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.

After market returns far exceeded expectations in fiscal year 2021, fiscal year 2022 was a difficult year that saw many pension systems post negative returns for the year. VRS recorded a 0.6% return for the year, which was below the expected long-term rate of 6.75% but exceeded many of its peers in a challenging year for investments. The volatile markets highlight the need to explore opportunities to further strengthen the health of the plans, particularly the statewide retirement and Other Post-Employment Benefits (OPEB) plans.

Key results and findings of this report:

• Following robust market returns in fiscal year 2021, future investment performance in the near term may be materially lower than both historic norms as well as projected returns over longer timeframes. This was true for fiscal year 2022 in which VRS had an investment return of 0.6% and the recently announced fiscal year 2023 return of 6.1% came in below the assumed 6.75% return.

• New target fund allocation was adopted and reflected in projections throughout this report.

• 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.

o In recognition of the importance of reducing long-term liabilities with the benefit of achieving savings over time, the Governor and legislature provided a one-time infusion of $750 million in June 2022 with an additional $275 million provided in June 2023. In addition, the Governor and General Assembly also expect to provide $55 million in June 2024 to certain Health Insurance Credit programs.

o Further, to provide additional funds into the plans, the Governor and General Assembly maintained the contribution rates in FY 2023 and FY 2024 at the same level as the previous biennium which improves plan health by lowering unfunded liabilities and generating savings over time. (Due to exceptional FY 2021 investment performance, the rates for FY 2023 and FY 2024 would have otherwise declined.)

• As roughly two-thirds of benefits are funded by investment income, receiving 100% of the Board-certified actuarially determined contributions not only avoids adding unfunded liabilities to the plans, but also ensures timely availability of assets to be invested to take advantage of compound interest. Of note, 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 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, 2022 Annual Actuarial Valuation. In this report, the focus is on:

• Muted economic forecasts including higher than expected inflation and more volatility in the markets.

• Non-investment related risks that can impact plan cash flow and costs.