Virginia is facing a big bill for failing to fully fund pensions for state employees and teachers — an estimated $160 million in each year of the two-year budget that the General Assembly and next governor will adopt in 2014.
And that’s just to fund 80 percent of the contributions the Virginia Retirement System says the state should make to ensure the pension system can pay long-term liabilities for state workers and teachers.
The estimate, given by Virginia Retirement System Director Robert P. Schultze to a legislative commission on Monday, represents an additional $320 million in state funds — nearly a third of what Virginia is already paying into the pension plans over the biennium.
The additional funding would be required for the next biennium under a commitment made by the legislature and Gov. Bob McDonnell last year to fully fund VRS certified rates by 2018-2020.
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“It will be important to stick with the plan,” Schultze told the Joint Legislative Audit and Review Commission on Monday.
The stakes are high for Virginia, which underfunded state and teacher pensions by $236 million in the budget year that ended June 30, based on the actuarial rates adopted by the VRS board of trustees two years ago.
The deepest damage to the retirement system was done in the previous biennium, when the state funded about one-third of the recommended contribution rates to avoid layoffs and major cuts in state services during the recession and slow recovery.
Still, legislators received some good news Monday from VRS, which estimates that it ended the most recent fiscal year with an 11.2 percent return on investments for a retirement system with $58.2 billion in assets.
The performance puts the retirement system just short of the $58.3 billion it was worth in 2007, before the recession sent investments plunging to a low of $42.6 billion two years later.
The VRS just implemented a new approach to making and evaluating investments to ensure the system achieves an average annual return of at least 7 percent “without adding significantly to the volatility of the portfolio,” VRS Chairwoman Diana F. Cantor told the legislative commission.
The volatility of investment markets has been a factor in the declining funded status of the retirement plans managed by VRS for state and local government employees, especially teachers.
VRS lost 21 percent on its investments in 2009, but rebounded with returns of 19.1 percent and 14.1 percent the next two years, respectively. The system then showed a return of just 1.4 percent in the 2012 fiscal year, before recovering again this year.
The VRS board has lowered its expected annual return twice, from 8 percent to 7.5 percent and then to 7 percent to reflect the uncertainty of financial markets.
But the General Assembly has continued to base its funding decisions on an expected annual average return of 8 percent. The result has been a widening gap between what VRS and its actuary say the system needs and what the state has been willing to pay.
The VRS will set contribution rates in October for state employee and teacher pensions for the next two years. It will set rates for hundreds of local government retirement plans in November. Local governments must pay the VRS rates, but the General Assembly and governor determine how much Virginia will contribute to state employee and teacher retirement plans.
Local school divisions pay a share of the cost of teacher pensions, but they will show all of the unfunded liabilities for the teacher retirement plan on their financial books in two years under new standards adopted by the Government Accounting Standards Board
“You don’t really think they’re going to sit still for that, do you?” asked Sen. John Watkins, R-Powhatan.
Local governments are likely to seek a remedy with the General Assembly next year that changes how pension contributions are made so the accounting liabilities are shared by the state, Schultze replied.
Under the new accounting standard, almost $15.2 billion in unfunded teacher pension liabilities would have to be divided among local school divisions and the governments that fund them. The change would result in an estimated new liability of almost $544 million in Chesterfield County and $507.4 million in Henrico County.
The recognition of the unfunded liabilities could result in lower bond ratings — and higher borrowing costs —for 2 percent of local school divisions throughout the United States, Schultze said.
The fallout should be less for states because bond-rating agencies already know their pension liabilities, Schultze said. However, he and other VRS officials emphasized that Moody’s and other rating agencies are watching to ensure Virginia lives up to its commitment to fully fund pension contribution rates by 2018-2020. If it does not, the calculation of liabilities will increase substantially.
“The only thing you have to worry about is whether Moody’s thinks we’re sticking with the plan,” Schultze said.
VRS and its investment team say they have made the changes necessary to generate a return large enough to help pay the system’s costs — including about $2 billion more a year in payments to retirees than in contributions to the system.
Asked by one legislator whether the system will have the money to pay its obligations in 50 years, VRS Chief Investment Officer Ronald D. Schmitz replied, “I think that’s more in your hands than mine.”