Lawsuit Contends Consultant Misled Detroit Pension Plan
Updated, 8:06 p.m. | With
the nation’s states and cities slowly sinking in a $3 trillion pension
hole, the professionals who advise their pension plans have long
wondered whether the fingers of blame might eventually point to them.
One of those fingers
has surfaced in bankrupt Detroit, and it is singling out Gabriel Roeder
Smith & Company, a top actuarial consultant for public pensions,
which has hundreds of clients across the country that rely on it to keep
track of data, calculate required annual contributions and advise on
key assumptions like future investment returns.
Detroit has been a
client of Gabriel Roeder since 1938, when the city first started
offering pensions. Now the city is bankrupt, the pension fund is short,
benefits are being cut and one of the system’s roughly 35,000 members,
Coletta Estes, is suing the firm, contending it used faulty methods and
assumptions that “doomed the plan to financial ruin.”
Gabriel Roeder’s job
was to help Detroit’s pension trustees run a sound plan, she says, but
instead the firm covered up a growing shortfall and encouraged the
trustees to spend money they did not really have. Her complaint contends
that the actuaries did this knowingly, “in concert with the plan
trustees to further their self-interest.” The lawsuit seeks to have the
pension plan made whole, in an amount to be determined at trial, and to
have Gabriel Roeder enjoined “from perpetrating similar wrongs on
others.”
Lawsuits like the one
Ms. Estes filed have also been brought against Gabriel Roeder by members
of Detroit’s pension fund for police and firefighters, and the fund for
the employees of surrounding Wayne County. The plaintiffs cite damage
growing out of Detroit’s financial collapse, but the litigation may have
implications far beyond southeastern Michigan because of Gabriel
Roeder’s status and influence in the world of public pensions. Its
method for scheduling pension contributions is exceptionally popular and
widely used by governments, although federal law does not permit
companies to use it. A former chairman of the Governmental Accounting
Standards Board, James F. Antonio, tried 20 years ago to disallow it for
governments, too, saying it “fails to meet the test of fiscal
responsibility.” But he was outvoted, and cities and states have been
using it ever since.
Gabriel Roeder said
the three lawsuits “are factually, legally and procedurally infirm and
reflect a gross misunderstanding of the nature of actuarial services.”
In a written
statement, the firm also said that it was still providing services to
all three pension funds and would vigorously defend itself against the
lawsuits “without further public comment.”
The three lawsuits are
separate from Detroit’s bankruptcy case. They were filed in Wayne
County Circuit Court by Gerard V. Mantese and John J. Conway, Michigan
lawyers who have tangled with Detroit’s pension system before. The
lawsuits focus on the calculations and analysis that Gabriel Roeder
provided to the trustees. Like many city and state pension systems,
those of Detroit and Wayne County are mature, complex institutions,
governed by trustees who do not necessarily have sophisticated financial
backgrounds and rely heavily on the meaningful advice and accurate
calculations of their consultants.
Detroit’s trustees did
not get that, Mr. Mantese and Mr. Conway contend. Even as the city slid
faster and faster toward bankruptcy, its workers kept building up
larger, costlier pensions, and the actuaries “assured the trustees that
the plan was in good condition.”
“Gabriel Roeder
recommended that the plan could maintain and increase benefits,” Ms.
Estes contends in her complaint, which was filed in September. That
might sound odd, coming from a plan member who stood to enjoy any
increases. But Detroit was making promises it could not afford, and Ms.
Estes is also a Detroit homeowner and taxpayer who argues she was harmed
as the city kept piling more and more obligations onto its shrinking
tax base.
As the residents of
other struggling cities have discovered, public pension promises, once
made, are extremely hard to break, even if the city goes bankrupt. Now
Ms. Estes has lost not only part of her pension but much of the savings
tied up in her house, while she and her neighbors overpay for paltry
city services. She says she might have been spared some of the misery
had Gabriel Roeder warned the trustees years ago that the pension system
was unsustainable and recommended changes.
“We just got blindsided,” she said.
In its plan to exit bankruptcy, Detroit proposes to claw back certain overpayments
that the pension system made improperly in the past. Ms. Estes said she
received a letter telling her she would have to forfeit $25,000 when
she reaches retirement age, without explaining how that would happen.
She is now 50.
Records for her
pension plan show a number of anomalies. Not only was pension money
spent on off-the-books benefits like “13th checks” and ad hoc death
payouts, but some of the actuarial assumptions clearly conflict with
reality. For example, Gabriel Roeder assumed that Detroit’s total
payroll was growing by 4 percent a year. But in fact, Detroit’s payroll
has been shrinking at 5 percent a year since 2003. Ms. Estes said that
the two dozen employees she supervised as chief operator of a city water
treatment plant all suffered 10 percent pay cuts in the last year, and
she herself resigned last June.
A steadily growing
payroll is an important element of Gabriel Roeder’s widely used funding
method. A big part of any pension actuary’s job is to forecast a plan’s
future benefit costs, then devise a contribution schedule that will
fully fund the benefits over time. There are many ways to do this, and
Gabriel Roeder’s method relies on assumed steady payroll growth. It
calculates an employer’s required annual contribution as a level
percentage of its payroll. This “backloads” the contributions so that
they may not cover the plan’s true costs in the early years, but will
rise automatically later as the payroll grows.
If the payroll
shrinks, however, the required contributions will skyrocket as a percent
of payroll, placing an extraordinary burden on the city and its tax
base. The federal pension law that bars companies from using this method
is not binding on states or cities, however, and virtually all of them
use it.
In Detroit, Gabriel
Roeder combined this funding method with a schedule to pay off
shortfalls over a “rolling” 30-year period. This meant, in effect, that
the 30-year period restarted every year at “Year 1,” or the low end of
the rising contribution schedule. The high end was always put off into
the future. Many governments “roll” their funding schedules back every
year in this manner. Mr. Antonio of G.A.S.B. was so perturbed by this
practice that he included a long statement of opposition to it in the
pension accounting standard now in force. He said it delayed proper
funding “on the theory that ‘over the long haul, everything will work
out.’ ”
His warnings were
largely ignored, and city and state pension systems have been free for
the last 20 years to do what their actuaries’ models suggest. The
pension accounting rules are now being updated, and starting next
summer, “rolling” contribution schedules will no longer be acceptable.
Backloading a city’s pension contributions on the assumption that the
payroll will grow will still be the norm, but over a shorter time frame.
That should reduce some of the risk.
In Detroit, Mr.
Mantese said it was “indefensible” for Gabriel Roeder to assume the
payroll was rising when in fact it was falling.
In its written
statement, Gabriel Roeder said it was not a plan administrator,
fiduciary or trustee for Detroit’s pension system and therefore did “not
make decisions of any kind on behalf of the retirement systems.” It
said it came to pension board meetings only when requested, usually just
“a handful of occasions per year,” and based its analysis and
recommendations on unaudited data supplied by the pension systems, the
city or the county.
In its most recent
report on Ms. Estes’s pension plan, submitted last November, the firm
did note that the payroll had declined during the previous year. It
recommended calculating contributions a different way for the next year
or two, “to avoid the contribution loss that occurs with a declining
payroll.”
Mr. Mantese also
questioned the plan’s assumption that its investments would earn 7.9
percent over the long term, when the average in recent years was much
less.
In an interview, Ms.
Estes said that for the 20 years she worked for the city water
department, she considered it her duty to provide pure, safe water all
the time — not just when the stock market went up or if the payroll grew
at a certain rate.
She said she thought the pension professionals should have been held to that standard, too.
“They had a job to do
and we trusted them,” she said. “And it turned out the trustees, the
advisers, the actuaries and the accountants misled us.”
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