Real Number on Detroit Pensions

The June 30, 2012 actuarial valuation report for the Detroit Police and Fire Retirement System is out.  The financial report for the Detroit General Retirement System is also out but the latest actuarial valuation for them is as of June 30, 2011 so, to make better comparisons, I start with the 6/30/11 actuarial report for PFRS also.  Based on these official numbers Detroit had one of the better funded public retirement systems in the country with a combined funded ratio of 91.4%.  However, as I have been doing for the New Jersey plans, here’s how I see  those numbers translating to reality:

OFFICIAL NUMBERS @ 6/30/11 (in millions)
……………………………GENERAL………PFRS……………TOTAL
Actuarial Assets………..3,080………….3,805……………6,885
Liabilities…………………3,720………….3,809……………7,529
Deficit………………………-640……………….-4……………..-644
Funded Ratio……………82.8%………….99.9%……………91.4%

The funds did not really have $6.9 billion in assets at June 30, 2011. The ‘actuarial value’ in this case means a phony value which in the private sector is used to ‘smooth’ valuations but in the public sector is used to distort. Here are the figures when we use market value of assets:

OFFICIAL NUMBERS @ 6/30/11 Assets at Market (in millions)
……………………………GENERAL………PFRS……………TOTAL
Market Assets…………..2,422………….3,380……………5,802
Liabilities…………………3,720………….3,809……………7,529
Deficit…………………….-1,298…………..-429……………-1,727
Funded Ratio……………65.1%………….88.7%……………77.1%

The plans include a DC component where employees can make voluntary contributions that are supposed to be segregated and protected so removing those amount ($671 million for the General and $239 for PFRS) from both the assets and liabilities of each brings us to:

OFFICIAL NUMBERS @ 6/30/11 Assets at Market – DC (in millions)
……………………………GENERAL………PFRS……………TOTAL
Market Assets…………..1,751……………3,141……………4,892
Liabilities………………..3,049………….3,570…………….6,619
Deficit…………………….-1,298…………..-429……………-1,727
Funded Ratio……………57.4%………….88.0%……………73.9%

Next we take a detour.  Another actuary was brought in to opine on these valuations* and noticed that the actuarial assumptions “don’t hold water” so, assuming Milliman would have bumped up the liabilities by 25% to reach their conclusion:

MILLIMAN NUMBERS @ 6/30/11 Assets at Market – DC (in millions)
……………………………GENERAL………PFRS……………TOTAL
Market Assets…………..1,751……………3,141……………4,892
Mill Liabilities………….3,811…………..4,463……………8,274
Deficit……………………-2,060…………-1,322…………..-3,382
Funded Ratio……………54.1%………….70.4%……………59.1%

And there we get near that $3.5 billion headline number.  Though a more appropriate bump-up in liabilities would have been 50%:

BURY NUMBERS @ 6/30/11 Assets at Market – DC (in millions)
……………………………GENERAL………PFRS……………TOTAL
Market Assets…………..1,751……………3,141……………4,892
Bury Liabilities…………4,574…………..5,355……………9,929
Deficit……………………-2,823………….-2,214…………..-5,037
Funded Ratio……………38.3%………….58.7%……………49.3%

Were you to add these two Detroit plans to the list of 100 public plans ranked based on their official funded ratios in a Milliman report last year the Police and Fire Plan would be in a tie at number 2 (behind only the Washington State Law Enforcement Officer’s and Fire Fighters’ Plan 1 and 2 at 126%) for the best funded large public plan in the country and the General Plan would tie for number 23 (with CALPERS among others).  Yet this is the news coming out of Detroit these days:

Many of [Detroit Emergency Manager Kevyn] Orr’s moves are bound to be controversial and mark a dramatic shift from paying pension and health care liabilities to one that puts residents first. Among the proposals is a plan to modify pension benefits and retiree health insurance.

Orr said he recognizes the state constitution protects retiree pensions but he wants to negotiate anyway — or possibly change the law.

“We might need legislative relief,” he said.

‘Legislative relief’ in this sense means passing whatever law is necessary to cut all benefits in half, a situation that should scare participants in every other public pension plan (except maybe those in the Washington State Law Enforcement Officer’s and Fire Fighters’ Plan 1 and 2) because Detroit today is their near future, no matter what some actuaries try to make them believe.

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* Though that Milliman report done July, 2012 seems to be a closely guarded secret perhaps because if Milliman were to apply the methodology they used to get their $3.5 billion number in Detroit to other public plans that they do actuarial work for (like the New Jersey Teachers Pension Plan) they might not be doing work for those plans much longer.

19 responses to this post.

  1. Posted by Tough Love on June 18, 2013 at 12:31 am

    Sounds like the Actuarial profession isn’t doing a good job (or ANY job at all?) in policing the work of it’s members ….

    John, what’s YOUR opinion of Gabriel Roeder Smith & Company’s valuations for Detroit’s two pension plans ?

    Reply

    • As far as format, it’s passable. I prefer the New Jersey valuations simply because I’m used to them but GRS did OK considering that there’s a DC plan embedded.

      As far as actuarial manipulation to understate liabilities I suspect there’s more of that going on based on going to that 7-year asset smoothing and their explanation for it:
      http://www.rscd.org/GRS%20smoothing%20letter.pdf

      Reply

  2. Posted by bpaterson on June 18, 2013 at 10:11 am

    JB1 as a neophyte reading all your posts/responses on this blog (and getting glazed eyes from it), can you please answer a couple simple questions that maybe the rest of the non-actuarials may have. I know this blog is not supposed to be a primer but it is accessible to all and some like me may have fundamental issues that need clarification:

    When the term ‘underfunded” is used, is that number that is determined a number that is arrived at if there are no additional monies from the govt and the employee match deposited into the pension funds.

    Also if that is the case, then reference all these final totals: is that based on keeping the public work force population the same moving out to the future and this workforce getting a certain raise % through out their lifespan. Thanks ahead of time..

    Reply

    • Underfunding is a very simple concept that has been redefined as needed usually to mask a real underfunding.

      It’s basically the amount you don’t have if you wanted to cash everybody out.

      It’s easiest to think of it in terms of one person – let’s call him Seb – working for some government – let’s call it Union County. Seb at age 40 gets a job with Union County after putting in a few years working on local campaigns. Cushy job getting $100,000 a year and there’s also a pension attached which promises to pay him 1% of his salary for every year he works after he retirees at age 65 and Union County will put money into a trust so there is enough to pay him that $25,000 a year when he hits 65 – 1% x 25 years x $100,000 salary (assuming no raises over the years). That’s one place where interest becomes really important. If Union County were to go to an insurance company to buy Seb that annuity it would likely cost them about $400,000 since the annuity interest rate would be about 2.5%. If that interest rate were 8% then the insurance company would only charge them about $250,000 for that annuity since they would expect to make 8% on that $250,000 they got paid and come out with a little profit.

      These days 8% is ridiculous for an annuity but that’s essentially what public plans are assuming so they can lowball their contributions.

      Now one last wrinkle. Seb doesn’t get that full $25,000 at day one. He accrues that pension over 25 years so after 10 years all he has earned is the right to get paid $10,000 a year when he hits age 65. That is now a deferred annuity and it has a value. If you assume 2.5% that value is about $110,000 at age 50. If you assume 8% it’s about $30,000. Now Union County would have been putting in money over Seb’s first ten years (unless Union County were in New Jersey between 1996 and 2005 when they had those contribution holidays) and would have accumulated something to prefund Seb’s benefit. If that amount worked out to be $50,000 then the plan would be $20,000 overfunded if you assumed an 8% return on assets over the years or $60,000 underfunded if you assumed a 2.5% return.

      Therein lies the problem. We live in a 2.5% world but actuaries are bought off by the governments that employ them to keep contributions low so they disregard reality (in NJ the funding interest rate is set by statute so it’s the politicians who disregard reality) and overstate how well these public plans are funded. All those official funded status numbers you see are taken from valuation reports that hang on for deal life to their 8% fiction. And those funded ratios are still dangerously low. Apply honest assumptions and you see these plans are toast and Seb is screwed.

      Reply

      • Posted by Tough Love on June 18, 2013 at 12:28 pm

        John, Nice summary, but let me add that while there is a “high probability” the workers won’t get all they have been promised, there is also a “certainly” that NJ Taxpayers will be screwed royally (via significant tax increases) for quite some time before our gutless, self-interested, vote-selling, contribution-soliciting, Union-owned elected officials address the root cause of this problem (that the promised pensions are WAY too generous), and do something about it (materially reduce FUTURE Service pension accruals for CURRENT workers ….. or better yet, freeze the Plans for all current workers and move them for future service to MODEST 401k-style DC Plans).

        Reply

        • Posted by Anonymous on June 19, 2013 at 10:53 am

          Won’t the overly generous part take care it itself when the inevitable reductions happen? Just a matter of when and how.

          Reply

          • Posted by Tough Love on June 19, 2013 at 11:57 am

            When we know that the Public Sector pensions accruing every day are way too generous and unsupportable, isn’t it “smarter” for changes to be made now, to stop digging the hole even deeper.

            In the twisted logic of politicians, if they do nothing and reductions happen because the money simply runs out, THAT is likely seen as “safer” to their political careers than appropriately seeking (Future Service) pension reductions now and hence confromting the Unions.

  3. Posted by Javagold on June 18, 2013 at 3:12 pm

    JB, i agree nice summary…….and it is why we are being financially raped at 8%, 7%,6%, 5% , 4% , 3% and even 2%…….in this ZIRP world Bernanke has us in

    These public takers are so stupid , they do not even understand that their greed is their death of the system

    Reply

    • Posted by Tough Love on June 18, 2013 at 3:40 pm

      Until Public Sector workers/retirees actually see a NJ Plan fail, meaning a material reduction in promised pensions, they DO NOT CARE, as they will always assume that they will be paid in full,and that raising the money to do so is the Taxpayers’ problem.

      Reply

  4. Those “savings” – the difference between what the state would have owed pre-Act 120 and what the state now owes – actually added to what the state owes the pension plans: $13.1 billion, according to House Democratic Appropriations Committee staff.

    Reply

  5. MONAHAN: In most states, it would take a court decision to change the legal protections for public pensions. In other words, the legislature would have to pass a law changing the terms of a public pension plan and affected participants would have to sue. In deciding such a case, a court could clarify, or even depart from, its earlier rulings and in doing so provide a new standard to analyze what changes to public pension plans are permissible. Because most state pension protections are the product of court rulings, it would take a new court ruling to change. As a result, legislatures don’t have any easy options.

    Reply

  6. In the United Kingdom , benefits are typically indexed for inflation (specifically the Consumer Price Index and previously Retail Prices Index ) as required by law for registered pension plans.

    Reply

    • Posted by Robert Mitchell on July 31, 2013 at 4:15 pm

      In the UK, those pension liabilities are not based on an assumption that funds will beat inflation by double or triple.

      Reply

  7. Those “savings” – the difference between what the state would have owed pre-Act 120 and what the state now owes – actually added to what the state owes the pension plans: $13.1 billion, according to House Democratic Appropriations Committee staff.

    Reply

  8. […] official valuations prepared by Gabriel Roeder Smith & Company (GRS) and applied a methodology similar to what I have been doing to arrive at what, in the case of Detroit, they believe to be the real funded status of the two […]

    Reply

  9. […] Over the last 35 years for private sector plans we have had mountains of legislation looking to assure that protections were in place for pensions and promises would be kept.  During that time absolutely no attention has been paid to public pension plans except by the sponsors of those plans and their enablers looking to maintain or increase benefit levels at the same time they were decreasing or eliminating contribution requirements all while maintaining the fiction of solvency which, in the case of Detroit, continued to the very end when the official funded level stood at 91.4%. […]

    Reply

  10. […] comically otiose).  But the Detroit situation (i.e. plans reformed in 2011 and reported to be 91.4% funded  in 2012) calls for subtler arguments – though still easily deflected – to becalm the […]

    Reply

  11. […] contribution requirement developed using the same warped ways and means that got Detroit a 91.4% funded ratio on the eve of their bankruptcy. New Jersey is deliberately underfunding pensions and they are […]

    Reply

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