Photo

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.

Photo

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.”