As an advisor in the Detroit area, I’m embroiled in multiple aspects of the Detroit bankruptcy. The effects of the nation’s largest municipal bankruptcy are substantial, as they present a new paradigm to advisors on “What do we tell our municipal employees about the safety of their pension and health care?” It presents a new set of mathematical thought processes as well.

Consider that on February 21, the city of Detroit’s emergency manager, Kevin Orr, presented a plan to U.S. district court judge Steven Rhodes to bring Detroit out of bankruptcy. One salient point of the plan is a reduction in the pensions of Detroit retirees. Police and fire retirees are poised for a 10% cut (4% if they accept right away), and general retirees are set to take a 34% reduction. This is on top of a giant increase in retiree health-care costs, where the retirees will get a fraction of the amount necessary to keep health care.

It’s unfair and aggravating that retirees take a hit for a situation they didn’t cause and a decision they didn’t take part in. Bondholders and creditors made conscious decisions to lend money to Detroit; pensioners had the presumption they were to receive a pension that was protected by the state constitution. But that’s not all. I don’t like the precedent; if you think about it, now the most distressed cities are having their risk increased, and that affects things ranging from the hiring of new employees to the issuance of municipal bonds. The private sector at least has a safety net of insurance, which apparently a state constitution cannot provide.

Beyond my moral and social objections, there’s a potential problem with the math.

You see, pension math and bond math are different. A bond has a specific legal obligation that is written and enforceable. So if I lend the city of Detroit $1,000, they agree to pay me back my money at a maturity date and pay interest in the meantime. The liability is known and measurable: The city owes me $1,000. In a pension, the city owes an annual obligation to fund the liabilities of the plan. Those liabilities are calculated using a complicated formula that takes into account a number of items:

a. The amount promised the retirees (their monthly pension);

b. An estimate of how long the plan has to pay it (the mortality assumption); and

c. The rate of return the plan will make to fund it (the interest rate assumption).

Does that sound as if there are a lot of moving parts? There are. But there’s more to the problem. According to the Detroit emergency manager, the unfunded liabilities of the pension system total $3.5 billion. In February, when the state of Michigan’s team came in, the unfunded liabilities were only $650 million. The city’s actuary, which represents literally hundreds of municipal pension systems and applies a rigorous set of established actuarial standards, reported Detroit’s general fund as 82.8% funded and the police and fire pension as 99.9% funded.

The emergency manager hired a different actuary, and that actuary recalculated the pension obligation using a different set of assumptions, which they called a “very rough preliminary guestimate,” and then they recharacterized the pension obligation bonds (secured bonds to fund the pension) as unsecured bonds outside of the pension (not the normal practice). That new calculation adjusted the assets way down to 32% for the general fund and 50% for the police and fire fund. This put the pensions below the 80% threshold to allow them to be under EM control.

In other words, the liability might be $3.5 billion or might be $650 million or might be some other number or nothing. In addition, the plans pay this liability over the lifetime of the pensioners, not all at once, or even on a schedule like bonds. During that time frame, the plan’s assets make money and retirees pass away. Depending on those factors, we can determine where the liability goes. If the plan makes more on its investments than the assumptions, the liability decreases or even vanishes.

 It reminds me of the quote attributed to Mark Twain: “Figures don’t lie, but liars do figure.”

Pension math is tricky, and I don’t think people’s financial lives should be at stake in a single calculation. The average Detroit general retiree gets a pension of $19,000, which by my standard is very modest, and to cut that by $6,460, plus make them pay all but $125 of their retiree health care is devastating. I guess I can liken this to an appraisal on a house. We get one appraisal, then another one comes in way lower. Do you automatically accept the lower number (in the case of liabilities, the higher number?) I’d rather see what the unfunded liabilities really are before the people who worked hard for the city get a haircut. Not only that, but if the plan’s assets are invested right, there may end up being no liability.

Let’s prove the figures. The retirees deserve it.

Leon LaBrecque, JD, CPA, CFP and CFA, is CEO and senior financial advisor of LJPR LLC, a registered investment advisor in Troy, Mich. His specialties include investment management for foundations and nonprofit organizations, financial planning for automotive employees and retirees, and retirement planning for police officers and firefighters. The views expressed in this article are his own and do not necessarily reflect the views of LJPR LLC or its staff.