By Karen Pierog
CHICAGO, May 1 (Reuters) - The Illinois Senate president and labor leaders on Wednesday began pushing a new plan to reform the nation's worst-funded state pension system that they believe can pass an expected constitutional challenge while still saving the state money.
The new plan would compete with another bill already on its way to a vote in the state's House of Representatives.
The competing plans by two of the state's most powerful Democratic leaders - Speaker of the House Mike Madigan and Senate President John Cullerton - set the stage for a showdown as the Illinois Legislature seeks to reform a pension system that is underfunded by at least $96.8 billion.
Cullerton met with leaders of a coalition of union leaders Wednesday in an effort to put together a plan that could withstand an inevitable court challenge. In a statement, Cullerton said the plan had a big enough impact on the state's pension underfunding that he believes it can win approval from the Democratic-controlled legislature.
He added that the leaders of the state's teachers, nurses, police officers, and other public employee unions "offered a credible and constitutional plan for consideration." The state's constitution declares that pension benefits, once granted, cannot be "diminished" during an employee's career or retirement.
Cullerton said he would present the plan to the state's Democratic caucus and to speaker Madigan.
Details of the plan were not immediately clear, but State Senator Linda Holmes, who was in the meeting, said the proposal may include elements of a measure she previously had introduced, including increased employee contributions and a requirement that the state make pension payments according to an actuarial formula.
Holmes noted Cullerton likely will continue promoting elements of his own plan, which would give workers who agree to lower cost-of-living adjustments to their pensions continued access to state-sponsored health care in retirement.
The drama in the state capitol of Springfield has caught the attention of investors who have purchased the state's general obligation bonds, as well as the more than $17 billion of pension bonds Illinois has sold since 2003 in an effort to begin catching up on payments into its five state pension systems.
Richard Ciccarone, a managing director and chief research officer at McDonnell Investment Management, said market concerns will linger until any constitutional challenges have run their course.
"Until the state gets confirmation from the court that the plan is valid, the issue is not likely to go away," he said, referring to the House speaker's bill.
Madigan's plan sets a cap on salaries used to determine pensions, limits cost-of-living adjustments on pensions for future retirees, increases retirement ages for workers currently under 45 years old, and hikes worker pension contributions by 1 percent over each of the next two fiscal years.
Additionally, the measure exempts pension changes from collective bargaining.
Four of the state's five pension funds - covering more than 190,000 retirees and nearly 270,000 active workers - would be affected by Madigan's bill. The judges union is exempt.
The plan was sent to the House floor on Wednesday after a brief committee hearing that produced a 9-1 vote.
At the hearing, Henry Baer, executive director of the American Federation of State, County and Municipal Employees Council 31, which represents 46,000 state and university employees, said state lawmakers seem to be determined to stop kicking the pension problems down the road.
"It's a good thing you're not kicking the can down the road," Baer said. "It's a bad thing that you're kicking our members in the butt."
Without reform, payments for retirement funds and for debt service on pension bonds are expected to total $7.7 billion in fiscal 2014, or almost a quarter of the state's general fund revenue.
Madigan's amendment is similar to a previous bill that did not pass, which would have reduced Illinois' annual pension payment by $2 billion and cut the unfunded liability by $30 billion.
State Senator Daniel Biss, a key sponsor of the failed bill, said lawmakers are coming to grips with the difficulty of pension reform. "When the issue is this hard, this emotionally complicated, this financially complicated, this politically complicated, it's brutal to get something done," Biss said.
Investors have been demanding hefty yields for Illinois' general obligation debt. The state's so-called credit spread was 140 basis points over Municipal Market Data's benchmark triple-A scale in the latest week - the second-highest among major muni issuers tracked by MMD.
Illinois' A2 rating, the lowest among states, could be downgraded further if no comprehensive pension fix passes, said Ted Hampton, an analyst at Moody's Investors Service.
"It would be more evidence the state can't come to grips with this politically," he said, adding that Moody's was monitoring developments in the legislature.