Over the course of two meetings on October 10 and 17, the Virginia Retirement System (VRS) Board approved a lower assumed rate of return (also referred to as the discount rate) and voted to certify to the Governor and General Assembly increased employer contribution rates for the teacher and state pension plans over the next biennium. These actions will have significant state and local fiscal impact.
On October 10, the Board voted to reduce the assumed rate of return from 7% to 6.75%. In FY 2019, VRS received a 6.7% return on its portfolio. The Board’s action stems from the belief that a lower assumed rate of return more accurately reflects the challenges of near-term investment environment forecasts and establishes a reasonable rate to determine set employer contribution rates and funded status of the plans. An investment return assumption that is set too low will overstate liabilities and costs, causing current stakeholders (i.e. employer contributors) to be overcharged and future stakeholders to be undercharged. Conversely, a rate set too high will understate liabilities, undercharging current stakeholders at the expense of future stakeholders. VRS last lowered its assumed rate of return in 2010 from 7.5% to 7%.
On October 17, the Board voted to increase the employer contribution rate for the teacher plan from 15.68% to 16.62%. The primary driver of this increase was the newly lowered assumed rate of return and the desire to maintain the funded status of the plan by increasing employer contributions. Over the long term, actual investment returns, benefits, and expenses determine the amount of contributions. This is expressed in the basic funding equation of “Contributions + Investment returns = Benefits + Expenses.” The current funded status of the Teacher Plan is approximately 74% of total liabilities, which are approximately $13.1 billion.
The increase in contribution rates will have an annual estimated state fiscal impact of approximately $90 million and an annual estimated local fiscal impact of approximately $120 million. The employer contribution for the teacher plan is shared by the state and local governments in accordance with the Local Composite Index for positions recognized in the Standards of Quality (SOQs). However, the employer pension costs of any positions employed beyond these standards are borne entirely by local governments.
The Board expressed confidence that the General Assembly would commit to supporting the state share of the employer contribution rate for the plans. Final contribution rates for the statewide plans will become available following the biennium budget process. Combined with projected revenue forecasts anticipated growth in other state budget obligations such as Medicaid, K-12, and higher education, the increase in commitments to VRS are likely to add further strain to available general funds in the coming biennium.
The VRS staff actuary will present summary information for local governments at the Board’s next meeting on November 20, with rates mailed to localities after January 1, 2020. Final contribution rates will be available at the conclusion of the 2020 General Assembly and will take effect on July 1, 2020 for FY 2021-2022.
A presentation on the overall status of VRS given to the Senate Finance Committee by VRS Director Patricia Bishop is available here.
VACo Contact: Jeremy R. Bennett