Rebecca Cook / Reuters file
A group of AFSCME union city of Detroit worker retirees protest against any cuts in their pensions outside the city county building in downtown Detroit, Mich., in this August 5, 2013 file photo.
Detroit’s municipal pension fund made payments for decades to retirees, active workers and others above and beyond normal benefits, costing the struggling city billions of dollars and helping push it into bankruptcy, according to people who have reviewed the payments.
The payments, which were not publicly disclosed, included bonuses to retirees, supplements to workers not yet retired and cash to the families of workers who died before becoming eligible to collect a pension, according to reports by an outside actuary and other people with knowledge of the matter.
How much each person received is not known. But available records suggest that the trustees approving the payments did not discriminate; nearly everybody in the plan received them. Most of the trustees on Detroit’s two pension boards represent organized labor, and for years they could outvote anyone who challenged the payments.
Since June, Detroit’s auditor general and inspector general have been examining the pension system for possible fraud or misfeasance, and their report is expected to be released on Thursday. Among the findings is likely to be how much damage was done by the extra payments.
“It was like dandelions,” said Joseph Harris, who served as Detroit’s independent auditor general from 1995 to 2005. “You just accept them. They were there, something you’ve seen all your life.”
When asked on what legal authority the trustees made the payments, Mr. Harris said, “My understanding was, it had to be approved by City Council, and council was under the belief that the money was there — that the pension funds were earning the money — with the consideration that in bad times the city would be making up the difference. I hate to say that. Ultimately the fund has to be funded by the taxpayers.”
Analysis 'not fully straight'
A spokeswoman for Detroit’s pension trustees, Tina Bassett, said she thought the outside actuary’s analysis, which concluded that the extra payments had cost the city nearly $2 billion over 23 years, was “not being fully straight with what happened.”
She said that the trustees were administering benefits that had been negotiated by the city and its various unions and that they had established an internal account to set aside “excess earnings” that would cover the cost. She said it was appropriate for retirees to benefit from market upturns because they had paid into the pension fund, so their own contributions had generated part of the investment gains.
“People were having a hard time, living hand-to-mouth, and we thought we would give them some extra,” Ms. Bassett said.
Of all the nonpension payments, she said, 54 percent went to active workers, 14 percent went to retirees and 32 percent went to the city, which used its share to lower its annual contributions to the fund. The excess payments were often made near the end of the year, when recipients needed money for the holidays, or to heat their homes.
Detroit has nearly 12,000 retired general workers, who last year received pensions of $19,213 a year on average — hardly enough to drive a great American city into bankruptcy. But the total excess payments in some years ran to more than $100 million, a crushing expense for a city in steep decline. In some years, the outside actuary found, Detroit poured into the pension fund more than twice the amount it would have had to contribute had it paid only the specified benefits.
And then the city’s contributions were not enough. So much money had been drained from the pension fund that by 2005, Detroit could no longer replenish it from its dwindling tax revenue. Instead, the city turned to the public bond markets, borrowed $1.44 billion and used that to fill the hole.
Even that did not work. In June, Detroit failed to make a $39.7 million interest payment on that borrowing — the first default of what was soon to become the biggest municipal bankruptcy case in American history.
Detroit said at the time that making the interest payment would have consumed more than 90 percent of its available cash. And besides, the hole in its pension fund was growing again, and it needed another $200 million for that.
When Detroit went to the bond market, it acknowledged that it needed cash for its pension fund but did not explain its long history of paying out more than the plan’s legitimate benefits, including the bonuses, known as “13th checks,” which were reported this month by The Detroit Free Press. Nor did the city describe the pension fund’s distributions to active workers, or that a 1998 shift to a 401(k)-like plan had been blocked and turned instead into a death benefit. In its most recent annual valuation, the plan’s actuary said it was still trying to determine the “effect of future retroactive transfers to the 1998 defined contribution plan” without mentioning that it had been changed into a death benefit.
All of these eroded the financial health of the pension system, but neither the magnitude of the harm, nor its effect on the city’s own finances, were disclosed to investors. German banks were big buyers of Detroit’s pension debt; now they are complaining that they were told it was sovereign debt, as if it were issued by a national government.
Finally, in 2011, the city hired the outside actuary to get a handle on where all the money was going. The pension system’s regular actuaries, with the firm of Gabriel Roeder Smith, would not provide the information because they worked for the plan trustees, not the city.
The outside actuary, Joseph Esuchanko, concluded that the various nonpension payments had cost Detroit nearly $2 billion from 1985 to 2008 because the city had to constantly replenish the money, with interest. It appears that Mr. Esuchanko could not get data for years before 1985.
His calculations included only the extra payments by Detroit’s pension fund for general workers. Detroit has a second pension fund, for police officers and firefighters, which also made excess payments. Mr. Esuchanko could not get the data he needed to calculate those, either.
When he reported his findings in November 2011, Detroit’s City Council voted to halt all payments except legitimate pensions. The police and firefighters’ plan trustees appear to have discontinued excess payments earlier.
An investment banker now advising Detroit, Charles M. Moore, has said in a court declaration that the trustees of the general pension plan were “effectively robbing” the fund when they diverted its assets. He criticized in particular the transfer of money from the pooled pension trust fund to a group of individual accounts for workers who had not yet retired. The individual accounts had been established as a savings plan for city workers; the board credited them with interest at its chosen rate, often higher than what the fund’s investments actually earned.
'Abuse of discretion'
“This abuse of discretion was most egregious in 2009,” said Mr. Moore, a managing director at the firm of Conway MacKenzie. He said the pooled pension trust had lost 24 percent of the value of its assets that year, but the trustees appeared to have credited the individual accounts with 7.5 percent interest.
“Hundreds of millions of dollars of plan assets intended to support the city’s traditional defined-benefit pension arrangements were converted,” he wrote, “to provide a windfall to the annuity savings accounts of active employees outside of the defined-benefit pension plan.”
The actuarial firm of Gabriel Roeder Smith did not respond to an e-mail request seeking information about the excess payments and how they were disclosed in its annual valuations. The firm has already been dueling with a second actuarial firm, Milliman, hired by Detroit’s emergency manager, Kevyn Orr. Milliman said the two city plans appeared to have a $3.5 billion shortfall, much larger than one previously disclosed by Gabriel Roeder Smith in its annual valuation.
Detroit’s trustees say they think Milliman was told to come up with a big shortfall on purpose. Under Michigan’s emergency manager law, a city’s pension trustees can be dismissed if the fund under their care falls below an 80 percent funding level.
Unions fear the machinations are under way to reduce their benefits in the city’s Chapter 9 bankruptcy case. They say this cannot happen because Michigan’s Constitution explicitly protects public pensions.
James E. Spiotto, an expert on municipal bankruptcy with the firm of Chapman & Cutler in Chicago, said that if pension money was, in fact, misused, leaving an insolvency, it might affect the terms of an eventual settlement.
He said it was conceivable that the city might sue the pension fund, arguing it was unjustly enriched by the infusion of money from the bond market, because the city itself was misled about the size and causes of the pension shortfall. But that approach, if successful in court, would pose a practical problem: if the pension fund disgorged the bond proceeds, its own financial condition would just get worse. And it still has an obligation to pay the pensions.
Another approach might be for the city to try to claw back money from people who received more than they should have, using bankruptcy rules about fraudulent conveyances.
“A clawback is always hard,” Mr. Spiotto said. Instead of trying to get back the money, he said, Detroit might try to reduce those people’s future pension payments, to get back at least part of the overpayments.
“Somebody should be responsible for it,” he said. “And I think the municipality may have a legitimate argument — ‘We don’t have to pay twice.’ ”