RD435 - Virginia Retirement System Comprehensive Annual Financial Report for the Year Ended June 30, 2010


Executive Summary:
In the wake of the "Great Recession" and its devastating impact on global markets, the Virginia Retirement System (VRS) recorded a 14.1% return on its investment portfolio. This is a significant improvement over the -21.1% return for the previous fiscal year. As a result, VRS ended the year with $47.7 billion in assets compared to a beginning balance of $42.6 billion on June 30, 2009.

Thanks to a highly skilled and experienced investment team, VRS took advantage of improved market conditions and achieved a superior investment return. The public equity program is the largest slice of the portfolio, and it produced a 14.8% return while the second largest slice of the portfolio, fixed income, generated a return of 14.2%. Other significant contributors to the portfolio were the smaller credit strategies and private equity programs with returns of 22.2% and 17.3%, respectively.

The VRS Board of Trustees is committed to sound long-term investment strategies, and we have established for our investment team a flexible and opportunistic investment policy in order to manage risk and take advantage of attractive investment opportunities. The Board is proud of our investment team and the results they produce on behalf of members and beneficiaries. Nonetheless, we believe the outlook for economic growth and equity returns will be muted as a result of fundamental imbalances that still exist in the worldwide economy. Therefore, the Board of Trustees has established a more realistic long-term investment return assumption of 7.0%, down from the previous assumption of 7.5%.

Historically, over two-thirds of VRS benefits have been funded by investment gains and the remainder by employer and employee contributions. The move to 7.0% means that we expect, over the long term, VRS will need to rely somewhat more on annual contributions to maintain a trust fund sufficient in size to pay future benefits.

Even with this year's investment gains, the portfolio has still not returned to its year-end high of $58.3 billion at the close of fiscal year 2007, just prior to the Great Recession. The 2008 and 2009 market declines, combined with reduced contribution levels set by the General Assembly, continue to weigh on the funded status of the plans and will have to be corrected with substantially higher contributions in coming years. The current contribution rates for FY 2011 and FY 2012 for the state employee plans and the teacher plan are about half of what the VRS actuary and the Board of Trustees have recommended.

Legislation enacted during the 2010 session of the General Assembly established a new retirement plan (Plan 2) for members joining the system on or after July 1, 2010, and promises to reduce required employer contributions over time. But significant savings from Plan 2 are not expected for about ten years. In the meantime, it is important for policy makers to appreciate the need for restoring contribution rates to actuarially prudent levels in the next budget period and beyond.

The board is served by an able staff that continues to provide superior investment management, benefit administration and customer service. VRS' performance in the annual CEM, Inc. pension benchmarking survey underscores our conviction. In the most recent survey, VRS' cost per active member and annuitant was $53 compared to the peer median of $84. VRS also outperformed our peers with a total service score of 80 compared to the peer median of 75. In a separate review, the same organization found that the VRS investment department easily outdistanced the median one-year total returns of our peer pension funds. Furthermore, VRS staff produced this superior return while incurring lower investment management fees than comparably structured portfolios.

Our administrative team also successfully implemented major plan design changes enacted by the 2010 session of the Virginia General Assembly. In addition, the team processed an unprecedented surge in teacher retirements amounting to 5,371 retirement inceptions effective July 1, 2010, an increase of 48.2% from the previous year's 3,623 retirement applications. Finally, VRS continued its progress toward implementing the Modernization Program, which will introduce a new Web-based world for employers reporting to VRS, allow members and retirees to manage their benefits online and enhance customer service.