CHICAGO – Illinois lawmakers adjourned their lame-duck session Tuesday after failing come up with reforms to the state pension system, leaving the $95 billion unfunded pension mess in the hands of the new General Assembly being sworn in Wednesday.

Lawmakers’ actions are being followed by voters, local governments, civic and business groups. They are also being watched closely by investors who demand substantial interest rate penalties to buy debt from Illinois, and rating analysts who have warned that trimming the size of the state’s obligations and burden of growing payments are central to stabilizing its rating.

With the legislative impasse showing no signs of easing Tuesday, Gov. Pat Quinn who had long banked on action being taken during the early January lame-duck session, floated the creation of commission modeled after the federal military base closure commission.

Under Quinn’s proposal, a special commission would recommend ways to restore solvency to the pension system and its suggestions would take effect unless challenged by lawmakers, similar to how the military base closure process works.

“I think this is a mechanism to break the logjam, to break the gridlock,” Quinn said in testimony before a House committee Tuesday. Lawmakers voiced concerns over its constitutionality and though it passed out of committee it never came up for a House floor vote.

The difficulty of reaching an agreement on how to shore up the state’s system is underscored by the fact that Democrats hold majorities in the Senate and House and Quinn is a Democrat. Republicans charged that the fault lay at Democratic leaders’ feet and it was up to Senate President John Cullerton, D-Chicago, and House Speaker Michael Madigan, D-Chicago, to settle on a framework.

The General Assembly is being sworn in at noon Wednesday and sponsors of various pension reform plans said they would reintroduce them immediately.

“This is essential. It’s something I’ve been working on with the speaker for the two years, it’s critical,” Cullerton said. Annual pension payment increases are “crowding out all the money we would use for education,” he said.

“Obviously we are worried about credit downgrades,” he added.

Pressure on Quinn and lawmakers to reform the system escalated throughout 2012. Quinn backed reforms that asked employees to move to a new plan with some benefit cuts in order to preserve retiree healthcare subsidies. Republican opposition over a key component of the reform that would gradually move the cost of suburban and downstate teachers’ pensions off the state’s back and on to local districts stalled a vote. Quinn was prepared to drop that piece but then lost Democratic votes needed during the regular spring session.

Quinn has continued to press lawmakers to vote but seemed unable to broker a deal that could generate sufficient support. The House plan, whose lead sponsor is Rep. Elaine Nekritz, D-Northbrook, limits cost of living increases in retiree annuities, phases in an increase in the retirement age for some employees, increases employee contributions, imposes caps on pensionable salaries, and gradually shifts from state coffers to districts the cost of funding local school teachers’ pensions.

The plan is aimed at fully funding four of the state’s five funds at a 100% ratio by 2043. It would shave about $28 billion off the state’s $95 billion of unfunded liabilities and reduce the fiscal 2014 payment by nearly $2 billion.

That package includes a legally enforceable provision that the state meet its required contributions. The funds are currently funded at just a 40.4% ratio, the poorest among the states. Nekritz dropped the teacher cost shift this week in an attempt to pass the package in the lame-duck session. The bill she intends to introduce to the new General Assembly will resurrect the cost-shift provision.

Republicans argue that such a move will force districts to raise property taxes or cut spending. Chicago representatives contend the shift is fair because the Chicago district covers its own pension payments.

The Senate package pushed by Cullerton asks employees to move to a new plan with reduced benefits to preserve their retiree healthcare benefits. The version approved by the Senate last year covered only two of five state funds.

Cullerton contends the House plan won’t stand up to the constitutional challenge unions have threatened. While any plan likely faces a labor lawsuit, Cullerton believes his plan can best survive the constitutional test because employees would voluntarily move to the new plan. Current law says that pensions cannot be diminished or impaired. Lawyers have differed on whether the law applies to only accrued benefits or benefits promised at the start of employment. Cullerton intends to reintroduce the package but will broaden it to cover four funds.

Cullerton has also has offered to bring the House plan up for a vote in his chamber but he wants a House vote on his version as a backup should unions succeed in litigation. Cullerton has argued that his plan would trim between $66 billion and $86 billion off of the state’s $300 billion in expected payments over the next 30 years.

Civic and business groups including the Civic Federation of Chicago, the Metropolitan Planning Council, and the Better Government Association last week pressed lawmakers to act on the House plan.

Moody’s Investors Service recently revised its outlook on Illinois’ A2 general obligation rating  to negative from stable, warning that pension obligations will likely worsen over the near term. The pressure on the state’s balance sheet is heightened by the partial sunset in 2015 of a state income tax hike. Standard & Poor’s rates Illinois’s $32.8 billion of debt A with a negative outlook. Fitch Ratings assigns an A rating and stable outlook.

The state will need to contribute $6.87 billion to cover pensions in the fiscal 2014 budget that takes effect next July. That’s up by about $1 billion from the payment made in the state’s $33.7 billion fiscal 2013 general fund budget.

The state’s unfunded liabilities of $94.6 billion are based on a smoothing of investment returns. Applying a market-based review, the state’s unfunded obligations are $96.8 billion for a funded ratio of 39%.

The state’s pension woes and fiscal struggles have far-reaching impact with the so-called Illinois interest rate penalty of between 25 and 200 basis points being imposed on credits across the state depending in part on a government’s reliance on state aid which in chronically late.

Local governments are calling on the state to act on local reforms as well. Chicago is grappling with $16.7 billion of unfunded obligations and faces a $550 million spike in pension payments in 2015. Cook County local governments carry more than $34 billion in unfunded obligations.

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