Detroit Retirees Got Extra Interest After Their Guaranteed 7.9%

Dec. 3 (Bloomberg) –- A little over four months ago the city of Detroit filed the largest-ever municipal bankruptcy. On Tuesday, a judge will determine whether or not it can stay in bankruptcy. Bloomberg takes a look at some of the numbers behind Detroit's decline. (Source: Bloomberg)

Edna Love’s 58 years as a nurse for Detroit’s health department earned her a $2,000-a-month pension when she retired in 2011. That pales next to the $1 million she got from a separate city-sponsored savings plan where she put 5 percent of her pay year after year.

The annuity savings program within the Detroit General Retirement System created a class of privileged retirees in a city where pensions average about $19,000 a year, according to municipal records. The accounts got $756.2 million from the pension fund during 1985 through 2007 as extra interest, atop a guaranteed 7.9 percent backed by public money.

“Where else could you earn that kind of money today?” Love, 83, said in a telephone interview from a retirement home in Saline, Michigan. “At the time the city was doing well, we weren’t worried about bankruptcy. It was a good place to work.”

The use of money from the $2.6 billion pension to bolster the savings accounts has drawn scrutiny from Kevyn Orr, the state-appointed emergency manager, whose plan to reduce Detroit pensions through the largest U.S. municipal bankruptcy stirs outrage among 20,000 retirees. Orr may recoup what the fund paid to the savings program, said his spokesman, Bill Nowling.

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People protest in front of the U.S. Courthouse where Detroit's bankruptcy trial occurred on Oct. 23, 2013. Close

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Photographer: Bill Pugliano/Getty Images

People protest in front of the U.S. Courthouse where Detroit's bankruptcy trial occurred on Oct. 23, 2013.

“There has to be a reckoning of what was legitimate interest for those annuity funds, and what was largess added by the pension board,” Nowling said. “There is some argument that that money belongs to the city, and creditors could try to claim it.”

Unusual Deal

Orr has said Detroit’s general retirement plan and its pension for police and firefighters are underfunded by a combined $3.5 billion, a figure system officials and unions call inflated. Michigan allows an emergency manager to take over a municipal pension less than 80 percent funded.

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Many of the 25 largest U.S. cities maintain pensions that are under stress, according to a Nov. 12 study by Chicago-based Morningstar Inc., an investment-research firm. Yet Detroit’s use of public-pension funds to pad employee savings plans is unusual, said Keith Brainard, Georgetown, Texas-based research director for the National Association of State Retirement Administrators.

“I’ve never heard of that happening,” Brainard said in a phone interview. “I’m not aware of a guaranteed return on a defined-contribution plan.”

Sharing Wealth

Detroit’s general pension is run by a board representing retirees and the city. The savings program, called a 401(a) after the section of federal law that authorizes it, was meant to boost retirement incomes and was supplemented whenever the general pension exceeded its investment target, said fund spokeswoman Tina Bassett.

The annuity plan in its current form dates to 1973, according to Michael VanOverbeke, attorney for the fund.

Employees contributed as much as 7 percent of their pay and from 1999 to 2011 received a guaranteed annual base return of 7.9 percent.

The program has paid new retirees or those who left the city wide-ranging amounts, depending on how long and how much they invested. In November 2005, the plan paid $852,707 to one worker, but only $2,700 to another, according to pension board minutes. People could take savings in a lump sum or monthly payments.

Leaking Money

Money for pensions and the annuity plan was commingled. If the pension’s return fell below 7.9 percent, enough was credited to the annuity fund to meet the guaranteed rate, according to Orr’s restructuring adviser Charles Moore.

The bonus interest applied to employee savings was “effectively robbing the general retirement system of precious funds” to sustain traditional pensions, Moore wrote in the city’s July 18 bankruptcy filing. He said that though the pension fund lost 24 percent of its value in 2009, it still guaranteed the savings plan’s 7.9 percent return.

The transfers and extra interest were authorized by the pension board and city council, and were discontinued last year, Bassett said.

“These were revenue from those investments and we thought we would be able to share them,” she said.

In 2006 and 2007, the pension paid the savings plan a total of $176.1 million by adding 13.5 percent and 15 percent interest respectively on top of the base rate. That raised the total return those years to 21.4 percent and 22.9 percent. No extra interest was paid from 2000 to 2004, or from 2008 to 2013.

No Skulduggery

Besides pumping up the savings accounts, the general pension paid $195 million to retirees with “13th checks,” year-end stipends in addition to their monthly benefit. In all, the 13th checks and payments to the savings program cost the general pension $1.9 billion, including foregone interest, according to a 2011 report to the Detroit City Council.

The pension did what was allowed under city rules and collective-bargaining agreements, said VanOverbeke, the attorney. Employees agreed to smaller pensions in return for larger savings accounts, VanOverbeke said.

In 2011, the city banned the 13th checks and ceased to guarantee minimum interest rates for the savings, basing them instead on private annuity-market returns, VanOverbeke said. This year, the savings plan earned no interest, he said.

“Things are being done appropriately and in accordance with the plan document,” VanOverbeke said. “They’re really making sure due diligence is done.”

Above Board

Orr wants to freeze the savings program and pensions and shift employees to a new defined-contribution plan such as a 401(k), Nowling said. Only vested police and fire fighters could keep their pension plan.

Orr’s proposed changes are in mediation with retirees and employee unions.

Retiree Mike Mulholland said he received $250,000 from his savings, along with a $1,650 monthly pension from his $41,400 final salary. As senior operator at Detroit’s sewage plant, he said he wishes he’d put more in savings during his 29 years.

“Everybody knew about this; it wasn’t hidden,” Mulholland said. A good retirement plan compensated for lower pay at the water department compared with similar jobs in the private sector, Mulholland said. He considers his retirement benefits deferred income.

“I didn’t make the rules,” he said. “I did as best I could working a job at a sewage plant, which not a lot of people would want to work.”

To contact the reporter on this story: Chris Christoff in Lansing at cchristoff@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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