Detroit Pensions: Stakeholders Segmented Edition

Long time, no post. A bit lazy and a bit busy I’ve been.

The public debate about public pensions is politically charged. Outside of rare company it may be impractical to have an intelligent discussion. Detroit has been a particularly high voltage case.

I won’t get into the politics or the trade-offs between the major interests. Instead I’ll note how even a seemingly monolithic stakeholder class can have very different interests within.

The Detroit pensioners voted 3 to 1 to accept a 4.5% benefit cut and termination of annual inflation adjustments (COLAs). It is worth considering a couple of angles here.

First, many people don’t get compounding and they don’t get how inflation compounding over many years can destroy the real value of a fixed income stream. For many of the pensioners the 4.5% cut means little, but the loss of inflation protection could be devastating over time.

But what about a rational, self-interested pensioner who understands the terms? How would he or she vote? Well, it depends on age. If a pensioner is old and only expects to live a short time more, it is best to avoid sharp benefit cuts and accept inflation risk in the package, since that risk will not amount to much. A younger retiree is in a different position. He or she may live 30 years or more. Budgeting for 2% annual inflation means budgeting for a real check that will be cut in half over time.  Worse yet this pensioner could be impoverished by unexpected inflation or longevity.

So there you have it. Within the retiree pool the structure of the cuts impacts some much more than others.

I don’t know what their bargaining position was or whether there were actuarially identical choices for benefit cuts.

 

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