After the largest municipal bankruptcy filing in U.S. history, the Detroit government is struggling for a solution to make payments on what is consdiered a major pension funding crisis.
Bankruptcy judge fears unfunded pensions
Retired federal judge Steven Rhodes presided over Detroit’s Chapter 9 filing case in 2013, and now fears that the city has no solution to resolve its unfunded pensions, according to CBS Detroit. At the Detroit Regional Chamber’s Mackinac Policy Conference, Rhodes argued that the city’s defined benefits compensation plans are insolvent and that the city should seriously consider alternative compensatory options, such as 401(K) retirement plans.
“Isn’t it time for us to be thinking about moving to defined contribution plans just like the private sector in this country has?” he asked. “The policy justification for doing that is that municipalities that are having trouble making their pension payments and who otherwise are under extreme financial pressure can’t afford to take the risk that the market places on them.”
According to the news source, the bankruptcy case in question resulted in a restructured compensation plan that provided Detroit with a 9-year deferral period before payment into the municipal pension system. However, when those payments initiate, the city will be responsible for lump sum expenditures to cover the duration of the deferral period.
Renegotiating the pension plan formula
In the aftermath of the Chapter 9 bankruptcy case, Detroit’s Emergency Finance Manager Kevyn Orr implemented a restructured formula that provides the same pension benefits level for retirees, but certain municipal employees will now be required to pay into their pension plans, CBS Detroit reported. This plan was enacted to alleviate the pressure on the city’s pension system funding ratio, which has dropped from 95 percent to 44 percent since 2004.
“Lance the wound very quickly. Be honest. Do it,” he argued. “It’s never going to meet its obligations at 44 percent. It can’t. It’s simple math. It can’t happen. So as long as you take that out (of the budget), you cripple the city.”
According to Crain’s, as part of the renegotiated pension plan system, over $756 million was eliminated from the city’s pension budget. There was an additional 4.5 percent cut on pensions for general municipal employees, a drop in interests rates from 7.9 percent to 6.75 percent, and a 2.25 percent cut in annual cost-of-living compensation.
The future of Detroit’s pension compensation
Detroit’s revised pension structure has alleviated some budgetary constraints in the short-term, but a major funding crisis looms for the city, The NY Times reported. The new system presents several of the same fundamental issues that led the city into debt because its funding formula is still contingent on future compensation, meaning the true cost of pension funding is not represented until the point of payment.
“The city has the potential to be saddled with an underfunded pension plan,” stated fiscal expert Martha E.M. Kopacz. “The city must be continually mindful that a root cause of the financial troubles it now experiences is the failure to properly address future pension obligations.”