Derivative Losses, Bad Bets, And Aggressive Assumptions Leave Detroit's Pensions Massively Underfunded

Tyler Durden's picture

Late last week, Detroit's emergency manager Kevyn Orr, outlined his plan to stop a disaster becoming a catastrophe in the slumping city. The initial suspension of payment on pension obligation bonds is just the start as Orr warns unsecured creditors may only receive up to 10 cents on the dollar as about $2.5 billion in general unsecured debt won't be recovered. Rather incredibly, the city's General and Police and Fire retirement systems have a combined underfunding of $3.5 billion made worse by "aggressive actuarial assumptions," and "investing in risky development projects around the city and loans that will never be repaid." Under more realistic assumptions the funding status of the two pensions drops from 83% and 100% to 65% and 78% and he notes that "if these pension funds' assets had just been invested in a conservative way," as opposed to the political and reach-for-yield driven extravagance, "they probably would be fully funded now." The bottom line is not just creditor haircuts but,"significant cuts in accrued, vested pension amounts for both active and currently retired persons."

Via Pensions and Investments Online,

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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.

 

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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.

 

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“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.

 

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“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,”