Pew Outlines How Detroit Can Bolster Its Pension Plans After Bankruptcy

WASHINGTON—A new report by The Pew Charitable Trusts examines the pension reforms that helped Detroit emerge from bankruptcy in 2014 and suggests ways in which the city can strengthen its retirement plans for general employees and public safety workers.

The report, “The Challenge of Meeting Detroit’s Pension Promises: Analysis of Progress to Date, the Path Forward, and Lessons for Other Public Sector Retirement Plans,” details the reforms already undertaken and examines recently proposed policies. Pew projects funding levels under different scenarios and makes specific recommendations so that changes to the city’s pension system can be implemented most effectively. The analysis seeks 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,” says Greg Mennis, director of Pew’s public sector retirement systems project. “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 July 2013, facing an estimated $18 billion in debt, Detroit became the largest U.S. city ever to file for federal bankruptcy protection. No other local or county government filing had come close to its level of debt. Sixteen months later, a deal negotiated between the city and its creditors, known as the plan of adjustment (POA), was approved by a federal court, allowing Detroit to emerge from bankruptcy.

The POA required Detroit to make significant changes to address its large financial obligations—about 40 percent of which stemmed from unfunded pension liabilities and the costs of other post-employment benefits, primarily retirement health care—and to develop a feasible approach toward long-term fiscal soundness. The agreement froze the city’s two existing pension plans, temporarily reduced city pension contributions to these plans to provide some budget relief, created two new plans for current and future workers, and established governance structures to oversee both retirement systems.

Pew’s report includes specific recommendations for further steps to help policymakers evaluate the long-term outlook for Detroit’s pension financing, with the goal of keeping budgets balanced and continuing to develop a clear path toward fiscal solvency. It suggests that officials in Detroit consider:

• Closely coordinating decision-making with the newly established 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—decisions that will have a significant impact on Detroit’s overall budget.
• Clarifying 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.
• Monitoring cash flow and plan for long-term liquidity issues resulting from the temporary reduction in the city’s required pension contributions through 2023, a step that allows the POA to provide a measure of budget relief.
• Measuring and managing administrative costs, which have been high when measured against comparable cities, largely because of the bankruptcy proceedings.

The report discusses each of these points in detail. It also finds that Detroit’s short- and long-term funding choices for its legacy plans can provide helpful insights for other jurisdictions around the country that have implemented new pension plans for recent hires while facing the ongoing challenges of keeping promises made to longtime workers.

Pew’s research and analysis are based on publicly available documents, including valuations, studies commissioned by the city, audit and annual reports, and biannual financial reports published by the state-appointed Financial Review Commission. The research was done with cooperation from city officials, and the financial and actuarial analysis is designed to complement and augment the work done by the actuarial firm retained by the city. Pew has been reporting on state and local pension data since 2007.

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The Pew Charitable Trusts is driven by the power of knowledge to solve today’s most challenging problems. Learn more at pewtrusts.org.