Detroit raises retirement risk

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With Detroit headed to bankruptcy, the decisions made about this case could have an impact on the retirement of state and municipal employees everywhere.

A key question to be decided is whether pensions are protected from bankruptcy. The Michigan constitution says state and municipal pensions “can’t be diminished or impaired.” While that sounds like a clear defense, this phrase may not be enough, explains Brad Reynolds, chief investment officer for LJPR, a suburban Detroit wealth management firm that specializes in retirement planning. “Deciding whether the federal bankruptcy law trumps the state constitution is going to be a protracted legal battle,” he predicts.

If the federal courts decide that Michigan’s constitution doesn’t protect insolvent government pensions, then not only are Detroit employees and pensioners at risk, but workers and retirees in other financially stressed regions could also see changes in their pensions and retiree health care. “I don’t think there would be a 180-degree change all of a sudden, but this decision will have an impact,” Reynolds says.

Another Detroit pension debate that could have broader implications is the argument over how big the pension liability actually is. Depending on who is doing the math, the obligations range from $650 million to $3.5 billion. One big issue is how much the annual return on invested assets is likely to be. The optimistic estimate is 8 percent a year, but many insist this percentage is too high given investment returns over the last 10 years. The lower the estimate, the higher the debt — in Detroit and elsewhere.

A third issue is the status of Detroit’s pension general obligation bonds. Historically, the municipal bond market and investors have viewed these bonds as a safe investment because municipalities can always raise taxes to pay debts. But the proposal to restructure the city’s debt says these bonds are unsecured and plans to offer bondholders pennies on the dollar. If this classification is upheld by the court, it will have far-reaching implications, not just for other troubled municipalities, but the municipal markets in general, says Reynolds.

None of this is good news for anyone saving for retirement — wherever they live.