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Ruling overturning Chicago pension reform rests on unusual state constitution

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An Illinois Supreme Court ruling that a law changing the benefits for two of Chicago's pension funds is unconstitutional means city officials must find another solution to the pension woes.

The Illinois Supreme Court ruled last week that the 2014 law, which would have increased employees' contributions and decreased retirees' annual cost-of-living-adjustments, violates the state constitution's provision that public retirement benefits “shall not be diminished or impaired.” The pension funds involved are the $4.6 billion Municipal Employees' Annuity & Benefit Fund and the $1.35 billion Chicago Laborers' Annuity & Benefit Fund.

Under the city's pension reform law, the two funds were estimated to become 90% funded by 2055, according to the city's 2015 financial analysis. Without the changes, the two funds' unfunded liability likely would increase $900 million per year. The municipal employees' fund would reach insolvency by 2026, while the laborers' fund would reach insolvency by 2029, according to the analysis.

Illinois is one of just a handful of states that have such a strong level of constitutional protection for pension benefits, experts said.

The decision follows a May 2015 Illinois Supreme Court ruling that unanimously struck down reforms, which were estimated to save $160 billion over 30 years to state-funded pension plans.

Few observers find the latest ruling surprising.

“Generally the rule of thumb is that you can't cut current employee benefits. So in light of the decision regarding the reform for state plans, it's not surprising what's happened in Chicago,” said Jean-Pierre Aubry, associate director of state and local research at the Center for Retirement Research at Boston College.

What the court “made abundantly clear is that the City of Chicago is on the hook to pay these benefits because they are constitutionally guaranteed even if the pension funds themselves go insolvent,” said Ralph Martire, executive director of the Center for Tax and Budget Accountability, a Chicago nonprofit economic research organization.

It also clarified that you can't take away existing benefits, he said.

Mr. Martire said the city has been underfunding the municipal and laborer funds by “north of $800 million a year.”

Rating agencies were quick to react to the ruling: Fitch Ratings Inc. on Monday dropped Chicago's credit rating to BBB-, a notch above junk, after the Illinois Supreme Court's ruling made it clear “that the city bears responsibility to fund the promised pension benefits, even if the pension funds become insolvent.”

According to Fitch's report, the Illinois Supreme Court's ruling “was among the worst of the possible outcomes for the city's credit quality.”

Also Monday, Moody's Investors Service Inc. said the ruling is a “credit-negative setback for the city.” Moody's in May downgraded Chicago's credit rating to junk.

Sources said Chicago's pension woes stem from chronically underfunding its four pension funds, which had a net unfunded liability of $20.1 billion at year-end 2014, according to the city's 2015 Annual Financial Analysis.

“Our suggestion has always been to go to a level dollar amortization, one that's not back-loaded like all the current plans,” Mr. Martire said. The annual level dollar payment must be set at a point where it can both increase the funded ratio of the plans “every single year until they get healthy,” and do this while “accommodating all payment obligations of the systems to cover benefits to current and future retirees over the payment sequence.”

Taxpayers will likely pay more, Mr. Martire said.

Mr. Aubrey said there's “no silver bullet” to fix Chicago's pension woes. “You can do what you want to new employees, go to (Washington) D.C., but none of that's going to reduce the promises already made.”

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