On Friday, the Illinois Supreme Court ruled that pension reform legislation passed in 2013, commonly referred to as Senate Bill 1, violates the pension protection clause of the Illinois Constitution. The Court upheld a previous circuit court ruling that invalidated the law in its entirety. The Court held that the State could not rely on its inherent “police powers” to diminish the benefits of membership in a pension system. Finding that Senate Bill 1 is “merely the latest assault in this ongoing political battle against public pension rights,” the Court held the pension reform legislation unconstitutional.

Background

One December 5, 2013, then-Governor Quinn signed into law Senate Bill 1, which became Public Act 98-599 (“the Act”), making comprehensive changes to four of the State’s pension systems. The Act affected Tier 1 members—those employees who began making contributions to a pension system prior to January 1, 2011. Among other things, the Act increased the retirement eligibility age for certain Tier 1 members, reduced cost-of-living adjustments (COLA) for current and future retirees, and capped pensionable earnings for Tier 1 members.

Shortly after the bill was signed, but prior to its effective date of June 1, 2014, five separate groups, including retirees and labor unions, challenged the legislation in court. These plaintiffs argued that the Act’s benefit reductions diminished and impaired the benefits of membership in each pension system in violation of Article XIII, § 5 “Pension Clause” of the Illinois Constitution. On November 24, 2014, a Sangamon County circuit court agreed and held the Act unconstitutional. The circuit court reasoned that Illinois courts have consistently held that the Illinois Pension Clause’s protection against the diminishment and impairment of pension benefits is absolute and without exception. The State argued that the constitutional protections for pension benefits had to be weighed against the State’s inherent authority to override and modify obligations when, in its judgment, such actions are reasonable and necessary to advance an important public purpose. According to the State, its reserved sovereign power—also referred to as its “police powers”—permitted it to change Tier 1 pension obligations for the overall public good in light of the State’s dire fiscal condition. The court rejected the police powers argument and found the Act and its changes unconstitutional.

The Court’s Opinion

In a strongly worded opinion harshly critical of the State and the General Assembly, the Illinois Supreme Court upheld the lower court’s decision. The Court first reviewed Illinois’ long history of underfunding its pension systems and the inclusion of the Pension Clause in the 1970 Illinois Constitution.

Illinois has been underfunding its pension systems for the better part of a century. As the Court noted, a 1917 report to the General Assembly characterized the condition of the State’s pension systems as insolvent and moving toward a crisis. The Illinois Public Employees Pension Laws Commission issued similar dire predictions in biennial reports between 1947 and 1969. These reports, however, went unheeded, and the State continued to underfund pensions. By 1969, the funding ratio for the State’s systems was approximately 42%, meaning that the pension systems had enough assets to cover less than half of their liabilities.

To address this chronic underfunding of the State’s pension systems, the 1970 Constitutional Convention delegates sought not to dictate specific funding levels for the pension systems, but to safeguard the pension benefits themselves by way of the Pension Clause. As the delegates explained, the Pension Clause accomplishes this in two ways: (1) it mandates a contractual relationship between the State, as the employer, and the employee; and (2) it prohibits the General Assembly from impairing or diminishing the pension benefits. Despite the delegates’ hope that prohibiting the State from diminishing pension benefits would induce the State to meet its funding obligations that did not occur.

The Court’s review of the underfunding since the 1970 Convention was, at times, a stinging criticism of the General Assembly. For example, in a footnote, the Court observed that Illinois’ neighbors–including Wisconsin, Indiana, and Missouri–all had funded their pension systems consistently over time, and maintained funding ratios well over 80%. Further, the Illinois Municipal Retirement Fund (IMRF), operating in the “same market conditions as the five State-funded systems,” maintained a funding ratio of almost 97%. The Court also noted that the State’s pension funding methods have been criticized by the U.S. Securities and Exchange Commission (SEC) as bearing “no relation to actuarial calculation.” Pension funds continued to be diverted to general revenue funds throughout the 1990s, and the State even lowered its required contributions in 2006 and 2007. Despite the Pension Clause’s inclusion in the Constitution, the Court observed that by 2013, the funded ratio for the States’ systems was 41%–nearly unchanged since the 1970 Convention. This history of the State’s own mismanagement and underfunding of the pension system seemed to play a critical role it the Court’s rejection of “the police powers” argument.

The Court’s Ruling

The Court squarely held that the Act’s reduction of benefits violated the Pension Clause. The Court found this issue was “easily resolved,” holding that “the [Pension Clause] 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.” Further, the benefits attach as soon as the individual joins the pension system as a member, not when that employee retires. Therefore, the Court held “there is simply no way that the annuity reduction provisions in [the Act] can be reconciled” with the Pension Clause.

Noting that the State had all but conceded this argument, the Court next addressed the State’s contention that due to the State’s dire fiscal condition, the State could invoke its police powers to override the protections of the Pension Clause. The Court rejected this argument, finding that exigent circumstances were insufficient to justify the Act’s changes, particularly because economic conditions are “cyclical and expected,” and “fiscal difficulties have confronted the State before.” Further, the Court rejected the State’s reliance on the Contracts Clause of the federal constitution to justify its police powers defense in this matter. Under cases interpreting the Contracts Clause, a State’s attempt to amend its own contractual obligations are highly suspect and must be reasonable and necessary to serve an important public purpose. Here, the Court found the State’s reliance on its own economic and fiscal problems to justify the Act’s changes was unacceptable, as the pension systems’ funding problems were “entirely foreseeable.”

According to the Court, “[t]he General Assembly may find itself in crisis, but it is a crisis other public pension systems managed to avoid and…it is a crisis for which the General Assembly itself is largely responsible.” Accepting the State’s police powers argument in this case would render the Pension Clause null and void, and this the Court refused to do. As a final matter, the Court held that the pension reform changes that it found unconstitutional were not “severable” from the Act’s other changes. Therefore, the Court ruled the Act unconstitutional in its entirety and permanently enjoined its enforcement.

In the Court’s view, “crisis is not an excuse to abandon the law. It is a summons to defend it.” Left unresolved by the Court, however, is precisely what the General Assembly may do to address the State pension systems’ unfunded pension liability. The Court found that there may be constitutional solutions, such as amortizing existing liabilities or raising taxes, and cited statements made during the legislative debates over Senate Bill 1 recognizing that there could be potential alternatives. However, the Court did not provide any “road map” to a comprehensive, constitutional reform package. Another area of uncertainty, given the Court’s extensive criticism of the long history of the State’s deliberate, or at least knowing, underfunding of the pension systems, is the holding’s applicability with respect to other, non-State public pension systems that are characterized not by taking of “pension holidays” but, instead, by a statutory funding scheme that has not proved adequate to fund the benefits on an actuarial basis. In the wake of the Court’s decision, Illinois legislators will return to the proverbial drawing board to craft a solution to the State’s $110 billion pension liability that will withstand constitutional challenge.