In the face of Detroitfs tumultuous bankruptcy
proceedings, in which multiple parties are quarreling to protect their
interests, the city and its unions have quietly negotiated a scaled-back pension
plan that could serve as a model for other troubled governments.
One of the most closely watched issues of the case is
whether a government pension plan can be legally cut in bankruptcy. Detroit,
saddled with a pension system it cannot afford, has introduced a new plan with
the cooperation of its unions, which have been among the most vocal opponents of
cutbacks.
While both retired and active workers now participate
in the same city pension system, the
new plan is intended only for Detroitfs active workers, who will shift to it
on July 1. Retirees will keep 73 percent to 100 percent of their current base
pensions under the cityfs proposal to exit bankruptcy.
The new plan is called a hybrid, which means the
workers will keep some of their current planfs most valuable features but will
give up others. Trading down to a less generous pension plan is often said to be
a legal nonstarter for government workers, so if Detroit succeeds, its hybrid
could become a model for other distressed governments from Maine to California.
Countless elected officials — from Rahm
Emanuel, the Democratic mayor of Chicago, to Chris
Christie, the Republican governor of New Jersey — are caught between
ballooning pension obligations, angry local taxpayers who donft want to pay for
them and labor lawyers who say itfs impossible to cut back.
gWe have a festering sore here,h Christopher M.
Klein, the judge in
the bankruptcy case of Stockton, Calif., said at a hearing in May, referring
to that cityfs surging pension costs. gWefve got to get in there and excise
it.h
Detroitfs current pension system simply costs too
much relative to its battered tax base, and the watchword for Detroit this
summer is feasibility. For the city to emerge from bankruptcy, its emergency
manager, Kevyn D. Orr, must convince Steven W. Rhodes, the judge overseeing
Detroitfs bankruptcy case, that his long-term financial plan is feasible. The
matter is to be decided at a trial to start in August.
There would be little hope of persuading Judge Rhodes
if Detroitfs workers were still covered by the existing pension plan and
struggling local taxpayers were still liable for the relentlessly mounting
obligations. For many years, the current plan allowed city workers to earn
benefits that others in Detroit could only dream about — full pensions at 55,
longevity bonuses, annual cost-of-living increases, an
extra g13th checkh in December and bankable sick leave that could be
converted to cash, among others. In recent years, the resulting pensions have
been greater than the per capita income of the residents who were expected to
pay for them.
On June 30, Mr. Orr will freeze that pension plan,
meaning that the cityfs current workers will not accrue any further benefits on
those terms.
Starting the next day, in the new hybrid plan, they
will still earn so-called defined-benefit pensions — a specified monthly payment
based on tenure, age and earnings history — something their unions consider
critical. But they will also start to bear most of the new planfs investment
risk. That means Detroitfs taxpayers — who pay a city income tax in addition to
property and sales taxes — will no longer face cash calls every time the planfs
investments drop in value. Officials hope that making the workers backstop the
investments will discourage overreliance on high-risk strategies.
This unusual combination of features gives both the
city and the unions an opportunity to declare victory and provides Mr. Orr with
ammunition for the coming feasibility trial.
But it also flies in the face of a legal principle
known as the vested-rights doctrine, which holds that the pension formula in
force on the day a public worker goes on the job cannot be reduced for the full
duration of employment. No such legal protection exists for workers in the
private sector, whose pension plans can be frozen at any time. But in the public
sector, the vested-rights doctrine is an article of faith, zealously defended,
and it helps explain why a bankrupt city like Stockton is proposing to saddle
its other creditors with big losses but not touch the pension plan.
The vested-rights doctrine is especially powerful in
California, growing out of court decisions dating back to 1947. Unions in San
Jose recently used it to keep the city from making
its workers contribute more toward their pensions. Employees of four
California counties argued in court last year that they had a vested right to
pad their pensions by counting things like unused vacation time in their benefit
calculations, despite laws prohibiting the practice. In March, Judge David B.
Flinn of Contra Costa County Superior Court ruled that there was no such thing
as a vested right to an illegal benefit — but
the ruling applies only to current workers. Retirees are still receiving the
padded pensions.
Californiafs state pension system, Calpers,
is a powerful proponent of the vested-rights doctrine, and many state and local
governments follow its lead.
In Detroitfs bankruptcy, however, the vested-rights
doctrine does not appear to be an issue. The Michigan law for distressed cities
gives emergency managers like Mr. Orr the power to set the terms of public
employment. That means he can legally freeze Detroitfs existing pension plans
and establish new ones for city workers, said Bill Nowling, a spokesman for Mr.
Orr.
gHe is not making any benefit cuts,h Mr. Nowling
added.
For Detroitfs retirees, itfs a different matter. They
are not being asked to give up benefits they had hoped to earn in the future;
they are being told they must give up benefits they have already earned.
Michiganfs constitution forbids this, so Mr. Orr is using the Chapter 9
municipal bankruptcy process, in which federal law applies. A
bitter battle is already taking shape.
By the time the fate of the retirees has been
decided, Detroitfs workers will already be earning hybrid benefits. To shift the
investment risk their way, Detroit has set up a series of eight gleversh to pull
if the planfs investments falter. They include setting up a reserve fund that
must be used to cover losses, raising the workersf required contributions,
lowering retireesf cost-of-living increases and making workers build up their
benefits more slowly.
Should investments not produce the expected returns —
in a protracted bear market, for example — leaving too little money to meet all
obligations, officials will be required to pull as many levers as it takes to
get the plan back to the 100 percent funded level within five years. Only if all
eight levers are pulled and the plan is still not responding adequately can
Detroitfs taxpayers be called on to rescue it.
To measure the level of funding, the plan will assume
a 6.75 percent rate of return. That still allows for a substantial amount of
risk, although it is less than the 7.9 percent assumption the city was using
when it declared bankruptcy. Officials of the American Federation of State,
County and Municipal Employees, which led the negotiations, did not respond to
calls seeking comment. The union is one of 48 that represent Detroitfs municipal
workers.
Even as they were negotiating the hybrid pension
plan, Detroitfs unions were still appealing a ruling last December by Judge
Rhodes that pensions could be cut under federal bankruptcy law, despite
protective language in Michiganfs constitution. The unions are required to drop
the appeal if they vote for Detroitfs plan of adjustment. From California,
Calpers has asked to serve as a gfriend
of the courth in the appeal, saying Judge Rhodesfs decision graises issues
that are of critical importance to Calpers and its 1.7 million members.h
Calpersfs brief argues that Judge Rhodes ruled
improperly and asks the United States Court of Appeals for the Sixth Circuit to
vacate his finding that state laws protecting pensions are not binding in
bankruptcy cases. Although Californiafs laws have no force in a federal case in
Michigan, Calpers expressed concern that rulings concerning Detroitfs bankruptcy
might recast the legal landscape in California.
gSuch a precedent can be, and has been, misconstrued
for the broad proposition that all pensions are subject to impairment in Chapter
9,h the Calpers brief said.
A version of this article appears in print on
06/19/2014, on page A1 of the NewYork edition with the headline: Detroitfs Idea
to Save Budget and Pensions.