Governor Promises Prompt Signature on Pension Overhaul

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CHICAGO — Illinois' governor promised a prompt signature on the pension overhaul lawmakers delivered Tuesday, setting the stage for battles over its legality and effectiveness.

Breaking two years of political gridlock, the General Assembly approved an overhaul of the state's pension funds billed by backers as a "historic" restructuring that will stabilize both the system and the state's fiscal foundation.

Critics attacked the plan as being either too hard on workers or too weak to repair a system saddled with $100.5 billion of unfunded liabilities. Illinois has the weakest pension system among the states.

Many lawmakers who voted in its favor Tuesday called the plan imperfect but warned it was the state's best shot at addressing the main cause for its steep credit deterioration. Some also raised concerns over the plan's ability to withstand the legal challenge unions plan to mount immediately after Gov. Pat Quinn signs the legislation.

"I would hope that the rating agencies would take recognition of the action today," Quinn said after the vote. "I think it is a historic step."

Fitch Ratings granted his wish Wednesday morning.

"Fitch views the passage of pension reform legislation in Illinois yesterday as a positive indication of the state's willingness to take action on this complicated issue after many failed attempts," it said in a statement.

The Democratic governor, up for re-election next year, cast aside his past criticism of lawmakers for their inaction and had nothing but praise for them after the vote. He said he will sign the bill "promptly" when it hits his desk.

"This landmark legislation is a bipartisan solution that squarely addresses the most difficult fiscal issue Illinois has ever confronted," Quinn said. "This bill will ensure retirement security for those who have faithfully contributed to the pension systems, end the squeeze on critical education and healthcare services, and support economic growth."

Quinn praised lawmakers for a showing "political courage" in approving the plan. He singled out members of the conference committee named in June to assemble a compromise plan and legislative leaders who took over negotiations in recent weeks and lobbied their members. Quinn had butted heads with lawmakers over the summer when he attempted to withhold their pay to press them into action. The courts overturned his move.

Labor's response to the legislation was swift and caustic.

Public employee union coalition We Are One Illinois issued a statement calling on Quinn to veto the package.

"He can stay true to his oath and the legal promise made to public employees and retirees by vetoing this unfair, unconstitutional bill," it said. "If he doesn't, our union coalition will have no choice but to seek to uphold the Illinois Constitution and protect workers' life savings through legal action."

The plan's sponsors estimate it will trim $160 billion off state payments owed to the system, with the goal of reaching full funded status in 30 years primarily by cutting benefits and infusing the system with supplemental state contributions in addition to scheduled annual payments. The changes would trim about $21 billion of the state's unfunded liability tab and about $1.5 billion off upcoming annual payments.

The state's five funds are currently just 39.3% funded. Contributions are rising with the $6.8 billion fiscal 2014 payment consuming 20% of the general fund budget, up from 12% in fiscal 2010.

The pension mess has driven the state's credit deterioration, with its ratings, once solidly in the double-A category, now the weakest among states at the low-single-A level. The three major rating agencies also assign negative outlooks to their GO ratings.

In addition to tarnishing its own reputation with investors, the state's credit struggles have driven up the costs of borrowing for most Illinois-based issuers, especially those dependent on the state for aid, such as its public universities. It's called by market participants the "Illinois penalty" or "Illinois effect."

Municipal Market Data said last week Illinois has the widest state GO spread to the MMD benchmark of any state with bonds maturing in 2025 trading recently at a 175-basis-point spread.

The state hopes to see a positive impact on interest rates as soon as next week when it takes competitive bids on a $350 million taxable general obligation issue. Updated rating reports should be issued soon but it's unclear whether an outlook shift would occur so quickly as analysts digest the impact of the reforms and a legal challenge looms.

The nearly simultaneous vote in each chamber followed hours of debate Tuesday less than a week after the General Assembly's leaders announced they had agreed on a plan. The state's credit slide played a prominent role in the debate.

Without action, House Minority Leader Jim Durkin, R-Western Springs, predicted the rating agencies could "move our credit rating even lower." Senate Minority Leader Christine Radogno, R-Lemont, issued a similar warning.

Rep. Darlene Senger, R-Naperville, said she believes the shift to an actuarially sound method to set state contributions would cause the bond rating agencies to wake up Wednesday and say "finally you did something and got it done and are going to move forward." If the legislative failed to act, she warned the state would "again be the laughingstock with bond houses."

The Senate tally came first with 30 members voting for the legislation, 24 against, and three voting present. The yes votes included 20 majority Democrats and 10 Republicans.

The House voted 62-to-53 in favor of the report with one voting present. The yes votes included 47 majority Democrats and 15 GOP members.

While some lawmakers warned the package didn't go far enough to warrant a label of "comprehensive" reform, others said it went too far.

Sen. William Delgado, D-Chicago, called the changes "morally wrong, morally corrupt" because of the impact on public sector employees and retirees.

Rep. Jeanne Ives, R-Wheaton called the changes "marginal" and said "this bill does not go big and is not substantial or solid."

Senate President John Cullerton, D-Chicago, let the conference committee chairman Sen. Kwame Raoul, D-Chicago, open and close the debate.

"We cannot continue to be the embarrassment of the nation," Raoul said, warning that the state's spending priorities and bond rating were at stake.

Cullerton pressed his members to support the bill although he said he has serious concerns over its constitutionality.

House Speaker Michael Madigan, D-Chicago, opened the House debate, calling the legislative package a "comprehensive" plan "that will lead to fiscal stability for the state and its pension systems."

Madigan stressed the changes won't cut current annuities, only their growth going forward. Some of the measures were approved in 2010 for newly hired employees. Madigan called the state's retirement systems simply too rich.

Civic and business groups praised passage of the plan, calling it a step in the right direction to address the state's fiscal ills.

Earlier in the year, Madigan had pushed his own plan that would have imposed even more stringent changes to save $187 billion but Cullerton backed a more modest plan that would have saved $58 billion. It asked employees and retirees to accept cuts in exchange for preserving their retiree healthcare subsidies. Cullerton believed it offered a better chance at withstanding a legal challenge.

The four legislative leaders took over negotiations in recent weeks from the conference committee. Democrats wanted the cost-of-living-adjustment, or COLA, change eased but Republicans pushed to maintain at least $160 billion in savings. The plan accommodates both objectives while limiting the cost-of-living adjustment changes for long term, lower income workers, Madigan told his chamber.

The changes restructure a central driver of the rising pension costs - the current 3% annual compounded COLA. Retirees would continue to collect the current 3% on only a portion of their annuities based on their years of service with the remainder tied to the consumer price index. Current employees also will miss between one and five annual adjustments depending on their age.  The legislation caps pensionable salary and raises the retirement age for those under 45 years on a graduated scale up to five years based on current age.

The state will shed its current statutory funding formula for one that is actuarially set by applying an entry age normal actuarial cost method, or EAN, which averages costs evenly over the pensioner's employment.

The state will make supplemental contributions in addition to the regular schedule.

They include $364 million in fiscal 2019 and then $1 billion annually through 2045 or until full funding is achieved. The state also will put 10% of the annual savings expected from the reforms back into the system beginning in fiscal 2016 until it's fully funded.

State contributions would be "guaranteed" and the retirement funds could ask the Illinois Supreme Court to compel the state to make them. Past pension holidays are considered a cause of the weakened system.

However, the General Assembly could vote to change the payment schedule.

Some employees could opt for a defined contribution plan like the private sector's 401(k) style plans.

Employees would contribute 1% less of their salaries than they do now under the overhaul plan and pension benefits could not be collectively bargained.

The state constitution considers participation in a retirement system an enforceable contractual relationship for which the benefits can't be diminished or impaired. The backers of the plan are banking on several arguments to withstand the legal challenge.

We've given our lawyers a "number of tools" to argue before the Illinois Supreme Court, said conference committee member Rep. Elaine Nekritz, D-Northbrook.

Contract law allows for alterations in some cases when either accepted by the parties or when consideration is offered. The plan's authors believe the employee contribution cut, the funding guarantees, the shift to an actuarially based funding formula, and the infusion of new revenues meet the standards for "consideration." Unions don't agree, arguing the provisions don't make up the lost value of the benefit cuts.

The state also will argue that without change the system is insolvent and there's no other solution.

A lengthy preamble to the bill appears designed to aid the state's case. "Having considered other alternatives that would not involve changes to the retirement systems, the General Assembly has determined that the fiscal problems facing the state and its retirement systems cannot be solved without making some changes to the structure of the retirement systems," it says.

The changes would affect four of the state's five pension funds, which cover teachers, lawmakers, state police, and general employees. The judges' fund would initially be left out to avoid a conflict of interest as judges decide the legislation's constitutionality.

Quinn said passage of the overhaul frees the state to focus on its other challenges which include crafting a fiscal 2015 with billions less in revenue if the partial expiration of a 2011 income tax increase occurs as scheduled.

Quinn sidestepped questions after the vote over the tax question. "We're take that issue up in the coming year," Quinn said.

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