Finance

Illinois’ Pension Reform Doesn’t Fix State's Credit Problems

Illinois’ status as the lowest-rated U.S. state won’t necessarily improve now that lawmakers have passed a measure to overhaul the state’s underfunded pensions.
by | December 4, 2013
Illinois Speaker of the House Michael Madigan, D-Chicago, speaking to lawmakers during a Pension Committee hearing Tuesday.
Illinois Speaker of the House Michael Madigan, D-Chicago, speaking to lawmakers during a Pension Committee hearing Tuesday. He reportedly said, "Something's got to be done. Something's got to be done." AP/Seth Perlman
 

Illinois’ status as the state with lowest credit rating in the U.S. won’t necessarily improve now that lawmakers have passed a measure to overhaul the state’s underfunded pensions, even as legislators see a better credit future as one of the perks of the reform.

Backers of the bill, which passed the legislature Tuesday, say the measure will erase a $100 billion pension shortfall by reducing or eliminating automatic annuual cost-of-living increases in state pensions, raising the retirement age for public employees and establishing a 401(k) option for some. Illinois has the nation’s worst-funded pension system and lawmakers have repeatedly hit roadblocks with reform attempts in recent years, largely because retiree pensions are specifically protected by the Illinois constitution. Unions have already vowed to challenge the law in court.

The bill, which passed the Senate in a 30-24 vote and the House in a 62-53 vote, also projects to save the state $160 billion over the next 30 years. However, as Fitch Ratings agency notes, the actual impact -- and therefore cost savings -- of the reform will not be known until an actuarial study has been completed. Credit ratings agencies had warned Illinois it could be in for more downgrades if it did not address its pension liability during the special session called this fall. But Fitch, while still calling the reform a "positive step," noted pensions were only part of that downgrade warning.

If Illinois wants to avoid a downgrade, it “will require timely action on a more permanent budget solution to the structural mismatch between spending and revenues in advance of the expiration of temporary tax increases,” wrote Senior Director Karen Krop in a note issued Wednesday. Temporary increases in both the personal and corporate income taxes that have been helping prop up the state budget since 2011 are scheduled to begin to phase out on July 1. Fitch rates Illinois A-minus with a negative outlook, the lowest of all its state ratings. Moody's and Standard & Poors rating agencies also rate Illinois the lowest among the 50 states.

Gov. Pat Quinn has not said whether the state would need to extend the tax hike although opponents of the pension reform have warned that the increases would become permanent. Another component of the pension reform would allow the Illinois Supreme Court to enforce the state’s contributions to the pension fund, contributions which Illinois for more than a decade has repeatedly skipped out on making in order to close budget gaps.

The bill also raises the retirement age by up to five years for current employees under the age of 45, making the retirement age 60 years old in many cases. In return, the legislation puts money in workers' pockets today by reducing the pension contribution taken from their paychecks. But Chris Tobe, founder of Kentucky-based Stable Value Consultants, said requiring less from workers will only perpetuate Illinois’ problem by lowering the amount of money being invested in the pension system.

“Solvency is based on cash flows primarily in 2014, 2015, and 2016 and this reform hurts cash flow in the critical years,” he wrote in an op-ed for Market Watch. “That means this reform could actually lower credit ratings instead of raising them.”

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