CHICAGO - The Illinois Supreme Court threw a monkey wrench into the state's finances Friday, voiding 2013 pension reform legislation as unconstitutional.
An appeal to the U.S. Supreme Court is not planned. "The court has provided a definitive interpretation of the constitution that must now guide the legislature and the governor going forward," said Maura Possley, a spokeswoman for Illinois Attorney General Lisa Madigan, who represented the state in the case.
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The state government faces $111 billion of unfunded pension liabilities, the leading factor in driving the state's bond ratings down to an A-minus level across the board, with negative outlooks hinting at further downgrades.
In addition to the setback to state finances, the high court ruling on state employees' pensions stands to impact 2014 legislation to overhaul Chicago's municipal and laborers' funds and negotiations to reform the city's police and firefighters fund.
Local governments across the state have also been seeking reforms to avert a scheduled spike in public safety contributions.
The sweeping nature of the fiscal threats posed by the court's action came into focus quickly.
All three ratings agencies responded Friday to the Supreme Court ruling.
"For the state, Moody's current rating and outlook did not factor in the proposed pension reforms, but the ruling provides additional evidence that pension benefit reductions will not be permitted," said a comment piece from Moody's Investors Service.
Rating agency reports have highlighted the legal challenge and the state's strong constitutional language protecting pensions as an implementation risks.
"This action coupled with the implementation risk of the current fiscal 2016 budget proposal and second round of pension reform introduced by the Governor underscores the profound credit challenges facing the state from a budget and liability standpoint," Standard & Poor's analyst John Sugden said.
The ruling "is clearly a set-back for state budget managers but does not have an immediate impact on Fitch's rating of the state," said a Fitch Ratings statement. "It was always clear that the reform would confront strong legal challenge that Fitch anticipated would be resolved at the state Supreme Court level."
The legislation approved by the General Assembly in December 2013 and signed into law by former Gov. Pat Quinn early in 2014 raised the retirement age for some employees, capped pensionable salaries, and limited cost-of-living increases while lowering employee contributions, directly impacting members' annuities.
Unions representing current and retired employees sued, arguing that the changes violated the state's pension clause, which says: "Membership in any pension or retirement system of the state shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired."
The state countered that under contract provisions in the state and federal statute it had the right alter the pension contract under its sovereign police powers.
A Sangamon County Circuit Court judge last year sided with the unions and voided the law in its entirety in a summary judgment ruling. The state appealed to the Illinois Supreme Court, which considered it on an expedited basis.
In clear language, the courts' justices agreed with the lower court in its voiding of the law.
"Retirement annuity benefits are unquestionably a 'benefit of contractually-enforceable relationship resulting from membership in the four state-funded retirement systems. Indeed, they are among the most important benefits provided by those systems," the opinion said.
"There is simply no way that the annuity reduction provisions [of the law] can be reconciled with the rights and protections established by the people of Illinois when they ratified the Illinois Constitution of 1970 and its pension protection clause," the opinion said.
"In enacting the provisions, the General Assembly overstepped the scope of its legislative power. This court is therefore obligated to declare those provisions invalid," justices concluded.
The decision sends the state and freshman Gov. Bruce Rauner back to square one on the key issue challenging the state's solvency.
It now also adds another burden for the General Assembly as the state grapples with how to close a more than $6 billion deficit in its budget for the fiscal year beginning July 1. The Republican governor is at odds with the legislature's Democratic majority over how to erase the red ink and over the governor's anti-union and pro-business "turnaround agenda."
The court's ruling "puts more pressure on the so-far-not-exactly-magical relationship between Gov. Rauner and the legislature, and worst case might embolden Gov. Rauner to push his turnaround agenda as a condition of negotiating about revenue raisers, but it's far from a game changer," said Matt Fabian, partner at Municipal Market Analytics.
"There are no winners today. If there's any good news, it's that Chicago and Illinois are resilient, and we've responded to great challenges before," said Ty Fahner, president of Civic Committee of the Commercial Club of Chicago, which backed the reforms the Supreme Court voided Friday.
The court soundly rejected the state's position that it was within its rights to cut benefits after raising taxes and cutting spending to stabilize the state's faltering finances, underscored by its battered credit ratings.
The state "made no effort to distribute the burdens evenly among Illinoisans," to address its fiscal ills, the opinion said. "It did not even attempt to distribute the burdens evenly among those with whom it has contractual relationships."
The court rejected the state's claim that other, less drastic measures were available when balancing pension obligations with other state expenditures became problematic, calling the state's argument "fatally flawed."
The opinion also agrees with union arguments that the state's pension crisis was of its own making. "Accordingly, the funding problems which developed were entirely foreseeable," the opinion said. "The General Assembly may find itself in crisis, but it is a crisis which other public pension systems managed to avoid."
The justices acknowledged the deep fiscal mess facing the state but said those concerns don't override their interpretation of the law.
"We do not mean to minimize the gravity of the state's problems or the magnitude of the difficulty facing our elected representatives. It is our obligation, however, just as it is theirs, to ensure that the law is followed," the opinion said. "Crisis is not an excuse to abandon the rule of law. It is a summons to defend it."
The winners were unsurprisingly pleased.
"It is a victory for anyone to whom the state of Illinois owes a debt," Linda Brookhart, executive director of one plaintiff, the State Universities Annuitants Association, said in a statement.
The voided pension reforms sought to shave about $145 billion off state contributions in the coming decades, including $1.1 billion in fiscal 2016, while bringing the system to full funding in 30 years. About $21 billion would be pared from the unfunded obligations' current tab of $111 billion. The system is just 39% funded.
The deterioration of Illinois' credit quality and bond ratings has driven its borrowing costs up. The state's 10-year yield was 110 basis points over the top-rated Municipal Market Data benchmark scale when it sold general obligation bonds in the spring of 2014, after passage of the reforms but before the November Sangamon County Circuit ruling tossing the legislation.
Secondary market spreads have ranged from the 170 basis point range over last summer to 140 basis points this year.
The impact is felt by issuers across the state who are forced to pay higher yield in what's known as the so-called "Illinois effect" or "Illinois penalty."
The opinion comes as no surprise to many from legal experts and market participants who long worried that the cuts would fail the pension clause's language test. Senate President John Cullerton, D-Chicago, had warned as much as he pressed for an alternative that would have asked employees to accept cuts in exchange for preserving their retiree healthcare subsidies. That plan likely won't work now following the high court's finding last year that those subsidies are protected by the pension clause.
Rauner proposed new reforms in the budget he unveiled earlier this year, counting $2.2 billion in estimated savings. The savings would be achieved by freezing as of July the level of benefits earned by employees hired before 2011 when a reduced tier 2 benefit structure was adopted. Rauner's proposed changes would shave $100 billion off state payments owed over the next 30 years and $25 billion off the state's unfunded tab.
"What is now clear is that a constitutional amendment clarifying the distinction between currently earned benefits and future benefits not yet earned, which would allow the state to move forward on common-sense pension reforms, should be part of any solution," Rauner spokesman Lance Trover said in a statement. "Lawmakers must approve putting such a question to voters, making it unlikely the process could be completed in time to impact the fiscal 2016 budget."
Rauner's plan would also offer an optional buyout for employees who started before 2011 who agree to lower a lower COLA and move to a 401(k)-style defined benefit plan.
The state's scheduled payment for its pension system next year is $6.6 billion, up $580 million from this year. Although the state approved pension reforms in December 2013, recent budgets did not assume any savings because of the expected legal challenge.
The court's opinion was unanimous with Justice Lloyd Karmeier the lead author; Chief Justice Rita Garman and justices Charles Freeman, Robert Thomas, Thomas Kilbride, Anne Burke, and Mary Jane Theis concurred. The legislation did not impact the judges' pension fund.
Chicago contends its existing reforms won't be impacted by the court's action - a position that contradicts its warnings in an amicus brief filed in the state case of a dire impact. Chicago is grappling with $20 billion of unfunded liabilities. "We believe our plan fully complies with the state constitution because it fundamentally preserves and protects worker pensions rather than diminishing or impairing them," said a statement from Mayor Rahm Emanuel's office.
The market Friday was only beginning to digest the news.
"We are not seeing any trading in Chicago credits today of 500,000 and greater," said an analyst from Interactive Data.
"With today's jobs report strengthening the Treasury market, we are seeing weakness in Illinois and Chicago Transit Authority Pensions," a Markit analyst said. "Bonds that traded on Thursday are 5 to 7 basis wider on Friday."
