Sept. 27 (Bloomberg) -- Detroit Emergency Manager Kevyn Orr called for freezing the general employee pension fund to save money, after a city union asked a bankruptcy judge to reinstate a program that gave retirees an extra check each year the system had excess earnings.
Before it ended in 2011, the policy of issuing a “13th” check and other payments cost Detroit’s general pension system $1.92 billion from 1985 to 2008, according to a report commissioned by the city. The city filed for bankruptcy before the Michigan Employment Relations Commission could consider restoring the checks, putting the issue on hold, according to records filed Sept. 24 in U.S. Bankruptcy Court in Detroit.
The actions came as city auditors released a report that questioned policies on pensions and other benefit programs. The investigation, ordered by Orr in June, cited excessive payments to employees’ savings accounts from the pension fund. Auditors also found hundreds of probably fraudulent or “highly questionable” unemployment compensation claims.
Detroit’s financial crisis has drawn the attention of President Barack Obama, who will send members of his cabinet to the city today to discuss possible federal aid through existing programs with Orr, Mayor Dave Bing and Michigan Governor Rick Snyder. The Obama administration officials will propose almost $300 million in combined federal and private aid for Detroit, the New York Times reported yesterday.
Orr wants to close the defined-benefit pension plan to new members on Dec. 31 and freeze accrued benefits for workers already vested. Those who aren’t vested would be shifted to a 401(k)-style savings plan, according to a memo provided by Tina Bassett, spokeswoman for the general retirement system. The proposal doesn’t affect the separate pension fund for police and fire department employees.
Bassett, in a written response, called the proposal “unseemly and disingenuous” because Orr didn’t seek input from the pension system and introduced it before U.S. Bankruptcy Judge Steven Rhodes has ruled on whether the bankruptcy can proceed.
Orr has said its biggest unsecured debt is an unfunded pension liability of $3.5 billion. The city also owes about $1.4 billion on bonds issued to bolster the two employee pension systems.
The 13th checks for retirees were allowed by the city almost every year for so long that they became a right that couldn’t be revoked unilaterally, according to a ruling by Doyle O’Connor, an administrative law judge with the employment relations commission.
“A practice that continues for three decades is a tacit agreement,” O’Connor said in an oral ruling in February. The city should have negotiated the change with the union as part of a new employment contract.
In its motion, the American Federation of State County and Municipal Employees asked Rhodes to lift the automatic stay, which prevents lawsuits against the city while it is in bankruptcy. Because of the stay, O’Connor hasn’t made a written recommendation that the commission can use to force the city to restore the pension board’s power to issue the extra checks, the union said.
O’Connor is retiring next month and the union said it wants him to be free to issue his recommendation to the commission.
Resuming the 13th-check policy “would bring back a practice that would really damage the funds,” Bill Nowling, a spokesman for Orr, said in a telephone interview yesterday.
Sharon Levine, an attorney for the union, didn’t immediately return e-mails requesting comment on the union’s Sept. 24 filing.
From July 1985 to June 2008, a pension board that is independent from the city council paid out what it considered excess money 18 times, or about $951 million in total. That included $121.1 million handed out in the 2008 fiscal year, the last for which information was available. The board made the payments if it earned more on investments than expected.
The pension board was following the direction of the city council, Bassett said. The board lacked the authority to pay out extra money without the city’s permission, she said.
Each year, the money was split three ways: part was returned to the investment fund, reducing the annual contribution owed by the city; part was given to retirees in the form of the 13th check; and part was given to current employees who participated in an optional annuity program in which they set aside some of their income for retirement.
Had the excess money been reinvested, the pension fund would have accrued an additional $1.9 billion, according to the 2011 report, which didn’t look into the pension system for police and fire employees. Keeping the excess earnings might have helped the general pension fund avoid a crisis, said Nowling, Orr’s spokesman.
Bonus checks typically ranged from $250 to $500 and were begun in the 1980s to help retirees struggling to make ends meet while the pension fund was reaping large returns on investments, Bassett said.
“These were revenue from those investments and we thought we would be able to share them,” Bassett said in a phone interview. Retirees “were struggling,” she said.
The average pension benefit for general retirees is less than $20,000 a year, she said. The bonus checks were approved by the city, and a reserve fund was created for them, she said.
Bassett said the “total collapse” of the Detroit economy caused the city’s financial crisis and hurt the pension fund. She disputed the actuary report as “not a clear picture.”
Of the excess earnings returned by the general pension fund from 1985 to 2006, 14 percent went to annual retiree bonus checks and 54 percent went to employee savings plans, Bassett said. The remaining 32 percent was credited to the city for payments to the fund.
In each of 13 years since 1984, the pension fund gave an effective rate of return of more than 20 percent to the employee savings plans, higher than market rates, according to the report issued yesterday by Detroit’s inspector and auditor generals. The bonus interest payments came from the general pension fund.
Detroit has about 20,100 retirees, twice the number of active employees.
Pension-system shortfalls prompted the city in 2005 to borrow $1.4 billion through pension obligation certificates, a debt that contributed to the city’s bankruptcy.
The case is City of Detroit, 13-bk-53846, U.S. Bankruptcy Court, Eastern District of Michigan (Detroit).