Moody's : Illinois Supreme Court Casts Doubt on Recent State and Local Pension Reform Efforts, a Credit Negative

Moody's has a warning for Chicago and Illinois taxpayers and bond holders of Obamaland:

On July 3, the Illinois Supreme Court found that state constitutional protections for pensions apply to retiree health care subsidies that were cut by the State of Illinois (A3 negative). The decision reversed a lower court’s March 2013 decision and remanded the case to the lower court for further proceedings. The court’s decision is credit negative for Illinois and local governments such as the City of Chicago (Baa1 negative).

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. 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 ruling shows that most of the justices have an expansive view of how the pension clause (Article 13, Section 51) should apply to pensioners. The majority opinion states that, “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.” 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.

The court still may be persuaded by arguments outside the scope of the current ruling, such as the idea that extreme pension funding pressure prevents the state or a local government from providing for public health and safety, a responsibility higher than adhering to pension promises. The ultimate outcome on the state’s pension reforms will remain uncertain until the court rules on their legality directly. In December 2013, the state passed sweeping legislation to address the severe underfunding of its pension systems. The legislation reduced cost-of-living adjustments (COLAs) for employees and retirees in four of the five state pension systems. The legislation also increased state contribution requirements and reduced employee contribution rates. The state’s actuaries estimated that these and other changes reduced accrued liabilities as reported by the three largest pension systems by approximately $21 billion as of June 30, reducing Moody’s adjusted net pension liabilities (ANPLs) for the three largest systems — the Teachers’ Retirement System (TRS), State Employees’ Retirement System (SERS) and State Universities Retirement System (SURS) — by a combined $32.7 billion, or 17%.

In May, a lower court judge barred the state from implementing its reforms until lawsuits challenging the changes were resolved. The matter will almost certainly be appealed to the state Supreme Court, no matter the outcome in the lower court.

Just a reminder.