Illinois Supreme Court Strikes Down Pension Reform Legislation

The State of Illinois has five public employee retirement systems, all of which provide traditional defined benefit plans under which members earn specific benefits based on their years of service, income and age. All of the pension plans are subject to the pension protection clause of the Illinois state constitution, which provides: “Membership in any pension or retirement system of the State, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.”

Funding for the pension systems is derived from three basic sources: contributions by the State through appropriation by the General Assembly; contributions by or on behalf of members based on their salaries; and income, interest and dividends derived from retirement fund deposits and investments. For as long as there have been public employee pensions in Illinois, there has been tension between the government’s responsibility for funding those systems on the one hand, and the costs of supporting governmental programs and providing governmental services on the other. In the resulting political give and take, the funding for public pensions has chronically suffered.

As long ago as 1917, a report commissioned by the General Assembly characterized the condition of State and municipal pension systems as “one of insolvency” and “moving toward a crisis” because of financial provisions which were “entirely inadequate for paying the stipulated pensions when due.” Similar warnings were issued by the Illinois Public Employees Pension Laws Commission in biennial reports it published between 1947 and 1969. Concern over ongoing funding deficiencies and the attendant threat to the security of retirees in public pension systems eventually led directly to adoption of the pension protection clause of the Illinois Constitution.

Nonetheless, the State continued to underfund its pensions, at times using an approach which the United States Securities and Exchange Commission has characterized as bearing “no relation to actuarial calculation.” By the end of June 2013, based on the market value of fund assets, the five State-funded retirement systems contained a total of only 41.1% of the funding necessary to meet their accrued liabilities. The funding rate was thus nearly unchanged from the 41.8% funding rate prior to ratification of the pension protection clause. By contrast, as of December 30, 2013, the Illinois Municipal Retirement Fund, another major public pension plan which operates in the same market environment as the five State-funded systems, but which is managed separately and not funded by the State, had an aggregate funding rate of 96.7% based on the market value of its assets.

Following downgrades in the State’s credit rating and facing the prospect that the credit rating would be reduced even further, the General Assembly engaged in heated and protracted debate over possible legislative strategies for dealing with the State’s fiscal problems through further changes to its pension obligations. After numerous failed attempts to reach consensus, the General Assembly ultimately enacted what became Public Act 98-599. The centerpiece of Public Act 98-599, which had a variety of different provisions, was a comprehensive set of provisions designed to reduce annuity benefits for members of four of the five retirement systems.

The new law utilized five different mechanisms for achieving this goal. First, it delayed by up to five years when members under the age of 46 are eligible to begin receiving their retirement annuities. Second, it capped the maximum salary that may be considered when calculating the amount of a member’s retirement annuity. Third, it jettisoned the current provisions under which retirees receive flat 3% annual increases to their annuities and replaces them with a system under which annual annuity increases are determined according to a variable formula and are limited. Fourth, it completely eliminated at least one and up to five annual annuity increases depending on the age of the pension system member at the time of the Act’s effective date. Finally, with respect to two of the plans, the Act also altered how the base annuity amount is determined for purposes of what is known as the “money purchase” formula, something available to members of the two systems who began employment prior to July 1, 2005, as an alternative to the standard formula for calculating pensions.

The Illinois Supreme Court struck down all five of the changes. It found the question of the reduction in retirement benefits to be “easily resolved.” The Court observed that it had previously held that the pension protection clause of the Illinois Constitution “means precisely what it says: If something qualifies as a benefit of the enforceable contractual relationship resulting from membership in one of the State’s pension or retirement systems, it cannot be diminished or impaired. 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. If allowed to take effect, Public Act 98-599 would clearly result in a diminishment of the retirement annuities to which Tier 1 members of the systems became entitled when they joined those systems.”

The Court noted that “the circumstances presented by this case are not unique. Economic conditions are cyclical and expected, and fiscal difficulties have confronted the State before. In the midst of previous downturns, the State or political subdivisions of the State have attempted to reduce or eliminate expenditures protected by the Illinois Constitution, as the General Assembly is attempting to do with Public Act 98-599. Whenever those efforts have been challenged in court, we have clearly and consistently found them to be improper.”

The Court concluded with particularly harsh words for the Illinois Legislature: “The pension protection clause expressly provides that the benefits of membership in a public retirement system shall not be diminished or impaired. Through this provision, the people of Illinois yielded none of their sovereign authority. They simply withheld an important part of it from the Legislature because they believed, based on historical experience, that when it came to retirement benefits for public employees, the Legislature could not be trusted with more.

“As we have noted before, delegates to the constitutional convention were mindful that in the past, appropriations to cover state pension obligations had been made a political football and the party in power would just use the amount of the state contribution to help balance budgets, jeopardizing the resources available to meet the State’s obligations to participants in its pension systems in the future. They understood that steps were necessary in order to protect public employees who are beginning to lose faith in the ability of the state and its political subdivisions to meet these benefit payments and to address the insecurity on the part of the public employees which is really defeating the very purpose for which the retirement system was established. The concerns of the delegates who drafted the pension protection clause and the citizens who ratified it have proven to be well founded. Even with the protections of that provision, the General Assembly has repeatedly attempted to find ways to circumvent its clear and unambiguous prohibition against the diminishment or impairment of the benefits of membership in public retirement systems. Public Act 98-599 is merely the latest assault in this ongoing political battle against public pension rights. As we noted earlier, through that legislation the General Assembly is attempting to do once again exactly what the people of Illinois, through the pension protection clause, said it has no authority to do and must not do.”

In re Pension Reform Litigation, 2015 IL 118585 (Ill. 2015).