Illinois $111 Billion Pension Deficit Fix Struck Down

Illinois will have to find a new way to fix the worst pension shortfall in the U.S. after a judge struck down a 2013 law that included raising the retirement age.

Yesterday’s ruling that the pension changes would have violated the state’s constitution undoes a signature achievement of outgoing Democratic Governor Pat Quinn and hands responsibility for tackling the state’s $111 billion pension deficit to Republican businessman Bruce Rauner, who defeated him in the Nov. 4 election.

State constitutions have been invoked elsewhere to try to prevent cuts to public pensions. In Rhode Island, unions settled with the state over pension cuts before their constitutional challenge could be put to the test. In municipal bankruptcy cases in Detroit and California, judges ruled that federal law overrode state bans on cutting pensions.

Illinois Attorney General Lisa Madigan, a Democrat, said she’ll appeal the ruling by Judge John Belz in Springfield and ask the state Supreme Court to fast-track the review.

“Today’s ruling is the first step in a process that should ultimately be decided by the Illinois Supreme Court,” Rauner said yesterday. “It is my hope that the court will take up the case and rule as soon as possible. I look forward to working with the legislature to craft and implement effective, bipartisan pension reform.”

Power Limited

Belz concluded that a 1970 constitutional provision barring cuts to public employee retirement benefits trumps the state’s claim that it has the power to trim future cost-of-living adjustments and delay retirement eligibility for some workers.

“The court finds there is no police power or reserved sovereign power to diminish pension benefits,” he said, voiding the legislation in its entirety and permanently barring the state from enforcing any part of it.

The plan to save about $145 billion over 30 years by reducing those adjustments and raising the retirement age for workers 45 and under was set to take effect on June 1 before being put on hold by a court order in May.

Illinois bonds weakened after the ruling. Taxable pension debt maturing in June 2033, the most frequently traded state securities, traded yesterday after the decision at a yield of 5.32 percent, compared with an average of 5.26 percent yesterday and 5.3 percent this month, according to data compiled by Bloomberg. It’s about 2.7 percentage points more than Treasuries.

Seven States

Seven states have constitutional provisions that protect public worker pensions, said James Spiotto, a bankruptcy specialist and managing director at Chicago’s Chapman Strategic Advisors LLC, which advises creditors on financial restructuring.

State and local governments must confront the rising costs of retirement benefits before they hurt essential services such as police and fire protection, Spiotto said in an e-mail.

“Labor and pension contracts under state constitutions and statutory provisions should not be interpreted as a mutual suicide pact,” Spiotto said. “A recovery plan with reasonable adjustments to pension benefits to what is sustainable and affordable is the only path forward for all concerned.”

Arguments Heard

Public worker unions sued over the legislation in January. Belz heard arguments over the pension reform plan two days ago.

The legislation’s challengers were buoyed in July by a state Supreme Court ruling that Illinois couldn’t cut contributions to government retirees’ health insurance premiums, known as other post-employment benefits, or OPEB.

“The market may be a little disappointed,” said Triet Nguyen, a managing director at New York-based NewOak Capital LLC. “Between the OPEB ruling and then this one, the new governor is going to have his hands pretty much tied.”

The health insurance case stands for the proposition that the constitution’s shield “absolutely protects pension benefits from any unilateral diminishment and impairment by the state under any circumstance,” members of the Illinois State Employees Association, the Retired State Employees Association and others suing to overturn the fix said in an August filing.

The state argued that it had been “on track” to pay down its unfunded pension liabilities over the next 40 years as required by 1994 legislation before being derailed by “a series of adverse events,” most significantly the economic downturn that gathered strength in 2007 and 2008 and crested the following year.

Great Recession

“To respond to the severe financial impacts of the Great Recession, the state is fully justified in exercising its reserved sovereign powers to enact modest reductions in future benefit increases for system members,” according to an Oct. 3 filing by Madigan.

We Are One Illinois, a coalition of public employee unions that sued to overturn the law, praised Belz’s decision.

“The Illinois Constitution means what it says,” the group said in a statement yesterday. “The court held today, as our unions have long argued, that the state cannot simply choose to violate the Constitution and diminish or impair retirement benefits if politicians find these commitments inconvenient to keep.”

The case is In re Pension Litigation, 2014-MR-000001, Sangamon County, Illinois, Circuit Court (Springfield).

Before it's here, it's on the Bloomberg Terminal.