Kevyn D. Orr, emergency manager for Detroit, outlined his plan on Friday to avert impending financial disaster, including benefit cuts for the city's two public pension plans.
Mr. Orr kicked off negotiations with the Motor City's creditors, insurers of creditors, and labor unions by suspending payment on Detroit's unsecured debt, starting with a $39.7 billion payment due Friday on certificates of participation, akin to pension obligation bonds.
Unsecured creditors may only receive up to 10 cents on the dollar under Mr. Orr's plan; his team said about $2.5 billion in general unsecured debt won't be recovered.
Detroit's liabilities total $17 billion, including $1.4 billion related to COPs and an additional $344 million in marked-to-market swaps related to the COPs, according to Mr. Orr's creditor plan.
In his proposal, Mr. Orr said the combined underfunding totaled $3.5 billion for the $2.77 billion Detroit General Retirement System and the $3.4 billion Detroit Police and Fire Retirement System, including the COPs and swaps liabilities.
Mr. Orr's pension fund analysis found that previous “aggressive actuarial assumptions” resulted in “substantially understated” funded status for each city pension plan. The funded status of the General Retirement System was 83%, while that of the police and fire fund was 100%, according to June 30, 2011, independent valuations.
Recalculations based on “more reasonable assumptions” substantially lowered the funded status of the General Retirement System to 65%, and the police and fire system to 78%, according to Mr. Orr's creditor plan.
“At this level of underfunding, the city would have to contribute approximately $200 (million) to $350 million annually to fully fund currently accrued, vested benefits. Such contributions will not be made under the plan,” Mr. Orr's proposal stated.
“Because the amounts realized on the underfunding claims (the COPs and swaps unsecured debt) will be substantially less than the underfunding amount, there must be significant cuts in accrued, vested pension amounts for both active and currently retired persons,” the creditor proposal said.
Bill Nowling, Mr. Orr's spokesman, said in an interview that the emergency manager's office only received the pension fund valuation review it commissioned from Milliman five days ago, not enough time in which to be able to make concrete plans about the pension funds.
“We have to sit down with the boards of both pension funds next week and hammer out an agreement about the true funded status of these funds. Once we do that, then we can make more specific recommendations about changes to pension benefits or fund structures,” Mr. Nowling said.
He stressed that there are no plans – yet – to freeze the city's defined benefit plans and substitute defined contribution plans or hybrid plans, but acknowledged both possibilities will be considered.
“As discussed in the creditors'meeting today, if these pension funds' assets had just been invested in a conservative way, instead of investing in risky development projects around the city and loans that will never be repaid, they probably would be fully funded now,” Mr. Nowling said.
Kirk Pinho, a reporter for Crain's Detroit Business, a sister publication of Pensions & Investments, contributed to this story.