Has Detroit over-inflated its pension liabilities?
Joshua Pugh, a writer and contributor to the Detroit News Politics Blog, has written about a topic that is a big one among muniland professionals. That is the question of whether Detroit‚Äôs Emergency Manager Kevyn Orr inflated pension liabilities to make the city‚Äôs debt appear larger, allowing for more aggressive haircuts for bondholders and pension holders. Pugh points out a Bloomberg Businessweek piece on his personal website:
How much does the city owe? Orr says Detroit has nearly $20 billion in debt and long-term obligations. Pension funds and bondholders have said in the past he‚Äôs inflating the numbers. Why would Orr do that? Because the more dire the city‚Äôs finances seem, the more aggressive he can be in pushing for concessions. Also, to be eligible for bankruptcy protection, the city must prove that it‚Äôs insolvent, meaning it has no way to pay its debts.
In 2004 and 2005, Detroit issued two sets of pension obligation bonds (Certificates of Participation) to fully fund the city‚Äôs pensions with an additional $1.5 billion. This is why, when I started looking at Detroit about 18 months ago, the pensions were surprisingly well-funded. Those pension bonds have now been lumped with general obligation bond debt, pension shortfalls (unfunded liabilities) and retiree health care as unsecured debt, which Orr intends to haircut.
The retiree health care value has been carried on Detroit‚Äôs books at the level that Orr cites for some time. But the unfunded pension liability has always been listed on Detroit‚Äôs financial documents as $650 million, rather than $3.5 billion that Orr claims. The pension shortfall was even listed as $650 million in February by the state’s Detroit Finance Review Team. What happened? Here is Blackrock‚Äôs Peter Hayes on the topic:
There is question as to whether the EM’s plan is inflating pension and OPEB liabilities. The unfunded pension liability was adjusted from $650 million reported in 2011 to approximately $3.5 billion‚ÄĒincreasing more than five times over two years through unspecified changes to accounting assumptions. This $3.5 billion now represents nearly one-third of the amount Detroit owes to its unsecured creditors, and raises required pension contributions to approximately 100 percent of the city’s $1 billion forecasted budget deficit over the next five years. OPEBs, which were never funded in the past, now have the largest claim at an estimated $5.7 billion.
Michigan Governor Rick Snyder and the Detroit City Council agreed to hire an outside actuary to review the two pension plans. Here is the story, according to Pensions and Investments:
The Detroit City Council hired actuarial consultant Milliman Inc., Seattle, late last year to prepare a report about ways to reduce pension and retiree benefit costs. A ‚Äėvery rough preliminary guesstimate‚Äô by Milliman adjusted the actuarial assets of the plans to 32 percent from 87 percent for the General Retirement System and to 50 percent from 102 percent for the Fire and Police fund as of June 30, 2010, according to the Milliman report, which was obtained by P&I.
A ‚Äúvery rough preliminary guesstimate‚ÄĚ is what Orr was using in his ‚Äúgood faith‚ÄĚ negotiations and is now taking to bankruptcy court?
Milliman made its adjustments by accounting for market value of the funds, the discount rate, mortality assumptions and the amount of the pension obligation certificates.
Pension calculations can seem to be a form of voodoo. Moody‚Äôs applies a lower discount rate, like the Milliman report did, to pension liabilities, while the two other major raters do not. Pension liability methodologies are, in essence, just opinions. More from P&I (emphasis mine):
The calculation Milliman used is atypical, said David Driscoll, Boston-based principal, actuarial consultant and head of the public pension fund practice at Buck Consultants LLC, New York. ‚ÄúAbsent an unusual circumstance, the issuer of POBs holds the liability, not the pension fund, which is merely the recipient of the proceeds of the bond sale,‚ÄĚ Mr. Driscoll said.
Orr could help everyone understand his case by releasing the Milliman report for study by actuaries and others.
This is not the only problem that Orr has created for himself around Detroit‚Äôs public pensions. Last Thursday the governor‚Äôs attorneys delayed an emergency hearing to challenge Orr‚Äôs plan for five minutes, and filed for bankruptcy soon after. This tale will live forever in muniland history. According to Reuters, A hearing in federal bankruptcy court has been called for Wednesday to address the question of whether the state court litigation can go forward. The fight between Orr and Detroit‚Äôs retirees has just begun.