News Story

The Detroit Bailout and Meaningful Pension Reform

Looking at the 'grand bargain' for the city

LANSING — If the Michigan Legislature is going to send state tax dollars to Detroit, and is serious about reforming the city, it needs to ensure that the defined benefit pension system is closed.

That was the consensus from two national experts on pension reform at an Issues & Ideas event Tuesday sponsored by the Mackinac Center for Public Policy. The panel, "The Detroit Bailout and Meaningful Pension Reform," featured Richard Dreyfuss, a senior fellow with the Commonwealth Foundation in Pennsylvania, and Stephen D. Eide, senior fellow with the Center for State and Local Leadership at the Manhattan Institute in New York.

A 10-bill package of legislation is being debated in the Legislature, which would send $195 million to the city of Detroit with certain strings attached. One of the bills, House Bill 5568, would close the current pension system and begin offering a 401(k)-type defined contribution plan to new workers. Retirees and current workers would be unaffected.

But there is opposition to closing the plan from unions and some analysts. The event took on some of the critiques of closing the system.

Michael Reitz, executive vice president of the Mackinac Center, who spoke at the event, said the first step for Detroit is to follow an old adage: "If you're in a hole, stop digging."

Regarding the closing of the pension system, which has contributed to the city having to file for bankruptcy, Reitz said, "If this isn't a no brainer for Detroit, I don't know what is."

Dreyfuss, who has assisted with municipal pension problems across the nation and wrote a report titled, "20 Myths About Public-Sector Pension Plans," focused on the myriad ways government managers underfund pensions: extended amortization periods, optimistic funding assumptions, not making annual payments, and inflating benefits. Dreyfuss said the way to solve this problem is by removing the money for retirement from the hands of politicians and giving it to the workers.

Dreyfuss then took on the "half truth" of the transition costs of closing a pension system. These costs were cited by the GOP-led House to stop a pension reform in 2012.

He pointed out that the Government Accounting Standards Board says that a closed defined benefit plan needs to amortize unfunded liabilities on a level dollar basis but is silent on the duration. Many of those who do not want to close pension plans say doing so would require too many upfront costs. But, Dreyfuss said, those opponents mistake accounting guidelines for funding requirements. 

He also said that Michigan House Republicans who have expressed concern over alleged transition costs instead defer to the hybrid plan being discussed in bankruptcy. But the hybrid plan contains a lowered discount rate that will require far more cash than the avoidable transition costs, he said.

Not closing pension plans means trusting the government and operating with flawed incentives to fully fund the plan. Governments have not done so, particularly in Detroit where more than 40 percent of the cost of an employee was for the pension plan. In the private sector, the costs per employee typically are between 3 and 5 percent, Dreyfuss said.

Dreyfuss closed with a 10-point summary:

  1. GASB does not dictate pension funding policies.
  2. New members are not needed to sustain a healthy pension plan.
  3. A 2014 Blue Ribbon Panel on Public Pension Plan Funding suggests amortization periods of 15-20 years (not 30 years as is typical).
  4. Closing a defined benefit plan should not further endanger it.
  5. Detroit’s existing funding policies are not adequate even for an ongoing pension plan.
  6. Consider the financial impact of adopting a 6.5 percent annual investment return assumption (most plans assume 7-8 percent).
  7. Correcting funding policy shortcomings in a defined benefit plan will result in higher contributions.
  8. Defined contribution plans do not have unfunded liabilities.
  9. MSERS (Michigan's pension system for state employees) was closed to new members in 1997 and still maintains an 8 percent asset return with a 24-year closed amortization period – identical to MPSERS (the state's teacher pension system).
  10. Consider the long-term interest rate.

Eide discussed what conditions the state should demand of Detroit.

He pointed out that, at the time of its bankruptcy, 92 percent of Detroit's unsecured debt was related to pensions.

The trustees of the pension system would use "excess" investment returns — those that beat expectations in good years — to boost benefits temporarily instead of putting the money back into the system to mitigate the bad years. Eide said this was "fiscal malpractice."

Eide said projections before bankruptcy showed that more than 70 percent of the city's general fund was going to go to legacy costs in 2013. Changing pension plans and retiree health care costs put it on track to be only 11 percent in a decade. This was done by changing the benefit formula, the discount rate, employee eligibility and the cost of living adjustment.

But, Eide said, there is a thin margin for error. Population is expected to decline by another 60,000 people through 2023 and the city has the highest income tax and property taxes in the state and the worst bond rating among cities.

He suggested that the city re-evaluate its pension restoration program, eliminate city/taxpayer liability for pension benefits going forward and establish better fiscal regulations and oversight.

Eide said his concern about the Detroit deal was what other cities would expect if there wasn't real change.

"People need to worry which other cities will have their hands out," he said.


Michigan Capitol Confidential is the news source produced by the Mackinac Center for Public Policy. Michigan Capitol Confidential reports with a free-market news perspective.