STUMP » Articles » Leap Day Pensions (and Finance) Watch: Detroit, Chicago, and California » 29 February 2016, 06:44

Just to note, ‘actuary’ was the winning word in a spelling bee recently.

Some wacky doings afoot in the public finance world – let’s check them out.

DETROIT: SUE THE ACTUARIES

It’s just in the idea stage, it seems, but I agree with Mark Glennon that this sort of thing will become a more and more popular “solution”. And it won’t just be the actuaries.

Detroit mayor eyes legal action over pension shortfall:

DETROIT (Reuters) – Detroit may sue some of the consultants who worked on its historic municipal bankruptcy over a $490 million pension funding shortfall that will result in bigger-than-expected city payments starting in 2024, according to Mayor Mike Duggan.

In his state of the city address on Tuesday night, Duggan said he is seeking advice from the city’s legal department to review any possible claims against consultants.

The mayor blamed the projected deficit on outdated mortality tables used by the consultants that assume retirees will not live as long. The consultants were hired under the city’s former emergency manager, Kevyn Orr.

Orr, an attorney at law firm Jones Day, who was tapped by Michigan Governor Rick Snyder in 2013 to run Detroit, declined to comment. A representative of Milliman, the city’s actuarial consultant, could not be reached for comment.

Detroit exited the biggest-ever U.S. municipal bankruptcy in December 2014, shedding about $7 billion of its $18 billion of debt and obligations. The city paid $177 million in legal and consultant fees to dozens of firms.

The city’s court-approved debt adjustment plan contained money to pay for pensions over the first 10 post-bankruptcy years, according to John Naglick, Detroit finance director. The plan also projected contributions by the city starting in 2024 needed to amortize the unfunded pension liability which was understated by $490 million, he added.

I love the specificity of the $490 million. Because these liability valuations are based on some very long-term assumptions. What are the error bars on that estimate, eh? More or less than $10 million?

But wait, there’s more.

$491 million pension shortfall may be result of using outdated actuarial tables

Ooooh, $491. Look at that precision. (me geeking out about precision)

Mayor Mike Duggan’s revelation that the city faces a $491 million pension fund shortfall shocked legal experts and city officials who thought Detroit had left budget-busting problems behind in bankruptcy court.

Interviews and court records, however, offer insight into what might have caused a half billion-dollar threat to Detroit’s budget and reveal missed warning signs during the frantic pace of the largest municipal bankruptcy case in U.S. history.

Duggan said the $491 million shortfall is not yet a crisis for Detroit, which shed about $7 billion in debt during the bankruptcy. That’s because the city has a projected $30 million surplus this fiscal year — money that will be used in the short term to help fill the pension gap.

…..
The city’s bankruptcy plan calculated the payment after projecting the life expectancy of city retirees based on old mortality tables, from the year 2000, according to the Detroit Financial Review Commission.

“They assumed people were not going to live as long as they would,” Duggan said during the Feb. 23 State of the City address.

Duggan did not identify which consultant was to blame for allegedly using outdated mortality tables to calculate life expectancy of city retirees, but the city’s actuary during the bankruptcy case was Seattle-based Milliman Inc. The city paid Milliman $1.97 million, according to bankruptcy records.

In November, the pension funds’ actuary, Southfield-based Gabriel, Roeder, Smith & Co., performed an updated mortality study.

The study concluded that instead of $111 million, starting in 2024, Detroit needs to pay $194.4 million, according to a Nov. 24 letter from the Michigan Department of Treasury to Gov. Rick Snyder, with further payments in subsequent years adding up to $491 million.

A Milliman spokeswoman did not respond to messages last week seeking comment. Former Detroit emergency manager Kevyn Orr did not respond to messages last week seeking comment.

Jeremy Gold, consulting actuary and owner of New York-based Jeremy Gold Pensions, said Friday that public pension plans are modeled a bit differently than private sector ones that follow the federal Employee Retirement Income Security Act, where actuaries have more control over assumptions about mortality and liability projections.

In public plans, actuaries often advise or consult with plan administrators and their governing boards, and projections can sometimes vary up to 50 percent between firms.

“The actuaries are not required to comment on whether or not what they are asked to assume is reasonable, and for reasons of their own they often seem to assume their clients’ assumptions are reasonable,” he said.

“I’m not faulting individual actuaries. They’re in a hard, competitive environment. If they give numbers that don’t allow for small enough contributions in the present for their client, there’s pressure they may lose to a competitive firm that makes different numbers and assumptions. If there’s going to be any bad guy, it’s going to be the profession as a whole. The standards of review are not stringent enough.”

Reminder — Jeremy Gold is the pension actuary who presented Where are the Screaming Actuaries? at an MIT conference last year.

Finally, Mark Glennon points out some salient facts of this case:

Some background: Prior to bankruptcy, Detroit officially reported its pensions were in pretty good shape — over 90% funded, based on work by Actuary A. After filing for bankruptcy, Detroit’s emergency manager thought that was too optimistic and ordered a new report from Actuary B, which concluded the pensions were in far worse shape — under 60% funded. Detroit based its reorganization plan on Actuary B’s work, and bonds and pensions were cut based on it. But Actuary B was still too optimistic, Detroit is now saying, which is why the funding schedule approved in its bankruptcy will be almost half a billion dollars short.

And here’s a strange part: It’s Actuary A that’s now reportedly advising Detroit that Actuary B’s work was too optimistic. Actuary A was already sued for allegedly understating pension problems in its pre-bankruptcy work.

…..
Consider the next levels of liability. Detroit’s anger reportedly is focused on an actuary and, perhaps, its former emergency manager and his law firm, which negotiated the reorganization plan. But think about bondholder reaction as pension projections prove false. Once their damages are ascertainable, isn’t litigation against a range of municipal bond industry regulars, including law firms, rating agencies, underwriters and accounting firms all but certain? That kind of litigation attracts the most aggressive class action lawyers.

Again, actual guilt won’t necessarily matter. Remember Arthur Andersen? The entire firm was shut down over its accounting work for Enron, throwing thousands of people out of work who never heard of Enron.

To be sure, different parties are part of the various lawsuits. And it doesn’t sound like lawsuit against Actuary B has actually been filed. In one of the stories, someone pointed out that this was a deflection by the mayor of Detroit, because he had some unhappy news to convey.

By the way, it wasn’t just valuation assumptions that was a problem in the Detroit pensions. There was also the assumption that payrolls would increase into the future (so there would be an increasing base with which to make contributions) and there was the whole 13th check nonsense.

And don’t get me started on the swaps situation.

In any case, actuaries have been sued in the past with respect to pension or OPEB (other-than pension employee benefits — usually retiree health plans) valuations. There have been settlements. This isn’t exactly new, but I’m not sure how far it gets when the client picks the major valuation assumptions.

And while actuarial firms may look like deep pockets to lawyers hard up for some nice, juicy cases, they definitely aren’t deep enough to fill large pension shortfalls.

ILLINOIS BUDGET FOLLIES

Oh, woopsie. Did we just “forget” to send out notices for renewals and thus reaped more in late fees? Why lookie there!

Due to the Illinois secretary of state’s suspension of mailing license-plate-renewal reminders as of October 2015, the state of Illinois has received a $1.2 million windfall in fees for late license-plate renewals during the first two months of 2016, according to the Associated Press. From Jan. 1, 2016 through Feb. 22, 2016, Illinois vehicle owners paid $2.7 million in fees for renewing their license plates late, up from $1.5 million during the same period in 2015. More than 136,000 motorists received fines for late vehicle-registration renewal in the first two months of 2016, compared with 63,000 people in January and February 2015.

$1.2 million is chump change in a billion-dollar deficit, but every little bit helps.

In other budget-related news, Chicago State University has sent out layoff notices:

Chicago State University sent notices of potential layoffs to all of its 900 employees Friday, yet another sign of the escalating budget crisis for the Far South Side public institution that stems from the state’s budget impasse.

The university, with about 4,500 students, declared a financial emergency this month to make it easier to fire tenured faculty, eliminate academic programs and take other extreme measures.

….
The financial problems are a result of the budget impasse in Springfield, which has left public colleges and universities without state funding since July. While all public schools are struggling to some extent, Chicago State is in the most precarious situation. About one-third of its budget comes from the state, and the school lacks financial reserves to fall back on.

University officials said they are unsure what percentage of staff and faculty will be laid off, and the layoffs won’t be announced for at least 60 days. A committee appointed by the board of trustees is reviewing all possibilities, Calhoun said. About 300 employees are faculty members, according to a union representative.

A Chicago State spokesman said the university issued the notices Friday because of a federal law, known as the WARN Act, that requires many employers with more than 100 employees to give 60 days notice in the case of possible widespread layoffs. The law, however, does not apply to state universities, according to an Illinois Department of Labor spokesman.

More political theater around the budget impasse, it seems.

But maybe not:

Declaring financial exigency typically makes it easier for universities to lay off employees, including tenured professors, who have the greatest employee protections. An exigency is defined by the American Association of University Professors as an “imminent financial crisis which threatens the survival of the institution as a whole” and one that cannot be alleviated by less drastic means than firing faculty.

Colleges and universities have been operating without money from the state since July 1, when Republican Gov. Bruce Rauner vetoed an out-of-balance spending plan sent to him by ruling Democrats in the legislature. Much of state government has received funding through various court orders or legislative and executive maneuvers to stay afloat, but higher education, for the most part, has had no relief.

Perhaps if one is at an institution that requires continual state funding for remaining in operation in a state like Illinois, one can’t really afford to give any faculty tenure. Just a thought.

Also, perhaps states should run universities. Just another thought.

It really doesn’t help that the state pension fund for the university workers is not all-that-funded (just like most of them).

Look at the size of the green bars there. That’s the result of deliberate undercontributions to the plan.

BAD INVESTMENTS ALSO DON’T HELP

Sure, undercontributions are a huge reason for the Chicago and Illinois pension crises.

But stuff like this doesn’t help:

A real estate venture created by President Barack Obama’s onetime boss and a nephew of former Mayor Richard M. Daley squandered $68 million it was given to invest on behalf of pension plans for Chicago teachers, cops, city employees and transit workers, a Chicago Sun-Times investigation has found.

The five public pension funds haven’t made a dime on the investments they made nearly a decade ago with DV Urban Realty Partners, a company created by Obama’s ex-boss Allison S. Davis and Daley nephew Robert G. Vanecko, records show.

In fact, the financially troubled pension plans have lost most of the money they gave DV Urban, which used the money to invest in risky real estate deals, primarily in neglected neighborhoods.

And that’s all I have to say about that. For now.

CALIFORNIA: ACCOUNTING

This is not just about California.

David Crane writes about not expensing promises when those promises are made:

What Accrual Accounting Would’ve Exposed

Nothing has the power of accrual accounting to unmask and curtail reckless fiscal behavior by elected officials. As one example, accrual could’ve stopped the largest non-voter-approved debt issuance in California history.

That happened in 1999, when legislation proposing a retroactive pension increase for state employees was introduced in the California Legislature. Accrual accounting would’ve forced state officials to acknowledge a large expense in the 1999 budget as a result of the legislation. But because the state employed cash accounting and no cash changed hands that year, the deal was hidden from that year’s budget. The legislation was quietly enacted into law without notice that elected officials had just transferred tens of billions of dollars to a special interest.

This is not unique to California. While public finance balance sheets sometimes show the effect of the new promises (remember, with some optimistic assumption sets), often that year-to-year change does not flow through to the income statement of the public entity.

Actually, I believe the term is “never”.

What flows through the income statement is the actual payments made to pension plans. So if one undercontributes to the pension plan, the difference between the contribution that should have been made and the one actually made is just disappeared.

Sure, you can see the obligation in the balance sheet, but to many people that isn’t really real, you know. The cash flowing out of the coffers is real.

But as the income statement and the balance sheet diverge, that means the liabilities on the balance sheet are less and less likely to be fulfilled.

And it’s not just pensions where this is problematic, but also retiree health plans for public employees. The issue there is it’s even more difficult to value those plans, because you’re not sure how much will be paid for claims for a year until it’s over. Pension payments are easier to project.

PUERTO RICO: BONDHOLDERS V PENSIONERS

It’s not unprecedented.

Moody’s did a report:

An in-depth Moody’s Investors Service report on recent municipal bankruptcies published Thursday finds that retirees have usually fared better than bondholders in court in recent years. According to Moody’s:

“In municipal bankruptcy, bondholders are likely to find themselves in fierce competition with retirees and current employees over the allocation of a municipality’s limited resources. The Detroit, Stockton and Vallejo cases demonstrate that retirees have done better in Chapter 9 cases than investors in general government debt. Stockton, Vallejo and Detroit therefore offer a glimpse into the likely future of Chapter 9 bankruptcy, in which two classes of claimants, retirees and bondholders, battle each other for the greatest recovery.”

Puerto Rico is not only running out of cash to make debt payments, but its pension fund is completely tapped out. It is paying current retirees from revenues, not from a pension plan. One reason the Treasury wants to prioritize pensioners is to keep younger workers in Puerto Rico. Without pensions, migration from Puerto Rico to the United States would likely pick up, further weakening the local economy.

I was wondering about all the howling of “unprecedented”. It happened in all major municipal bankruptcies of late.

The thing in, in the bankruptcies named, it seems to me the pensions are likely to get cut again. The problem seems to me is that the valuation assumptions are often still too optimistic, and when the municipality finds the money in the pension funds running out…. it’s not like they’re going to be able to issue pension obligation bonds easily.

Maybe avoid cutting pensions now, but that just means the pensions will get cut later.

See you in 4 years for the next leap day update!