RD271 - Virginia Retirement System (VRS) Stress Test and Sensitivity Analysis – August 2020

Executive Summary:

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

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:

• COVID-19 creates uncertainty in global markets and unpredictable impacts to future market returns.

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

• 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. However, available resources to take such action are limited at this time due to the current economic climate and uncertainty regarding revenue.

• Adjustments to mortality assumptions are expected in spring of 2021 as part of the next quadrennial plan experience study. New tables suggest additional improvements in mortality are likely, which could increase plan liabilities in coming years. However, as a matter of course VRS has routinely adjusted its mortality assumptions to reflect actual plan experience. Therefore, the impact of the new mortality tables may be muted by VRS’ long-standing demographic assumption review, analysis, and adjustments conducted to more closely align assumptions and tables with actual plan experience. In addition, COVID-19 may affect longevity expectations, but it is too early to have any relevant data related to these potential impacts.

• 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. The Governor and General Assembly met and even accelerated the statutory requirement to fund 100% of the Board-certified contribution rates.

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

This report is intended to assist policymakers and stakeholders in assessing the soundness of the System. To better understand the risks associated with funding the System, this report examines a range of potential outcomes, both economic and demographic, that could endanger the long-term funding of the System and prevent the System from reaching full funding. Again, this report focuses primarily on analyzing negative outcomes, since such outcomes would result in the greatest challenges for the plan sponsors and System.

This report is based on the June 30, 2019 Annual Actuarial Valuation and reflects the changes that have occurred over the past year, including the changes to actuarial assumptions adopted by the VRS Board of Trustees in April 2017, and the change in plan discount rate adopted in October 2019. In this report, the focus is on:

• The impacts of COVID-19 and resulting forward looking expectations.

• Risks to long-term funding, including investment volatility, contribution risk, and longevity risk.