The NY Post had a good piece today by William McGurn on the state of the union (pension system) in Detroit, making the case for Detroit to switch to defined contribution plans for their union workers. McGurn is right on the mark that the such a move is critical for the city's revitalization. Dispensing with this one particularly enormous financial burden which has added greatly to the city’s fiscal insolvency would change the city's finances for the better going forward. However, he seems skeptical that such a radical change could ever be achieved.
There is a way to implement a change to a defined contribution system. Even though the city of Detroit is billions of dollars in debt, the emergency manager, Kevyn Orr, has the opportunity to make to make it happen.
Orr is currently at odds with the unions over the total amount that union’s two pension system are underfunded. Using the actuarial projections provided by the unions, the funds are only short by $650 million, while Orr's calculations show that the underfunding is a good $3.5 billion. Who is right? Orr believes he is correct and some independent studies seem to back his assertions. In actuality, it doesn’t necessarily matter who is correct, because the conflict actually provides a solution for the city.
If the unions wish to argue that their pension liability is merely $650 million, the city should wholeheartedly agree to fully fund their request — with one important condition. The unions must either a) agree to a fixed annual contribution to the defined benefit plans going forward, or b) (the better solution) cease using a defined benefit plan and move to a defined contribution plan going forward for all of their employees. In either case they must take full ownership, responsibility, and management, from here on out.
Once the unions pensions are fully paid up with the $650 million from the city, they will be in a position to take over the management of their funds. Let the unions use their expertise and earn the 8% that they maintain should be readily achievable. If they can do it, their members will continue to thrive-as-usual, ultimately collecting the pensions that have been promised to them for work up to this point. If they can only earn 3-4 or 6%, it will be on them to explain to their own members why their numbers are suddenly now off.
Even though $650 million sounds like a large number to pay off and fully fund the union pensions, it is a small amount to pay for the fiduciary freedom that comes with not having to manage an incredibly complex, risky, and fiscally unsound system. Such a move will contribute greatly to the long term health of the city of Detroit.