RD107 - Virginia Retirement System Comprehensive Annual Financial Report for the Year Ended June 30, 2013

Executive Summary:
I am pleased to present to you the Virginia Retirement System (VRS) Comprehensive Annual Financial Report for the fiscal year 2013.

The Virginia Retirement System (VRS) achieved an 11.8 percent net return on its investment portfolio for fiscal year 2013, ending the year with $58.4 billion in assets.

During fiscal year 2013, the public equity program returned 18.6 percent, the private equity program returned 11.7 percent, the real assets program returned 10.7 percent, the credit strategies program returned 10.5 percent and the fixed income program returned -0.1 percent.

The portfolio included $25.2 billion in public equity, $10.4 billion in fixed income, $10.6 billion in credit strategies, $5.0 billion in private equity and $5.5 billion in real assets, as of June 30, 2013.

The strong return on VRS’ investment portfolio resulted in $6.2 billion of added resources for the trust fund. As the market remained volatile after the 2008 financial crisis, the Board continued to focus on the appropriate asset allocation and risk profile of the trust fund.

The VRS Board appreciates the skills of the professional investment staff, which has provided superior investment management during very difficult economic times and has generated strong returns that will help secure the stability of the portfolio for members of the system. By expanding our internal investment team to manage more than one-third of the portfolio, VRS saved more than $11 million this year in investment management fees.

Good news on the investment front was matched by a technological step forward, as VRS rolled out a new online reporting system for employers. After extensive pre- and post-launch training, employers across Virginia began using myVRS Navigator in November 2012 for reporting and submission of contributions and reviewing their employee’s VRS account information. An Employer Transition Team assisted employers in accessing myVRS Navigator, updating employee data and producing reports. This new web-based platform provides a stable foundation for additional functionality in the future, including further improvements in both efficiency and customer service. In the next phase of Modernization, myVRS Navigator will be expanded in a number of areas like benefit calculations and distributions.

At the same time, VRS staff spent much of the year preparing to implement the new VRS Hybrid Retirement Plan for most employees hired on or after January 1, 2014. Communications, education and outreach to employers were a major focus of the year, as staff produced a variety of print and electronic resources to explain the new plan; held forums and presentations for employers; developed internal systems to meet the plan’s requirements; and provided answers to frequently asked questions about the plan and its features. Pension reform communication and systems development are on target for the plan’s rollout in early 2014.

The VRS Board offers its thanks to VRS’ administrative staff members for the time and effort they have expended on the launch of myVRS Navigator and in preparation for the Hybrid Retirement Plan. These major agency-wide initiatives have required “all hands on deck,” and staff members have demonstrated VRS’ core values of teamwork, integrity, agility and accountability in their work throughout the year.

To support the Hybrid Retirement Plan and the Commonwealth of Virginia Defined Contribution Plans, VRS selected ICMA-RC as our third-party record keeper. Founded in 1972, ICMA-RC is a U.S.-based, non-profit corporation and an established provider of public-sector retirement plans, serving approximately 9,100 public-sector plans and more than 1 million participant accounts, with $45.6 billion in assets under administration as of June 30, 2013. The transition from the current record keeper for the defined contribution plans, ING, will begin in late December 2013 and should be completed in January 2014. Because the changeover will be completely electronic, current plan participants will enjoy a seamless transition with no action required from them. In addition, they will see a decrease in the plans’ management fees, while the fund lineup will remain the same.

Another achievement this year was the development of a written funding policy. In June 2012, the Governmental Accounting Standards Board (GASB) issued Statement No. 67, Financial Reporting for Pension Plans, which addresses financial reporting for state and local pension administrators, and Statement No. 68, Accounting and Financial Reporting for Pensions, which establishes new accounting and financial reporting requirements for governments that provide their employees with pensions. The guidance outlined in these statements changes how governments calculate and report the costs and obligations associated with pensions in important ways. These statements make a definitive separation between funding for and accounting of pensions and move away from defining an “annual required contribution” that was used by VRS and other public sector employers as a de facto “funding policy.”

As a result, the VRS Benefits and Actuarial Committee began reviewing the VRS funding policy for defined benefit plans in February 2013 and recommended a written VRS funding policy that was approved by the Board at its October meeting. These approved funding principles include use of the Entry Age Normal actuarial cost method; use of the five-year asset smoothing method; amortization of legacy unfunded liability over a 30-year closed period, with new sources of unfunded liability explicitly amortized over 20-year closed periods; and the 10-year payback of the retirement contribution payments deferred for the 2010-12 biennium will remain as a separate 10-year closed amortization period, ending in fiscal year 2020.

VRS continued to work toward its goal of reaching full funding of the recommended contribution rates. Although encouraging, market returns are unlikely to make up the amount needed to support the system. Pension reform will help, but associated cost reductions will be slow to appear, since most benefit changes apply to future generations of employees. Pension reform by itself will not restore our funded status to prudent levels, unless it is also accompanied by contribution increases. In order to sustain VRS over the long term, we must continue to follow a three-point strategy in the coming years: pension plan design changes that will produce significant cost reductions within the next decade; reasonable investment returns; and legislative action to increase contribution rates to actuarially required levels.

A funding rate of 80 percent of the Board’s certified levels has been approved as a critical second step in the schedule by which contribution rates will gradually reach 100 percent of the Board’s certified levels by fiscal year 2019. We appreciate your continuing commitment, and that of future governors and legislators, to increasing contribution rates as we move forward toward our goal of full funding for these rates.

On behalf of the Board of Trustees and the VRS staff, I would like to express our gratitude to you for your continued support and leadership. The Board stands ready to assist you in fully implementing pension reform in Virginia.


/s/Diana F. Cantor
Virginia Retirement System