CHICAGO - The Illinois Supreme Court's recent decision that state constitutional protections of pension benefits apply to retiree healthcare premium subsidies "casts doubt" on recent local and state pension reform efforts, Moody's Investors Service said.

The court's decision "is credit negative for Illinois and local governments such as the City of Chicago," said analyst Tom Aaron in the rating agency's weekly public finance credit outlook.

The decision applies only to the state's overhaul of its retiree healthcare premium subsidies, and the court did not rule on whether the changes actually impaired retiree benefits, just that they are protected under the pension clause. The case was sent back to the lower court to decide the impact of the changes.

Many view the decision as an ominous sign for the state's pension reforms passed in December, Chicago's overhaul of two of its four pension funds, and efforts by Chicago and other local governments to reform public safety pensions ahead of a mandate next year to raise contributions.

That's because the decision provided insight into how a majority of justices view the constitution's pension clause's language as providing a strong contractual guarantee. The clause reads: "Membership in any pension or retirement system of the state, any unit of local government or school district… shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired."

"The majority of the justices expressed views that run counter to the rationale used in recent pension reform legislation for certain city and state plans," Moody's wrote. "We therefore perceive increased risk that the Illinois Supreme Court will rule the pension reform legislation unconstitutional, which would jeopardize $32.7 billion of pension liability reduction."

The state's $100.5 billion of unfunded pension liabilities has driven its steep credit deterioration down to the low-single-A category with a negative outlook assigned by Fitch Ratings and Moody's and a "developing" one applied by Standard & Poor's. The state's interest rate penalties also narrowed after the reforms were adopted.

The city's overhaul of its laborers and municipal funds addressed about half of the city's $19.5 billion of unfunded liabilities which have driven its recent credit deterioration down to the Baa1 level by Moody's.

The ruling showed justices' proclivity to side with pensioners.

"Where there is any question as to legislative intent and the clarity of the language of a pension statute, it must be liberally construed in favor of the rights of the pensioner," the ruling said.

"This and other sections of the ruling signal how the court could side with pensioners when it eventually addresses the constitutionality of recent state pension reforms, which have already been challenged, as well as Chicago's pension reforms, which we expect will be challenged," Moody's said.

A series of lawsuits against the state reforms have been consolidated and remain at the circuit court level. Various labor groups have threatened to challenge Chicago's reform package but have not yet filed any lawsuits. The city also has cut retiree healthcare benefits, shifting many to federal healthcare exchanges but those changes are being challenged.

State Attorney General Lisa Madigan and Chicago Mayor Rahm Emanuel's administration have sought to stress that other arguments will be presented to the court in defense of the pension benefit changes.

The state will argue that its dire financial condition and other steps taken to rein in costs left it with no other option under its sovereign rights but to alter benefits to save the pension funds in order to preserve state services.

The Supreme Court's decision throws into question how a majority of justices might view that argument. They concluded after reviewing debate on the pension clause during the 1970 constitutional convention that it was "aimed at protecting the right to receive the promised retirement benefits, not the adequacy of the funding to pay for them."

The state will also argue that it offered "consideration" in altering the state's contractual obligation by reducing employee contributions and enacting stronger payment guarantees.

"The ultimate outcome on the state's pension reforms will remain uncertain until the court rules on their legality directly," Moody's said.

On the retiree healthcare front, the case goes back to the circuit court level, where the state is expected to argue that as part of the overhaul that cut automatic premium subsidies, employees were awarded $222 million in wage hikes.

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