Legal battle over Illinois pensions ends with consolidation upheld

The Illinois Supreme Court on Friday ended a three-year legal battle over the constitutionality of the pension consolidation passed by the General Assembly and signed into law by Gov. JB Pritzker in 2019. The law, Public Act 101-0610, which took effect Jan. 1, 2020, pooled most of Illinois’ local police and firefighter pension fund assets into two statewide pension investment funds.

Suing Pritzker and the boards of trustees for the police and firefighters’ pension funds were 36 active and retired beneficiary members from over a dozen suburban and downstate police and firefighter pension funds. They represented a small but vocal fraction of the nearly 650 local police and firefighter pension funds affected.

The plaintiffs argued that the pension consolidation impinged on their previously exclusive management of investments, diluted their voting power and forced them to bear the costs of the transition to the new system. In so doing, they said, it violated the pension protection clause and the takings clause of the Illinois constitution.

The state Supreme Court rejected their arguments, siding with the circuit court and the appellate court decisions in favor of the defendants.

“Oh, it was expected,” James McNamee, president of the Illinois Public Pension Fund Association, a nonprofit umbrella organization representing public retirement funds, said of the decision. “We didn’t think it was unconstitutional to consolidate … The theory of what they were looking to do is, by having the funds consolidated, it would cut down on administrative costs and management costs. It also expanded the investment authority of what they could do. Under the old law, you couldn’t get into private equity, which is one of the largest returns.”

Before consolidation, the pension funds could invest only in fixed income. With this move, the General Assembly and the governor were seeking bigger returns and lower fees, McNamee said.

The consolidation may also help reduce costs by strengthening the pension funds’ negotiating power, said Richard White, executive director of the Illinois Police Officers’ Pension Investment Fund. He added that the heft of the statewide funds will allow the funds to hire top investment managers at “competitive pricing” and the difference in fees will go toward funding pension benefits.”To give a sense of the size of the IPOPIF consolidated fund versus the member funds, on December 15, 2023, the board agreed to hire three international small-cap equity manager hires,” he said. “The allocation of approximately $450 million is 1.5 times the entire assets of one of the largest Article 3 funds.”

But consolidation is not a magic fix for the many other structural problems local pension plans are facing.

In a report on Illinois pensions released in June, S&P Global Ratings said many Illinois cities, towns and villages will continue to wrestle with the results of poorly-funded single-employer pension plans, high property taxes and weak demographic trends. It all adds up to higher pension obligations and a budget squeeze, S&P said. 

“The consolidation of the single-employer downstate and suburban public safety plans into a multiple-employer agent plan will provide some administrative cost savings,” the report noted, “but for many plans, the shift to an asset mix that justifies a discount rate greater than 7% may mean more volatility and potentially higher costs.”

And in a July 2021 pension brief, S&P found that many local governments in Illinois have failed to make meaningful progress toward fully funding pensions because of “weak statutory funding requirements below actuarial recommendations.” 

It noted that many Illinois municipalities use single-employer pension plans for public safety officials, and these plans tend to strain creditworthiness through undisciplined funding, inability to reform benefits and political reluctance to raise revenue, among other factors. The report predicted that the consolidation will not do much to mitigate short-term cost pressures.

Pritzker spokesperson Alex Gough said the pension consolidation is an example of “the responsible fiscal judgment that is required to keep Illinois on the right track after decades of mismanagement.” He said the administration expects that thanks to the broader array of investment opportunities, the consolidated funds will outperform the individual funds over the long term.

IPPFA’s McNamee, a retired cop himself, said he understands the perspective of the plaintiffs in the lawsuit. Police and firefighters’ pension funds are the largest membership groups within the IPPFA. Put simply, he said, the plaintiffs’ big issue was: Who’s going to control our money? 

“Police and firemen generally are very suspicious of anybody coming in and taking their assets,” he said. “And it is their assets … The public thinks these are taxpayer funds. No, they’re the police and firefighters’ funds that they own.”

Illinois is also grappling with massive unfunded state pension liabilities. The state’s total unfunded pension liabilities came to $139.8 billion as of June 30, 2022, according to a December 2023 report from the Illinois Commission on Government Forecasting and Accountability. Based on the market value of the pension systems’ assets, pensions were 43.8% funded, the report found.

While Illinois made contributions above the levels required by statute in 2022 and 2023, it did not manage to reverse the past decade’s trend of a growing unfunded aggregate liability, according to the COGFA report.

The state’s pension obligations are among the factors weighing on its bond ratings, which were as low as BBB-minus or the equivalent across the board as recently as July 2021. A series of upgrades has brought the ratings to A-minus or equivalent, still the lowest of any state.

Eric Kim, Fitch Ratings’ head of state government ratings, said that “constitutional limitations” in Illinois act as a barrier to modification of the state’s “elevated pension obligations.” And he noted that because the Supreme Court decision involved local pension funds rather than the state pension funds weighing on Illinois’ budget, it likely will not affect Illinois’ A-minus rating or stable outlook from Fitch. 

“Sustained progress toward structural balance and improved liability management, primarily through materially narrowing the wide gap between actual and actuarially determined pension contributions, could be a positive if Illinois were able to achieve this,” Kim said. “Conversely, reverting back to unsustainable fiscal measures such as deeper pension funding deferrals could be a negative rating driver if Illinois were to head down that fiscal path.”

S&P also assigns the state a rating of A-minus with a stable outlook. S&P Director Scott Nees said he did not foresee a rating change at this time. The consolidation has already been factored into S&P’s analysis, he said. 

While S&P expects the consolidation to cut administrative costs and help produce better long-term investment returns, “the net positive impact in these areas will be incremental and not large enough to drive credit ratings,” he said.

“Pension funding remains a credit driver for the state rating and also is important in our city and town analysis,” said Joseph Vodziak, associate director at S&P. “The state has been taking actions to improve overall pension discipline in the past few years, and we have incorporated those actions into our state rating.”

Kroll Bond Rating Agency — which recently affirmed the state’s junior obligation Build Illinois Bonds sales tax revenue bonds at AA-plus with a stable outlook — declined to comment. Moody’s, which has assigned Illinois an issuer rating of A3, outlook stable, did not respond by press time.

“It is always our hope that rating agencies will recognize our efforts, and we’re proud of the nine upgrades we have already received,” Pritzker spokesperson Gough said.

He noted that while local property taxes are ultimately decided by municipalities, “local governments are already seeing reductions in the payments they are required to make into the system.

“Whether they are returning those savings to local taxpayers or spending those savings elsewhere is a question for local governments,” he added.

It remains to be seen if the statewide first responders’ funds’ managers will prove to be better stewards than their predecessors.

As for investment returns, the governor’s office insists that’s a long game, and acknowledges “market forces” may impact the funds in the short term.

According to the Illinois Firefighters’ Pension Investment Fund’s most recent quarterly report, the fund had three-month net cash flows of negative $2,657,813 and a net investment loss of $257.89 million in the third quarter of 2023. The Police Officers’ Pension Investment Fund’s most recent quarterly report shows total assets dropped to $9.196 billion from about $9.4 billion during the third quarter, a net investment loss of $305 million.  

So was the expensive, multi-year lawsuit worth it? To settle the matter democratically, IPPFA’s McNamee suggested, maybe so.

“Democracy is messy; it costs more than dictatorships,” he said. “But then you have less say in what’s going on around you. There’s a reason why people like having a say in local governments.

“We still are involved, and we’ll still be checking with the investment board about how our assets are invested,” he added of pension fund trustees. “We still do our job, and our job still should be to hold their feet to the fire to make sure they’re performing well.”