O'Keefe in the News

City socks away cash against ‘pension cliff’

City socks away cash against ‘pension cliff’

March 5, 2018

As published by Chad Livengood, Crain’s Detroit Business

  • Detroit poised to shed state financial oversight by April
  • Looming pension payments of $143 million annually resume in 2024
  • City has created savings fund to cushion blow to general fund budget

In March of 2013, Detroit was hurtling toward a historic trip through bankruptcy court with over $100 million in unpaid pension bills and a negative fund balance of $72 million.

Five years and $7 billion in debt reduction later, Detroit is poised to regain full control of its finances by next month after six years of state oversight following three consecutive years of balanced budgets and a fund balance exceeding $500 million at the end of the 2017 fiscal year.

As Mayor Mike Duggan prepares to deliver his annual State of the City speech Tuesday that will likely touch on the impending end of state financial control, an old liability that contributed to Detroit’s municipal government insolvency still looms over the city’s future.

Starting in 2024, Detroit officials project they will face annual payments of at least $143 million after the city’s bankruptcy debt-cutting plan required just nominal payments of $20 million from 2016 to 2019 and no payments from 2020 through the 2023 fiscal year.

“It’s not a problem today or tomorrow. But it’s a huge problem in 2024,” State Treasurer Nick Khouri told Crain’s.

Detroit’s 2014 bankruptcy court-approved reorganization gave the Duggan administration what amounted to a nine-year reprieve from paying full pension payments as the state and philanthropic foundations stepped in to fill the void in a “grand bargain” deal that preserved a city-owned art collection from being auctioned off to satisfy creditors.

“We didn’t resolve all of the legacy obligations in the bankruptcy. We made them more affordable,” said Bill Nowling, who was former Emergency Manager Kevyn Orr’s spokesman during the bankruptcy. “Somehow, that’s gotten lost in all of the discussion on this.”

To prepare for the sudden spike in payments, the Duggan administration and City Council have created a savings fund with the goal of socking away $335 million in surpluses over eight years that will be used to gradually ease the city into making full pension payments again by 2033.

The Duggan administration’s plan calls for gradual $5 million annual increases in general fund expenses for pensions, starting with $35 million this year and doubling by 2025. The remaining balance owed would come from the pension savings fund.

“We wanted to allow the city to grow the amount that would come out of its budget every year until 2033, which is a long slope that we thought we would be able to manage,” said John Hill, the city’s chief financial officer.

The pension savings fund, formally known as the Retiree Protection Fund, was set up to try to ensure future administrations and City Councils don’t attempt to tap it for a different use in the event of another financial crisis.

Detroit created an irrevocable trust through the Bank of New York dedicated to paying pensions — an approach that won plaudits and a credit-rating boost from Moody’s Investors Service.

“The most important part is the money can only be used for pension payments,” said Khouri, who chairs the Detroit Financial Review Commission that is expected to release its oversight of city finances by next month.

Bank of New York will invest the funds in securities and municipal bonds, which are generally secure investments with yields of 3 percent to 4 percent, Hill said.

Hanging onto the cash
City officials opted for the trust fund investment approach instead of making advance payments now to the 24,000-member General Retirement System and the 14,300-member Police and Fire Retirement System.

Both pension funds have performed well in recent years, with the General Retirement System netting a 14 percent in the fiscal year that ended June 30, 2017 and police and firefighters’ pension fund yielding a 12 percent return, according to annual reports.

The funded level of both Detroit retirement systems have also rebounded in recent years as the pension funds reaped gains from a booming stock market and shed many of the riskier real estate investments the funds’ trustees got into before state intervention began in 2012.

The General Retirement System was 67 percent funded at the end of its 2017 fiscal year, up from 53 percent in 2014 before the bankruptcy was finalized and 4.5 percent cuts in base pensions for retirees were imposed.

At the end of fiscal 2017, the Police and Fire Retirement System was about 78 percent funded, up from 74 percent in 2014, according to its annual report.

Under Detroit’s bankruptcy debt-cutting plan, retired police officers and firefighters did not see any reduction in their base pension, but their automatic 2.25 percent annual cost-of-living increases were reduced to 1 percent to improve the fund’s health.

With the pension funds on seemingly better financial footing, some city employees have questioned why the Duggan administration isn’t just putting surplus funds directly into the two pension funds.

“Certainly we would have preferred that they put money in the fund,” said John Serda, chairman of the Detroit Police and Fire Retirement System and a police department captain. “But we also understand they’re under no obligation to do so.”

Serda praised the Duggan administration for being “forward thinking” now about long-term pension liabilities during this period of post-bankruptcy relief from paying on debts owed to workers.

He also understands the city wants financially flexibility; there’s no legal obligation to make payments to the trust fund over the next six years.

“It would have been an advantage when the market is strong, but maybe not so much when the market weakens,” Serda said.

The city’s use of the trust fund that yields less investment returns than the profits the pension funds have reaped in recent years was based on lessons from Detroit’s bankruptcy, Hill said.

“If we put it into the pension plan and they had a few years of losses — which they’ve had before — then we’re done,” Hill said. “We still have to make those payments, and we don’t have the money we put in.”

Khouri, whose department has been heavily involved in Detroit’s financial problems since the failed 2012 consent agreement, also praised Detroit officials for their budgetary preparation.

“It is very difficult for any government organization to see a problem in 2024 and put cash into it today,” he said.

Patrick O’Keefe, a local financial turnaround consultant who has studied Detroit’s fiscal problems for years, said the city’s approach to the long-term pension payments coming due is “smart.”

“What Mike (Duggan) is banking on is the tax base will continue to get bigger and they’ll continue to generate more revenue,” said O’Keefe, CEO of O’Keefe & Associates in Bloomfield Hills. “When you get to 2024, he’ll hopefully have enough cash to pay the $143 million, because he doesn’t have it now.”