By Karen Pierog
CHICAGO, May 5 (Reuters) - Now that the Illinois House of Representatives has passed a plan to repair a state pension system underfunded by $100 billion, attention is turning to the meaning of three words in the Illinois constitution: "diminished or impaired."
Those words cap a clause that is designed to force Illinois to meet obligations to its retired public sector workers. And the state's labor unions have vowed to go to court if the bill that passed on Thursday, backed by the powerful Democratic House Speaker Mike Madigan, becomes law.
Reduced cost-of-living increases, increased employee contributions and other changes violate the constitution, union leaders say.
Years of skimping on contributions and the investment-sapping effects of the financial crisis have come to a head in Illinois, where about one-fifth of the state's general revenue in the next fiscal year will be owed to its pension plans.
The constitutional issue is far from simple. Madigan told Reuters on Thursday that he intentionally tailored his bill to stand up against a constitutional challenge. But others who have studied it - including a lawyer for another powerful Democrat, Senate President John Cullerton - say the unions may have a case.
The pending legal challenge has created uncertainty in Illinois, as well as with analysts and investors in the state's bonds. For some though, the comprehensive approach of Madigan's plan seems to be offering at least a measure of relief that, after years without progress, pension reform could come to Illinois, which has the lowest credit rating among states.
Robert Amodeo, asset manager at Western Asset, which has $460 billion in assets, called the approval of pension reform by the Illinois House a positive development - though far from conclusive.
"The fact that the state has seriously begun to address the pension problem is a welcome development," Amodeo said.
If the Madigan plan wins Senate approval and is signed into law, he added, "we will look very closely at investing in those securities."
The Madigan measure sets a cap on salaries used to determine pensions, limits cost-of living adjustments on pensions for future retirees, increases retirement ages and hikes worker pension contributions. It introduces cost-saving changes to calculating the state's annual pension contributions and also exempts pension changes from collective bargaining.
For the constitutional battle, the most important part of the bill is an introductory "statement and findings." The lengthy passage is targeted at the clause in the state's 1970 constitution that describes public employee pensions as "an enforceable contractual relationship, the benefits of which shall not be diminished or impaired."
Madigan's preamble argues that the state has a right to amend pension promises when other vital interests are at risk. It lists numerous fiscal woes facing Illinois as annual payments to its five pension funds top $6 billion.
"The General Assembly finds that the fiscal crisis in the state of Illinois jeopardizes the health, safety, and welfare of the people and compromises the ability to maintain a representative and orderly government," the bill states.
Asked by Reuters if the opening section was designed to inoculate his bill against constitutional challenge, Madigan had a simple response: "Yes, it was," he said.
Legal experts said Madigan's approach would present a court with a balancing of interests: the obligations to retirees versus the state's duty to protect health and welfare.
The constitutional provision is not absolute, argues Tyrone Fahner, a former Illinois attorney general who is president of a business executives' group, the Civic Committee of the Commercial Club of Chicago. "The state cannot commit suicide" in order to preserve pension benefits, Fahner said. "They have the absolute power to preserve the state and its basic functions."
Ann Lousin, a professor at John Marshall Law School who was a researcher at the 1970 constitutional convention and wrote a book about the Illinois constitution, said Madigan's approach could invite a court to look at other options available to the state. For example, Illinois does not tax pension or Social Security benefits as many other states do, but the House adopted Madigan's bill rather than fixing the pension problem with a new tax.
"The court will want to know if you've done all you can," Lousin said.
Union representatives say they can win a lawsuit based strictly on the constitution's pension clause.
"By making unilateral cuts in constitutionally protected benefits, this bill fails to pass constitutional muster under the Illinois Constitution either under a pension clause analysis or a contracts clause analysis," said John Stevens, a partner at law firm Freeborn & Peters, and legal counsel to a coalition of Illinois labor unions, at the bill's sole House hearing on Wednesday.
The Senate in March passed a bill sponsored by Cullerton, the Senate president, that addresses constitutional challenges by giving retirees a choice between cuts in pensions and access to state-sponsored health care in retirement. And this week Cullerton began working with unions to fashion a new proposal the unions will not challenge in court.
Eric M. Madiar, Cullerton's chief legal counsel and author of a widely respected white paper on legal issues relating to pension reform, said Cullerton is keeping constitutional review in mind at every step. "We have decided to take a different approach that appreciates what the law is and work within the law to frame it rather than have this risky approach," he said.
But State Representative Elaine Nekritz, the House's point-person on pension reform, said the Madigan bill is both good law and good policy. "I believe it's constitutional and necessary for us to dig ourselves out of a financial hole," she said.