Pension Deficits Get Renewed Scrutiny Post-Detroit Filing

The bankruptcy of Detroit, which may cut retirement benefits of 30,000 current and former city workers, is causing investors to scrutinize billion-dollar shortfalls in government pensions in other parts of the country.

Chicago, Philadelphia, New York, Phoenix and Jacksonville, Florida, are among large cities that had 60 percent or less of what they need in their retirement systems to cover promised benefits, according to data compiled by Bloomberg. At least 29 public plans in 16 states are less than two-thirds funded, according to Boston College’s Center for Retirement Research.

The Wall Street credit crisis that peaked in 2008 sent stocks tumbling and cut the value of pension assets, while most plans count on annual investment gains of about 8 percent. The losses are forcing governments to find ways to cut benefits and pump more money into their retirement systems, leading to disputes between unions and political leaders.

Detroit “brings that concern to the forefront again,” said Matt Dalton, who helps manage $1.6 billion of munis at Belle Haven Investments Inc. in White Plains, New York. Pension obligations are among “the most stressful situation for the state and cities.”

Concern that localities aren’t doing enough to ensure pensions and related benefits are funded has led munis to weaken compared with Treasuries, said David Litvack, head of tax-exempt fixed income research at New York-based U.S. Trust, a unit of Bank of America Corp. Yields on 10-year AAA munis were 113.6 percent of those on similar-maturity Treasuries yesterday, up from 97.6 percent a month earlier. The higher the percentage, the cheaper munis are relative to federal debt.

Growing ‘Stress’

“The market thinks the risk is going up,” Litvack said. “The incidence of stress is growing.”

Detroit last week filed the biggest municipal bankruptcy in U.S. history because of its inability to meet $18 billion in debt, setting off a court fight with unions seeking to stop the city from cutting benefits protected by Michigan law.

Emergency Manager Kevyn Orr, appointed by Republican Governor Rick Snyder, estimates that the city owes $3.5 billion to its retirement funds, which have been selling assets to pay benefits. Pension overseers dispute Orr’s figures and say the deficit is about $700 million, a difference based on competing assumptions of fund investment earnings.

Population Drop

The bankruptcy stemmed from a decades-long slide that cut the city’s population by more than half, and years of borrowing to cover $700 million in bills since 2007, along with retirement obligations that its pensions don’t have the cash to pay.

Deficits in public retirement plans are drawing attention from bond analysts. Moody’s Investors Service in April said it may cut the credit ratings of $12.5 billion of debt sold by 29 municipalities, including Minneapolis and Cincinnati, because of potential pension costs. This month, Moody’s lowered Chicago’s grade, citing the third-largest U.S. city’s $36 billion gap.

No large American city is facing the same depth of financial distress as Detroit. Its collapse provides an extreme example of what’s at risk for investors, workers and taxpayers if municipalities fail to fix their pensions.

“The underlying issue here is really the health of the city,” said Dean Baker, an economist with the Center for Economic and Policy Research in Washington. “You could say they didn’t put enough into their pension fund, which is certainly true. But that was really just a desperation measure for a city that was facing all sorts of really big problems. It was really symptomatic of a larger city decline.”

Earnings Assumptions

Estimates of public-pension shortfalls vary based on assumptions about investment earnings. The Center for Retirement Research in Newton, Massachusetts, estimates the collective deficit of state and local pensions is from $1 trillion to more than $3 trillion, depending on investment-return assumptions.

In the first quarter of this year, the largest 100 state and local retirement funds held $2.9 trillion in assets, about the same amount as in 2007, according to the U.S. Census Bureau. To make up for years when assets didn’t increase as governments assumed they would, pensions will have to either invest more, obtain better returns or cut benefits to close the gap.

In 2011, local governments put $57 billion into retirement funds, a small share of their $1.2 trillion budgets, according to Census Bureau and U.S. Commerce Department figures.

‘Troubled’ Pensions

“Pensions are troubled, but not hugely out of line,” Baker said. “If you put it off long enough, they will face serious strains trying to meet those burdens.”

Chicago had just 40 percent of what it needed to meet future pension payments as of 2011, according to data compiled by Bloomberg. Mayor Rahm Emanuel, a Democrat, can’t curb benefits without approval from the state legislature, which hasn’t acted. The city’s pension contribution will rise from $467 million in 2014 to $1.2 billion in 2015, Moody’s said, calling the increase a “tremendous strain” on the budget.

Kathleen Strand, a spokeswoman for Emanuel, didn’t immediately respond to a telephone call seeking comment.

Other cities have been more successful in pushing through changes. Voters in San Diego, where mayoral candidates in 2005 debated seeking bankruptcy protection to escape pension debts, last year approved a ballot measure steering new public employees into 401(k)-style retirement plans. They are based on a worker’s contributions instead of salary and years of service.

Bill Paying

New York Mayor Michael Bloomberg has pushed for changes to state laws governing public pensions that would let the city reduce its costs. The amount the nation’s largest city contributes each year is set by an independent actuary.

“Every year, we pay our full bill,” said Marc LaVorgna, a spokesman for the mayor, who is founder and majority owner of Bloomberg News parent Bloomberg LP.

To shore up its pensions, Philadelphia, the fifth-largest U.S. city, has altered benefits for new municipal employees, said Mark McDonald, a spokesman for Mayor Michael Nutter. It may dedicate part of its sales-tax revenue to pensions.

Phoenix approved changes requiring new workers to contribute more toward their retirement and letting the city contribute additional revenue to the pension system. “It will put us in a significantly better position,” Mayor Greg Stanton said in an interview. “Phoenix is not Detroit.”

In Jacksonville, Mayor Alvin Brown is pushing a plan to boost employee pension contributions and pare benefits for new city workers, said David DeCamp, a spokesman for the mayor.

Limiting Benefits

In April, Providence capped cost-of-living adjustments for retirees, shaving $170 million from its pension deficit. The Rhode Island capital is among those cities with the least set aside for pensions and has less than a third of its projected need, according to the Retirement Research center.

In New Haven, Connecticut, where the pensions are underfunded by about half, budget director Joe Clerkin said the city negotiated benefit cuts and increased contributions from some workers. He said municipal leaders have had a “great sense of urgency” in recent years to try to curb pension liabilities.

“I don’t think the Detroit situation per se stokes that,” Clerkin said in an interview. “I think it’s a terrible story, but in terms of our case, we’ve been working really hard to avoid that situation.”

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