Detroit’s Fallout: How Safe Are Other Municipal and City Pensions?

Detroit labor union workers and current retirees were dealt a blow late Tuesday after a U.S. bankruptcy judge ruled that the city’s debt restructuring could continue on and bring changes to their pensions.

Three lawsuits were filed in an attempt to prevent retirees’ benefits from being part of the bankruptcy restructuring, calling the city’s Emergency Manager Kevyn Orr’s historic bankruptcy filing unconstitutional due to a provision in the Michigan state constitution.

A U.S. bankruptcy judge ruled Wednesday that challenges to Motor City’s bankruptcy were suspended, leaving retirees and future pension recipients all over the country are left questioning the security of their nest eggs.

Pension Funding Levels

What’s stunning is how well funded Detroit’s pensions were even at the height of the recession, claims Andrew Biggs, resident scholar at the American Enterprise Institute.

In 2009, Detroit’s pensions were 93% funded, according to the Pew Institute, compared to other cities like Providence, R.I, which was only 42% funded. Pension data often lags, and the Pew study is the most up-to-date information.

“It shows you how quickly things can go wrong,” Biggs says.  “I am guessing today the pension is about 75% funded, so things can go south very quickly when you take a lot of investment risk and/or don’t make your payments.”

Detroit was hit by the perfect storm in many ways, he explains, with policy incompetence and major debts. Most other struggling cities aren’t in as dire straits: Its total pension obligations for the city’s 21,000 retirees are an estimated $9 billion in unfunded liabilities, $5.7 billion of which are tied to health-care benefits for workers.

Detroit’s pension landscape has also shifted in the past decade, according to the Detroit Free Press. In 2004, the pension was about 50-50 between workers paying into the system and workers collecting. Today, its 40-60, with more than half retired and collecting, and the remaining 40% bearing the load.

“My guess is in Detroit, if you do get cuts in the pensions, I don’t think they will stick it to the retirees the way they stick it to the bond holders,” he says.

Detroit vs. Other Struggling Cities

Some of the worst-funded pension systems, where participants are paying into the program but the state isn’t necessarily meeting its obligations, include Illinois, California, New Jersey and New York, according to Biggs.

“States can’t go bankrupt, and in places like California, they can raise taxes by and large before you really feel it,” he says.

But for a city like Detroit, which has lost more than half its population in the past 50 years, raising taxes isn’t as much of an option, and relying on the local economy to offset costs is also unlikely.

National Center for Policy Analysis senior fellow Pamela Villarreal says Detroit has a much less likely chance of recovery compared to other struggling cities and municipalities, simply because it was sinking for so long.

“Its economic growth and tax revenues are pretty slim right now,” she says. “But overall, the default rate for city pensions is pretty low; it’s historically been about 1%.”

That being said, Villarreal points out that the Congressional Budget Office reports state and city pensions are at their lowest funding levels in more than two decades. She agrees with Biggs that a bankruptcy that would disrupt pension plans as is being seen in Detroit would be unlikely, but it’s not impossible.

Social Security Safety Net

Pensioners in Detroit are lucky in one sense, Biggs says, because they can apply for Social Security benefits. In other states, like Massachusetts for example, those with public pensions cannot collect Social Security benefits as well. If a Detroit-like situation were to occur in one of these locations, residents’ financial situations could a lot worse.

“In many places public workers are not eligible for Social Security because they do not participate,” he says. “Then you have a problem because your entire retirement is based in pensions. So yes, you should be scared.”