As the city of Detroit’s financial condition deteriorated, its employee-pension funds made hundreds of millions of dollars in bonus payments to retirees. Those extra checks swelled the city’s retirement debt and played a role in the Motor City’s eventual bankruptcy. Yet Detroit’s struggles haven’t stopped the retirement systems of other cities and states—including some with severely underfunded pensions—from continuing to dole out bonuses.
The Philadelphia school system, with less than half the assets it needs to meet its future obligations, is set to hand out $62 million in bonuses, sometimes referred to as 13th checks, to its retirees this year. The payments are authorized by 2007 legislation that grants the extra checks when the pension system exceeds its investment projections, regardless of the system’s debt. Rising retirement costs—up from $55 million in 2011 to $154 million last year—have aggravated a financial crisis in the city’s schools. Despite a state-approved $60 million boost in cigarette taxes last year to bolster their finances, Philly schools project an $80 million deficit next year, partly because of another $34 million spike in pension costs. Still, the Philadelphia city council has refused to rescind the 2007 bonus law, arguing that the extra retiree payments this year will be only a small component of the system’s $5 billion in debt. Mayor Michael Nutter, by contrast, has called the payments irresponsible and tried to stop them.
Extra pension payments also remain a problem in some communities surrounding Detroit. Wayne County’s finances, for example, are so shaky that Moody’s has downgraded the government’s debt rating to junk-bond status. County executive Warren Evans recently released an audit showing that the county could run out of cash by June, raising the prospect of a state takeover or bankruptcy. But the county’s retirement system, which is only 45 percent funded, keeps handing out extra pension checks from a bonus pool, established by county ordinance in 1985, which receives money when investment gains beat projections. The checks cost the county $16 million annually. In 2010, the county began taking money out of the bonus pool and transferring the cash into its underfunded pensions. Retirees sued to stop the practice, and a state appeals court backed them. A Michigan court had similarly blocked Detroit officials from suspending its bonus program before the city entered bankruptcy court. Eventually, federal bankruptcy judge Steven Rhodes allowed Detroit to stop the 13th checks and revamp its troubled pension system.
In some cases, employee-dominated pension-fund boards are handing out bonuses against the wishes of government officials. The pension trustees of the police and fire funds of the city of Hollywood, Florida, sent out bonus checks in 2013 averaging $19,000 for retired firefighters and $6,400 for retired cops. But the city’s pension funds have less than half the money they need to pay future obligations, according to a recent Fitch Ratings report, and they owe nearly $500 million. City officials complained to the state’s retirement board about the checks. The board ruled last summer that it was illegal for the pension trustees—themselves members of the pension system—to distribute the money when the system had such large debts.
Retirees and elected officials who support these payments argue that pensioners should share in a system’s gains during good investment years. But critics point out that the additional monies that pension systems earn when their returns are better than forecasted are supposed to be used to offset times when returns don’t do well. In a seriously underfunded system, siphoning off investment gains makes it virtually impossible for a fund to climb back to financial health—except by tapping taxpayers for big new contributions.
Arthur Levitt, former chairman of the Securities and Exchange Commission, summed up the problem when he was called to investigate the finances of San Diego’s pensions a decade ago. In a comment on the city’s practice of paying out bonuses to retirees when investment returns exceeded 8 percent, Levitt noted: “Designating earnings in excess of 8 percent as ‘surplus’ made it look as if the City could grant additional benefits without providing a funding source for them. This impression was (and is) misleading.” In 2012, San Diego residents voted for reforms that instituted a new pension system and eliminated the bonuses for incoming workers. But retirees in the current system still get the extra payments. In 2013, reports the San Diego Union-Tribune, the pension system handed out $5.5 million in bonuses, even though it is saddled with $2.3 billion in debt.
Illinois residents face pension debt of $100 billion, according to state estimates—and twice that much, in the view of some independent analysts. Yet the Illinois Municipal Retirement Fund (IMRF) still pays retirees a 13th check every year and sends local governments the bill. The bonuses amounted to $41 million in 2013. The IMRF, retirees say, is better funded than other pension funds in the state. But with retirement costs rising for local governments thanks to Illinois’ huge pension liabilities, the additional money for the bonus program puts a further squeeze on already-pinched Illinois budgets.
Some governments provide retirees 13th checks in lieu of annual cost-of-living adjustments. But unwinding the bonuses has proved difficult. For years, Mississippi has bundled cost-of-living adjustments into a single check paid out to retirees at the end of the year. But Mississippi’s pension system is now in trouble, with funding levels at about 60 percent of what’s necessary to meet future obligations. Last year, some Mississippi officials urged the state to freeze the growth in the 13th checks, or eliminate them entirely for retirees under 65. But the state legislature balked, arguing that the checks are really cost-of-living adjustments, not bonuses. Still, many other states with underfunded pensions—including Colorado, New Jersey, and Rhode Island—have already eliminated or suspended such adjustments. Whether one calls them bonuses or cost-of-living adjustments, they’re an expensive feature of any pension system, especially one sunk in debt.
Detroit’s bankruptcy, in which retirement debt played such a prominent role, was supposed to be a cautionary tale for state and local officials. But not everyone was watching closely, it seems.