The tentative deal reached between Detroit Emergency Manager Kevyn Orr and the Detroit pension funds has been characterized in the New York Times and other news reports as a victory for workers and retirees. This is true only in the sense that much worse cuts had been threatened.
The confusion stems from a tendency to treat cost-of-living adjustments (COLAs) as icing on the cake rather than necessary for subsistence, when in fact workers would be better off with equivalent across-the-board cuts than an erosion in the real value of benefits. COLA cuts take a bigger bite as retirees age and face dwindling savings and higher out-of-pocket health costs (exacerbated, in this case, by proposed cuts to retiree health benefits).
The deal would initially cut the pensions of general employees by 4.5 percent and eliminate these workers’ 2.25 percent annual COLA. Police and firefighters would see no initial cuts and would retain a 1 percent annual COLA. Though the uniformed services face a smaller cut in percentage terms (a reduction of roughly 15 percent in real lifetime benefits as shown in the table below), they lose more in dollar terms because they tend to retire younger and have larger pensions. Because Detroit police and firefighters aren’t covered by Social Security, their real incomes in retirement may be nearly as affected as those of general employees, who face larger cuts in percentage terms but at least will receive inflation-adjusted Social Security benefits.
For general employees, the 4.5 percent initial cut is trivial compared to the elimination of the COLA. The combined effect reduces the real value of lifetime benefits by almost a quarter: 22 percent for the typical male retiree, 25 percent for the typical (longer-lived) female retiree. Retirees who live longer than average will see the real value of their annual benefits reduced by half or more. The Social Security Administration estimates that one in five 60-year-old men and one in three 60-year-old women will live to 90 or older, at which point annual benefits will be less than half what the retiree would have received with a 2.25 percent COLA (not shown). The real value of benefits at age 90 will be even lower if the pension fund actuaries’ 3 percent inflation assumption proves accurate.
In the current political environment, workers and retirees may be relieved that the proposed cuts—to benefits supposedly protected under the Michigan constitution!—aren’t even deeper. But media outlets do a disservice when they suggest that the COLA cuts are a detail, when in some cases they amount to more than what the Times article described as initial “deeper” proposed cuts.
Proposed cuts to Detroit pensions
|General Retirement System members*||All Retirees||New Retirees|
|(nominal $)||(real $)||(nominal $)||(real $)|
|Prototypical male worker who retires at 60 and dies at 81||24%||$126,595||22%||$76,205||$155,010||$105,710|
|Prototypical female worker who retires at 60 and dies at 85||28%||$181,461||25%||$105,509||$222,191||$140,209|
|Police and Fire Retirement System members**||All Retirees|
|(nominal $)||(real $)|
|Prototypical male worker who retires at 55 and dies at 82||16%||$181,683||14%||$107,604|
|Prototypical female worker who retires at 55 and dies at 86||18%||$251,847||16%||$137,780|
Note: Table 1 shows proposed reductions in lifetime benefits based on an average annual benefit of $24,156 for new (2013) GRS retirees, $19,728 for all GRS retirees, and $31,434 for all PFRS retirees (the average pension benefit received by 2013 PFRS retirees was not disclosed in the actuarial valuation). Real benefits are based on a 3% inflation assumption. Life expectancies and average benefits are from the 2013 GRS and PFRS actuarial valuations. Retirement ages are illustrative but appear realistic based on age and service tabulations.