RD560 - Virginia Retirement System Stress Test and Sensitivity Analysis – December 2018

Executive Summary:

The purpose of this report is to assist the VRS Board, stakeholders, policymakers and the public to better understand and assess the risks inherent in the funding of the pension system. This year’s report investigates various risks faced by VRS and measures their potential impact on the defined benefit programs.

Over the last fiscal year, financial markets have provided better than assumed returns, positively impacting projected funding levels and contribution rates. While VRS was a leader in lowering the expected long-term rate of return of the pension funds, several risks remain and opportunities exist to further strengthen the health of the plans, particularly the statewide retirement plans.

Key results and findings of this report are:

• Strong investment performance in fiscal year 2017 mitigated some of the impact of the assumption changes resulting in slightly lower contribution requirements for most plans.

• Significant resources must remain dedicated to addressing the amortization of the legacy unfunded liabilities.

• The outcomes related to investment risk for VRS statewide retirement plans with large unfunded liabilities would be more severe than the better funded local retirement plans.

• Analysis suggests that accelerating the payback of the legacy unfunded liabilities could provide significant long-term savings and better position the statewide plans to weather future volatility in investment returns, thereby serving to reduce investment risk.

• Even while mortality assumptions have already been adjusted to reflect members living longer, new studies suggest additional improvements in mortality are likely, which could increase plan liabilities in coming years.

• Decreases in active covered membership in some statewide plans could cause increases in future employer rates as a percentage of a smaller covered payroll.

• As roughly two-thirds of benefits are funded by investment income, receiving 100% of the Board-certified actuarially determined contributions not only avoids adding liabilities to the plans, but also ensures assets are available timely to be invested and take advantage of compound interest.

• Pension reforms, specifically plan design changes, have reduced the future costs of benefits. In addition, these reforms have reduced employer’s risk by introducing shared risk in the defined contribution component of the hybrid plan. Approximately 30% of a hybrid member’s benefit has no future investment or longevity risk for employers.

• Due to strong market returns and movement to fully funding the actuarially determined and Board certified contribution rates, unfunded liabilities have declined and over the last five years the funded status of the plans has improved by approximately 10 percent.