Virginia and its local school systems would pay more in pension benefits for their employees in the next two-year budget under new contribution rates that reflect lower expectations for long-term investment gains by the $82.3 billion retirement system.
The Virginia Retirement System board of trustees adopted new rates on Thursday for five pension plans to fund retirement benefits for state employees — including state police, law officers and judges — and public school teachers. With the exception of judges, all of the contribution rates were higher than those adopted two years ago for the current budget.
The rates reflect a decision by the board last week to lower the assumed long-term rate of return on retirement system investments from 7% to 6.75%. Investment returns pay about two-thirds of the cost of pension benefits for more than 85,000 state employees and almost 150,000 teachers, as well as retirees and former employees.
In the fiscal year that ended June 30, VRS earned 6.7% on its investments, below the assumed long-term rate of 7% that had been used since 2010 to determine contribution rates. However, last year’s return was close enough to expectations that it had “limited impact on results,” said Wallace “Bo” Harris, a retired state employee who chairs the board’s benefits and actuarial committee.
Going forward, the lower assumed rate of return will have a major effect on the state budget. It will require an estimated $215.6 million more in contributions in each year of the next two-year budget — $93.8 million from the state and $121.8 million from local school divisions — if the General Assembly and Gov. Ralph Northam adopt the VRS rates next year. The state and localities share the cost of teacher pensions.
State and legislative budget officials endorsed the decision to lower the assumption for future investment returns, which VRS called “the single most consequential” factor in determining what contributions will be required from government employers for future employee retirement benefits.
“I know it’s going to take more money out of the budget, but it’s the right thing to do,” Secretary of Finance Aubrey Layne said in an interview.
House Appropriations Chairman Chris Jones, R-Suffolk, also said he supports the board decision because of the current investment environment.
“That’s a prudent move at this point,” Jones said in an interview.
Sen. Tommy Norment, R-James City, co-chairman of the Senate Finance Committee, said in a statement: “The secretary of finance has expressed some concerns about the sustainability of state revenues. I respect his judgment. A conservative approach is better than an aggressive one.”
The new VRS rate of return assumption is among the lowest among public pension systems in the U.S. Seven other pension systems assume a return of 6.75%, while six use a lower rate.
The decision to lower the rate of return will increase the unfunded, long-term pension liabilities for the five state retirement plans by about $2.3 billion — from $18.4 billion to $20.7 billion. It also will lower the funded status of the plans — a measure of current funding for expected future obligations — by about 2 percentage points to 74.5% for state employees and 73.5% for teachers.
The funded status had fallen to 65% for state employees and 62% for teachers in 2012, before the state enacted pension reforms to lower long-term retirement costs, commit the state to paying its full share of retirement contributions, and pay back contributions the state had deferred in 2010 to avoid deep budget cuts after the recession.
Beginning in 2013, VRS began reducing its unfunded liabilities over 30 years. The reforms also included creation of a hybrid retirement plan — combining traditional pensions and 401(k)-style savings plans — that reduce state and school system retirement obligations for most state employees and teachers hired after Jan. 1, 2014.
“As more and more people go into the hybrid plan, we’ll see rates fall,” said Larry Langer, principal at Cavanaugh Macdonald, the system’s private actuary.
“It takes time for these kinds of reforms to take place,” Langer said. “It is taking place and pension reform is working.”
The retirement contribution rates adopted on Thursday would require government employers to pay 14.46% of payroll for employees in the main state plan; 16.62% for teachers; 26.26% for state police; 21.88 for other sworn state law officers, such as game wardens and marine police; and 29.84% for judges.
The rates increase about 1 percentage point for teachers and most state employees. The rate for judges fell because the state filled dozens of vacant judicial slots in the current budget, increasing the overall payroll in the plan, Langer said.
Employees contribute 5% of pay toward their retirement plans. Those hired under the hybrid plan contribute 4% to their pension and at least 1% toward their individual savings plans.
VRS based the rates on an actuarial analysis of the system’s assets and obligations on June 30. The retirement system uses the actuarial valuation to set employer contribution rates every two years for inclusion in the two-year budget that the General Assembly and governor approve in even years.
VRS will approve contribution rates for other local government employees next month. The retirement system serves about 722,000 active and inactive members, retirees and beneficiaries.
The rates approved on Thursday will affect local school budgets, which include teacher pension costs.
Henrico County Manager John Vithoulkas estimated that the 1 percentage point increase in the teacher contribution rate will cost the county $3.8 million to $4 million.
But Vithoulkas called the decision to lower the investment return assumption “a smart play” to ensure that the retirement plans are sustainable. “I think it’s the fiscally wise choice,” he said.