 years ago.

[Fnemecek]

The average pension for retired police officers in Detroit is not especially rich: it is $28,501 a year. But with more than twice as many retirees as active workers, Mr. Brookover wrote, the costs of paying for the pensions “threaten both the city’s fiscal viability, as well as its wherewithal to provide public safety for its citizens.”

Pure, unmitigated bull crap.

For starters, the City makes contributions to the pension while the employee is still working, in order to provide for their future retirement. This is why the fund makes investments. If the contributions were made for current needs, pension funds wouldn't have a reason to invest.

As for threats the City's financial stability, and our ability to provide public safety for our citizens, I would argue that the primary threat is our debt load. We pay more for debt service out of the general fund than we do for police, fire, EMS, road maintainance, and street lights combined.

On top of that, there is also the overall structure of the administration, with administrative overhead that is simply out of line with national norms.

[Fnemecek]

Mayor Dave Bing of Detroit referred to both carrot and stick in his budget address this month, when he spoke of the need to reduce pensions for current workers, and to move away from traditional pension plans to those more like 401[[k)’s for “at a minimum all new hires.”

Will someone please inform Mayor Bing, Governor Snyder, and every single reporter in Michigan that the idiom "carrot and stick" refers to a combination of reward + punishment in order to encourage a certain behavior. The planed conversion to a 401[[k) offers no reward.

Do X or I'll make you do it is an example of an ultimatum; not a carrot and stick approach.

However, if I were to say that I was going to pay a bonus to every reporter who used the "carrot and stick" idiom correctly, but fine everyone who used it incorrectly, that would be a carrot and stick approach.

[Locke09]

Pensions are causing problems for the City for the same reason that they began causing problems for private industry.

1. Rising health care costs. The City budgets each year to cover retiree health care. That is not included in the funds that were invested for the pension payments. Dissect the budget and you will see that the City budgets this as though it were a current employee cost - which it isn't. Neither public nor private employees are at fault for rising health care costs. But no one is taking on the healthcare insurance industry. It is easier to make it seem like employees are just greedy.

2. Underfunded pension obligations that must be fully funded by law. When the federal government decided to mandate that companies fully fund their pension obligations, they established a timeframe. They gave public employers longer to catch up than private employers. If employers had been making the kind of contributions they should have been making from the beginning, they wouldn't have gotten stuck playing "catch up" in the middle of a recession. They are now penalizing employees for their failure to be fiscally/financially responsible. They wasted money during good times instead of funding their future obligations. The City sold pension obligation bonds to get its pensions fully funded. Now the City has to make payments on those bonds. Those payments are also budgeted annually as an employee cost, even though it represents money they should have paid into the funds years ago.

This is why City Council should not approve the Mayor's request to withhold next year's payment into the fund. It just makes the debt larger again.

[Packman41]

[QUOTE] For starters, the City makes contributions to the pension while the employee is still working, in order to provide for their future retirement. This is why the fund makes investments. If the contributions were made for current needs, pension funds wouldn't have a reason to invest.[QUOTE]

Well, not exactly.

The City makes contributions for both future AND current needs. First, if the Pension trustees do not invest smartly [[read the FREEP articles) then the taxpayers of the City have to contribute more. Second, if the trustees make promises to the retirees that cannot be met by investment proceeds then the taxpayers of the City have to contribute more.

Today you have a scenario where the trustees are not held accountable for their actions but the taxpayers are forced by law to fund any obligations.

Take a look at the 2010 Audit of the Police and Firefighters Pension Fund - link is in post #1. On page 5 of 31 you will see several things going on:

1. Contributions from employer and employees have been steadily declining over the last 3 years.
2. Total benefits paid out are increasing over the past 3 years. A 10% increase in the last year.
3. Net [[decrease) in assets, they paid out $32.4 million more than what they took in from contributions AND investment income.

Currently, there are 2 people collecting a pension for every person paying into the fund. This is a sign that the plan is unsustainable and needs a dramatic change to fix it and save Detroit.

[Locke09]

[QUOTE=Packman41;241694]

Second, if the trustees make promises to the retirees that cannot be met by investment proceeds then the taxpayers of the City have to contribute more.

Today you have a scenario where the trustees are not held accountable for their actions but the taxpayers are forced by law to fund any obligations.

Currently, there are 2 people collecting a pension for every person paying into the fund. This is a sign that the plan is unsustainable and needs a dramatic change to fix it and save Detroit.

This isn't exactly accurate either.

First, trustees cannot make promises to the retirees that result in new obligations to the City. Unions and Management negotiate pensions. Trustees can only provide what has already been negotiated. There is the complaint about the 13th check that is often given, but that is allowable within existing rules. The trustees are not making up new benefits to give to retirees without City approval.

Second, the number of current workers vs. the number of retirees is irrelevant. As I have already noted, pension funds are supposed to be 100% funded to meet all existing future obligations. Meaning, if not another penny is placed into the fund, it should be able to meet its obligations to existing retirees [[and those who are vested) based on actuarial tables and assumptions about the average interest rates. As you lay off more and more employees, of course the ratio of employees to retirees is impacted. But the fund is supposed to be sustainable regardless, which is why the federal government began to require that some years ago.

But, as you noted, bad investments and problems on Wall Street can cause losses to the fund that must be made up for by the City. I would say Wall Street is the bigger impact. But this is a problem only because the City guarantees a certain rate of return. Objectively speaking, the City should not be guaranteeing 7.9% annual returns, then they wouldn't have so much to make up when the market is down. They probably should cut that in half to something like 4%. But I happen to know that until this recent Recession, the City's funds routinely did far above 7.9% in returns in most years. And as Wall Street is now recovering, those funds are starting to recover as well. But the City shouuld still reduce that guarantee.

[Fnemecek]

Locke09 beat me to the punch.

[Det_ard]

The very nature of defined benefit plans dictates that one group [[retirees) is guaranteed something and another group [[taxpayers) is tasked with fulfilling that guarantee, no matter what. Given the uncertainty in future pension fund returns, medical expense inflation and life expectancy, I don't see this as a good deal anymore for the public. Previously made promises have to be dealt with, but going forward it doesn't make sense to me to be on the hook for someone elses' defined benefits. The transfer of that open-ended risk has become too costly.

[Wesley Mouch]

The very nature of defined benefit plans dictates that one group [[retirees) is guaranteed something and another group [[taxpayers) is tasked with fulfilling that guarantee, no matter what. Given the uncertainty in future pension fund returns, medical expense inflation and life expectancy, I don't see this as a good deal anymore for the public. Previously made promises have to be dealt with, but going forward it doesn't make sense to me to be on the hook for someone elses' defined benefits. The transfer of that open-ended risk has become too costly.

The 'open-ended' risk is unfortunately a reality for everyone. Public employees, union employees, and just plain people. In the best world, our government would set some standards for care for its citizens that is reasonable, and make that a social cost.

There's no problem w/ defined benefit programs, unless a subset of people are receiving a disproportionate share of benefit -- and that's what many people think. They have no such benefit, and then are asked to fund the benefit for others. That is intrinsically unfair. The union argument that benefits for 'me' raises 'your' standard of living doesn't play well. And it plays less well when the gap between the pensioned-elite and the 401k'd taxpayers increases. [[And pity the poor without any retirement support)

I propose that 10% of all public employee pensions be set aside to fund defined-benefit programs for the unemployed.

[Packman41]

Quotes are from Locke09

“First, trustees cannot make promises to the retirees that result in new obligations to the City. Unions and Management negotiate pensions….The trustees are not making up new benefits to give to retirees without City approval.”

I see your point here. While I technically said “trustees” I was actually referring to the process of how promises are “negotiated” with all the parties; City, Unions, Management, Trustees, et.al. In the past the “negotiators” promised more and increasing benefits to the retirees regardless if they knew how to pay for them. They were just told to “make it work out” and get: [[1) more contributions from the taxpayers of the City or [[2) invest in riskier assets to earn more investment income – or both.

“Second, the number of current workers vs. the number of retirees is irrelevant. As I have already noted, pension funds are supposed to be 100% funded to meet all existing future obligations. Meaning, if not another penny is placed into the fund, it should be able to meet its obligations.”

No. The number of current workers is relevant. These pension funds were designed much as Social Security and a ponzi scheme – you need more contributions from current workers flowing in to the Fund to pay benefits to the retirees. I recognize you noted the 100% funding comment twice before, but that does not make it so.

The Fund has NOT earned enough investment income to be 100% funded. They need more money from both the taxpayers of the City AND from current employees.

From 2010 Audit:
Income
Net Investment Income: $205,398,053
Employee Contribute: $ 10,764,969
Employer Contribute: $ 32,808,485

Benefits Paid Out
Total Benefits: $278,924,572

[[DECREASE) in Assets: [[$ 34,211,383)

By the way Total Benefits paid out in 2010 was UP 14.8% more than in 2009

Also the yield on investment income was 16.9% that is VERY GOOD. Compared to -14.8% in 2009 and -6.3% in 2008 when they lost a combined $1.23 Billion in assets – yes, with a B, billion. Even with very good results the fund lost $34.2 million in assets. What will happen when the returns are more normal, say 7% to 8%?

“I would say Wall Street is the bigger impact”

I agree with you. That is why everyone must understand the larger picture of supporting the economy. Meanwhile the SEC investigation of the mismanagement of the pension funds continues and that should stop the corruption inside the fund.

“But this is a problem only because the City guarantees a certain rate of return. Objectively speaking, the City should not be guaranteeing 7.9% annual returns, then they wouldn't have so much to make up when the market is down. They probably should cut that in half to something like 4%.”

You are correct the City [[as the voice of the taxpayers) should NOT be guaranteeing a certain rate of return. The negotiators for the City did a lousy job representing the taxpayers.

Meanwhile, you suggest a 4% guaranteed yield on investment and I would suggest no guarantee is necessary.

Why should the taxpayers guarantee something that is not available to them in the marketplace. Does “Wall Street” offer a guaranteed rate of return? Of course not.

So why look to the taxpayers to do something as big and powerful as Wall Street won’t do?

[Fnemecek]

No. The number of current workers is relevant. These pension funds were designed much as Social Security and a ponzi scheme...

First, let's get the terms right. A pension system that requires an 9.25% return on investment in order to be financially viable is not a "Ponzi scheme". As long as the fund earns a total return on its investments that is equal to, or greater than, 8% then it requires no additional support from the taxpayers beyond what is agreed to while a given employee is working.

The problems only arise when the City either doesn't make the contributions required for current employees or the rate of return is less than 9.25%.

Also the yield on investment income was 16.9% that is VERY GOOD.

A 16.9% rate of return is indeed a very good yield. However, that's not what the pension fund earned in 2010, nor is it what the fund earned in 2008 or 2009. 16.9% is its composite return over the past several years.

The fund had exceptional performance in 2004, 2006, and 2007. This is what has brought its composite earnings up to the 16.9% level. Unfortunately, its returns since 2007 have weighed the fund down considerably.

The fund only earned 6.8% in 2010. This was after losing a considerable amount of money on investments in 2008 and 2009.

3 years of bad earnings do necessitate an infusion of cash. It also points to the fact that we need to take a very close look at the type of investments they are making.

However, it is not a "Ponzi scheme".

[Fnemecek]

One should also point out that during the 3 years of exceptional performance, the City did not make its full contribution to the pension fund. The additional earnings served as a credit towards what the City should have to contribute.

Now that investment earnings have swung the other way, we're seeing the need for additional contributions. If the City had made its full contribution every year then, even with the current losses, it is doubtful that there would be a need for any additional contributions this year.

[Locke09]

Packman41,

You are still looking at years that are feeling the impact of the Recession. The gains will get better and better as the economy stabilizes. If you look at years before the recession you might be amazed at the returns. If you look at audits prior to the recession you will also find the years, not too long ago, that the funds were 100% funded and even higher. Go far enough back and City employees can tell you about the years, during the Young Administration, that the funds actually bailed the City out of financial problems. And total benefits are up in large part because people are being pushed into retirement and even early retirement by layoffs.

I get your concern about any guarantee. But banks or other institutions that ask for your money in exchange for an annuity do guarantee you a specific annuity amount for life. They have to be guaranteeing some rate of return to do that. I have such annuities that I am paying into. I actually picked 4% because that is what one of mine guarantees. 4% was reasonable at the time I started paying into that annuity. In fact, there are many financial instruments where taxpayers can get guaranteed rates of return. The longer you agree to let your money sit somewhere, the higher the rate of return that will be guaranteed.

Now the stock market is an entirely different beast. Not comparable.

[Packman41]

Fnemecek wrote:
“A 16.9% rate of return is indeed a very good yield. However, that's not what the pension fund earned in 2010, nor is it what the fund earned in 2008 or 2009. 16.9% is its composite return over the past several years.”

Well that is not what the audit report from Plante & Moran says on page 6, see:http://www.rscd.org/P%20%20F%20Audit%202010.pdf Their quote: “The DPFRS total fund composite return for the year [[emphasis mine) was 16.9 percent.” And then they go onto list the annual returns going back to 2004. I took their statement at face value and financial reports always show annual returns, unless they cite a specific time frame, such as a 3 or 5 year average. I did not see that in the audit report.

“A pension system that requires an 9.25% return on investment in order to be financially viable is not a "Ponzi scheme". As long as the fund earns a total return on its investments that is equal to, or greater than, 8%.....” and “The fund only earned 6.8% in 2010. This was after losing a considerable amount of money on investments in 2008 and 2009….3 years of bad earnings do necessitate an infusion of cash.”

You could be right about the fund not being a Ponzi scheme. But it sure has not worked out that way.

Yes, at 9.25% return on investment that could happen, but if and only if all of the other assumptions used by the actuaries are correct. Such assumptions as:
Investment Income – we’ve discussed that and you think they’ve earned a 6.8% return last year – below the 9.25% theshold.
Early Retirements – if more people retire early, then they collect benefits for longer than expected
Mortality Rate – people are living longer and collecting more than planned.

“It also points to the fact that we need to take a very close look at the type of investments they are making.”

Here we can agree. And I think this is how the whole thread got started – on a topic of how the fund has been mis-managed. An overarching SEC investigation would be one clue.
So now the trustees did a lousy job of investing the funds that were given to them. So maybe you need to turn to the trustees to make an infusion of cash instead of the taxpayer. When I was a kid the last person to touch the [[now broken) vase was at fault.

The Detroit pension funds are not alone. The vast majority of state, municipal and union pension funds are severely underfunded. Look around at all the problems the other states are having – no one can deny this. Because this is so widespread that is why I likened it to a Ponzi scheme.

“One should also point out that during the 3 years of exceptional performance, the City did not make its full contribution to the pension fund. The additional earnings served as a credit towards what the City should have to contribute….Now that investment earnings have swung the other way, we're seeing the need for additional contributions.”

The reason the City made full contributions is because they borrowed the money – they kicked the can down the road.

As the audit tells it, back in 2003 the City needed to make contributions to both the Police & Fire and the General Fund of $1,440,000,000, yes that is billions. Since the City did not have that kind of loose change lying around they went to the bond market and borrowed the money. I did not see in the audit the interest rate the City must pay to the bond holders, i.e. the lenders. What I did read was that $740,000,000 was contributed to the General Fund and $630,000,000 was contributed to the Police and Fire Fund. The rest was used to pay closing costs, legal, etc.

So now the City is paying interest on $1.44 billion and hoping they can invest the money at a greater investment yield than what they have to pay on interest charges to the bond holders. I can assure you that did not happen in 2008, 2009 and maybe not in 2010. So this was an additional expense paid by the taxpayer.

Now let’s make a quick calculation about the additional contributions required.

From the audit:
Assets held for pension benefits: $3.017 Billion
Liabilities, Acturial Accrued: $4.221 Billlion

Shortfall: [[$1.204 Billion)

Something is going to give.

[Fnemecek]

Fnemecek wrote:
[I][COLOR=#3e3e3e]
Well that is not what the audit report from Plante & Moran says on page 6, see:[COLOR=#3e3e3e]http://www.rscd.org/P%20%20F%20Audit%202010.pdf Their quote: “The DPFRS total fund composite return for the year [[emphasis mine) was 16.9 percent.”

16.9% is the composite rate, not it's rate of return.

http://www.investorwords.com/16001/composite_rate.html

The rate of return for 2010 was 6.9%.

$205,398,053 [[investment income) / $3,017,949,234 [[size of the portfolio) = 0.069 [[rate of return).

Early Retirements – if more people retire early, then they collect benefits for longer than expected

If people take an early retirement, they don't get the full value of their pension. They get an amount that is adjusted downward for those factors.

The reason the City made full contributions is because they borrowed the money – they kicked the can down the road.

As the audit tells it, back in 2003 the City needed to make contributions to both the Police & Fire and the General Fund of $1,440,000,000, yes that is billions. Since the City did not have that kind of loose change lying around they went to the bond market and borrowed the money. I did not see in the audit the interest rate the City must pay to the bond holders, i.e. the lenders. What I did read was that $740,000,000 was contributed to the General Fund and $630,000,000 was contributed to the Police and Fire Fund. The rest was used to pay closing costs, legal, etc.

So now the City is paying interest on $1.44 billion and hoping they can invest the money at a greater investment yield than what they have to pay on interest charges to the bond holders. I can assure you that did not happen in 2008, 2009 and maybe not in 2010. So this was an additional expense paid by the taxpayer.

Right. The City should have gone into receivership and/or bankruptcy back in 2003. If they had, most of the problems that we are now dealing with would have been dealt with already.

However, the infusion required back in 2003 was a result of the City not making its required contributions for several years prior for employees who were still working. If the City simply made its contributions all along, there wouldn't have been a need for the infusion of cash in 2003 nor would any of the other problems exist.

Now let’s make a quick calculation about the additional contributions required.

From the audit:
Assets held for pension benefits: $3.017 Billion
Liabilities, Acturial Accrued: $4.221 Billlion

Shortfall: [[$1.204 Billion)

Something is going to give.

If you look at page 26 of the PDF [[labeled as 24 in the report), you'll see slightly different numbers. The actuarial value of the fund's assets is listed at $3,945,205,453. This brings the unfunded AAL down to $276,085,592 - roughly $1 billion less than you cite here.

[1KielsonDrive]

Yeah, you know how it goes, gamblers lose the house and all the occupants and neighbors of the house lose their asses.

[Fnemecek]

Right. Oversimplify everything to the point of becoming useless; then use an otherwise useless conclusion to justify an otherwise unjustifiable conclusion.

[1KielsonDrive]

Right. Oversimplify everything to the point of becoming useless; then use an otherwise useless conclusion to justify an otherwise unjustifiable conclusion.

Ha, ha. You're funny. And so ummmm, heavy, man.

[reddog289]

Sounds like when my Union Stewart was explaining the last contract to me.