Health benefits for retired public workers: the next muni bond crisis?

By Alison Frankel
July 7, 2014

The Illinois Supreme Court set off some pre-holiday fireworks ruling Thursday that the state constitution protects health benefits for retired public workers — even though the constitution’s so-called pension protection provision does not specifically mention healthcare coverage.

The state high court said that subsidized healthcare is one of the benefits of membership in the state’s public pension systems so it falls within the broad ambit of the clause, which bars impairment of state employees’ pension and retirement benefits.

The ruling in Kanerva v. Weems aligns Illinois with Hawaii and Alaska, the two other states that have construed constitutional protection for public pensions to encompass healthcare benefits. Other states, most notably New York, have held that similarly phrased clauses shielding state workers’ pensions do not prohibit states from shifting healthcare costs onto retirees.

As Reuters reported over the weekend, the state supreme court’s decision does not directly strike down a 2012 Illinois law requiring retirees to contribute part of the cost of their healthcare coverage, but reinstates a consolidated challenge to the law by public workers’ unions. The governor’s office has said it is still confident the law will be deemed constitutional. Other experts seemed dubious that the 2012 pension reform law would survive.

Assuming it does not, will holders of Illinois debt end up feeling the pain of the state’s constitutional obligation to cover the healthcare costs of retired public employees? And if so, is the pain likely to spread to debt holders in other states whose retirees’ benefits are protected by similar provisions?

Not according to longtime Chicago bankruptcy lawyer James Spiotto, now at Chapman Strategic Advisors. Spiotto said there’s a difference between the retirees’ contractual rights and the property rights of bondholders. Even though the new ruling says the constitution prohibits interference with the healthcare benefits of public pensioners, Spiotto said, the retirees are not entitled to revenue streams that back public debt. “Bondholders get paid first,” he said.

Donald Craven, one of the lawyers representing retired Illinois State workers in the pension reform challenge, agreed with Spiotto that the Supreme Court ruling does not give public pension funds any rights over bondholder revenue streams.

Instead, he said, constitutional protection for retirees’ healthcare coverage means the state may have to curb some discretionary spending. “It’s not that we don’t have enough money, though some would say we didn’t spend the money wisely,” Craven told me. “We’re not going to have a tag sale.”

Nor will Illinois — or any other state with a constitutional pension protection clause that is deemed to encompass retirees’ healthcare coverage — have to sacrifice essential government services or infrastructure to pay those benefits, at least according to Spiotto. “As a practical matter,” he said, “states can only pay what they have.” Illinois would probably still be permitted to cut its healthcare obligations to retirees “in a limited way and for a higher purpose,” Spiotto said.

He also pointed out that retirees will lose bargaining power if Illinois municipalities are forced into Chapter 9 bankruptcies; U.S. bankruptcy judge Steven Rhodes ruled last December in Detroit’s historic Chapter 9 that insolvent cities, in some circumstances, can cut constitutionally protected retiree benefits. Federal bankruptcy judge Christopher Klein is poised to decide the same question in the Chapter 9 bankruptcy of Stockton, Calif., when trial in that case resumes this week.

Law professor emeritus Edward Kionka of Southern Illinois University, who argued for retired workers at the state supreme court, said that the ruling will force Illinois lawmakers to make good on their unfunded obligation to retired workers, a liability they’ve been ducking for decades. “They’ve been unwilling to do the other things they need to balance the budget,” he said. “How they’re going to do it now, I don’t know.”

Kionka said that constitutional protection for state pensioners’ healthcare coverage is under consideration in lower court outside of Illinois, including a North Carolina appeals court. The Illinois decision may reverberate in other states with broadly worded pension protection clauses, though, as Kionka noted, its impact will depend on the language of other states’ constitutional clauses and of their laws shifting healthcare obligations to retirees.

Illinois’s constitutional pension protection provision, for instance, was based on New York’s — yet the Illinois Supreme Court reached a different conclusion than the New York Court of Appeals about whether healthcare costs fall under the constitutional shield. In a 1985 case known as In re Lippman, New York’s Court of Appeals concluded that a local school board was not violating the state constitution when it hiked retirees’ premiums for healthcare coverage.

In her dissent from Thursday’s decision, Illinois Justice Anne Burke said New York’s Lippman precedent supports Illinois’s 2012 Illinois pension reform, but the six justices in the majority said the Lippman case is distinguishable because (among other things) Illinois imposed a whole new requirement on pensioners, unlike the local school board in New York, which just boosted the contribution rate.

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