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May 18, 2015 01:00 AM

Illinois, Chicago run out of options

Funds forced to address liabilities after court rejects pension reform

Christine Williamson
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    Tim Boyle/Bloomberg
    Chicago Mayor Rahm Emanuel believes Chicago's pension reform efforts are solid and won't be overturned.

    Illinois and Chicago lawmakers have little choice but to start paying off the substantial unfunded liabilities of their public employee pension plans now that the Illinois Supreme Court unanimously ruled that state pension reform passed in 2013 is unconstitutional.

    The court said in its May 8 ruling that the pension reform law violated the state constitution's clause that pension benefits “shall not be diminished or impaired,” because it would have reduced cost-of-living adjustments, capped pensionable salaries and raised retirement ages.

    “In ruling as we have today, we do not mean to minimize the gravity of the state's problems or the magnitude of the difficulty facing our elected representatives,” said Justice Lloyd Karmeier, writing for the court.

    The ruling faulted the state for underfunding the plans and said the underfunding “is a crisis for which the General Assembly itself is largely responsible,” Mr. Karmeier wrote.

    The impact of the ruling on the five state pension plans is clear: The reform measure, which was slated to go into effect on June 1, is dead.

    Whether reforms made to some Chicago public pension plans are unconstitutional under state law likely will be decided by the courts as well. The pension stakes are extremely high for both the state and Chicago. The aggregate unfunded liability of Illinois' five state defined benefit plans totaled $111.2 billion, with a funding ratio of 39.3% as of June 30, 2014, while the collective unfunded liability of Chicago's four public plans totaled $20.1 billion, with a funding ratio of 34.3% as of Dec. 31, 2013.

    Choice for workers

    Among state-level solutions being floated is pension reform legislation Senate President John Cullerton is working on that would not affect retirees or their health insurance and might give workers “a choice regarding salary increases counting toward pensions or keeping a compounded annual cost-of-living adjustment in retirement,” a statement said. A “plan like this” could save around $1 billion a year, Mr. Cullerton estimated.

    Gov. Bruce Rauner's still-in-formation plan would preserve earned benefits, create a new 401(k)-type plan and ask voters in 2016 to remove wording from the Illinois Constitution that protects retirement payments, Bloomberg reported.

    The state pension plans in question are the $44.8 billion Teachers' Retirement System of the State of Illinois; the $17.3 billion Illinois State Universities Retirement System; the $15.1 billion State Employees' Retirement System; $705 million Illinois Judges' Retirement System; and $51.6 million Illinois General Assembly Retirement System.

    “It seems less likely that the governor's plan will pass — or that any plan where benefits are curtailed would pass — the state court's test,” said Matt Fabian, partner, Municipal Market Analytics Inc., Concord, Mass.

    “There is no more leverage for state officials. Anyone on the other side of the bargaining table will not be inclined to compromise on pensions after `the Supreme Court said my pension is protected,'” stressed Jeffrey R. Brown, the William G. Karnes Professor of Finance and the director of the Center for Business & Public Policy, College of Business, University of Illinois, Urbana-Champaign, in an interview.

    Mr. Brown said “there are only three things you can do: change the non-impairment clause of the Illinois Constitution, which I'm not suggesting is feasible; come up with the money by raising taxes or expanding the tax base, including ending the state's tax exemption on retirement income; or cut all other government spending to the bare bones.”

    The constitutional clause regarding non-impairment is crystal clear in its application to the pensions of public employees at every level of government in Illinois, Mr. Brown said, adding “no sane person could interpret the law any other way.”

    City of Chicago officials, however, disagree that the Supreme Court's ruling applies to reforms made to its public pension plans. Chicago Mayor Rahm Emanuel was adamant that the city's 2014 pension reform law is constitutional. “That reform is not affected by today's ruling, as we believe our plan fully complies with the state constitution because it fundamentally preserves and protects worker pensions rather than diminishing or impairing them,” according to a statement.

    Police, fire plans excluded

    The Chicago pension law, which was passed in June and became effective Jan. 1, raises employee and employer contributions and reduces retiree cost-of-living adjustments for the $5.1 billion Chicago Municipal Employees' Annuity & Benefit Fund and $1.4 billion Chicago Laborers' Annuity & Benefit Fund.

    Excluded from Chicago's 2014 pension reform law were the $3.3 billion Chicago Policemen's Annuity & Benefit Fund and the $1.1 billion Chicago Firemen's Annuity & Benefit Fund.

    Hearings on lawsuits challenging the constitutionality of pension benefit cuts for participants in the two city funds — put on hold pending the Illinois Supreme Court ruling on state pension cuts — will resume July 9.

    Despite the confidence of Chicago's mayor and treasurer in his administration's pension solution, Moody's Investors Service said in a statement when it cut the city's rating to junk status: “We expect the costs of servicing Chicago's unfunded liabilities will grow, placing significant strain on the city's financial operations absent commensurate growth in revenue and/or reductions in other expenditures.”

    The city's rating was cut to Ba1 from Baa2; the Chicago Park District rating, to Ba1 from Baa1; and the Chicago Board of Education to Ba3 from Baa3. The downgrade makes Chicago the lowest rated of large U.S. cities and triggers covenants in its credit agreements that will significantly increase costs.

    Chicago's options narrowed

    The court's decision to overturn state pension law also assigned the city of Chicago, the schools and park district a negative outlook, said Moody's in a rating report: “We believe that the city's options for curbing growth in its own unfunded pension liabilities have narrowed considerably.”

    Standard & Poor's last week also lowered the rating of Chicago's general obligation credit to A- from A+, a statement said, also referencing the Supreme Court's decision.

    S&P put the new rating on its credit watch with negative implications — also an indication that a further cut could well come soon.

    Fitch Ratings Friday afternoon also cut its rating for Chicago's credit to BBB+ from A- and put the city on negative watch, also citing fiscal pressures that the Supreme Court's decision put on the city by limiting its ability to alter pension benefits.

    Mr. Emanuel said in a statement: “This action by Moody's is not only premature, but it is irresponsible to play politics with Chicago's financial future by pushing the city to increase taxes on residents without reform.”

    A statement from the Chicago Park District said: “Moody's rating action reflects a complete disregard of the Park District's 81-year existence as an entity separate and distinct from the city of Chicago both legally and in the manner in which it is governed under Illinois statutes.”

    Pensions & Investments' reporters Rick Baert, Meaghan Kilroy and Rob Kozlowski; columnist Greg Hinz of Crain's Chicago Business, P&I's sister publication; and Bloomberg contributed to this story.

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