Virginia pension fund in trouble if market meltdown hits

RICHMOND, Va. (AP) — Virginia’s pension fund is in a worse position to handle a market meltdown than it was before the Great Recession more than a decade ago, according to a recent state report. That’s despite a 10-year bull market and pension reform efforts by lawmakers to make the fund more resilient.
The Virginia Retirement System’s recent “stress test” predicts that a market crash or several years of lower-than-expected returns would add billions to the plan’s current unfunded liabilities. Such hits would leave lawmakers with limited and painful options, like slashing services or raising taxes to meet required contribution levels or underfunding the pension plan and leaving higher costs for future generations to pay off.
“If we were to go through what we did in ’08 and ’09, we’re screwed,” said Secretary of Finance Aubrey Layne said in an interview earlier this year. “We’re screwed, I don’t know what else to say.”
The Virginia Retirement System is one of the biggest in the country and serves about 705,000 current and retired state employees, public school teachers and certain city and county public sector workers. Contributions from the state, these agencies and their employees fund one-third of the pension fund while investment returns make up the rest.
A fiscally conservative state without strong public sector unions, Virginia has avoided pension crises that have hit states like Illinois, New Jersey and Kentucky. Lawmakers in those states have responded to massive unfunded liabilities by proposing tax hikes or limiting pension benefits.
But Virginia lawmakers skimped on contributing to the pension fund for decades, paying only a portion of the yearly amount that actuaries said was needed. And losses from the Great Recession, which saw the fund lose 21 percent of its value in 2009, have also helped put the fund’s health at risk.
The stress test was done based on the value of the retirement system’s fund as of June 30, 2017, when the unfunded liabilities for just the state employees’ portion of the plan was about $5.8 billion and the total unfunded liabilities were more than $20 billion. Among the findings:
—If financial markets were to repeat what happened during the Great Recession, the unfunded liability for the state-employee plan more than double and hit $12.5 billion.
—If the pension fund were to see five years of 5 percent returns instead of the projected 7 percent, the state plan’s unfunded liability would increase $2.2 billion.
—If the pension fund were to see 10 years of 5 percent returns instead of the projected 7 percent, the state plan’s unfunded liability would increase $4.2 billion.
Virginia generally ranks in the middle of the pack in terms of its unfunded liability compared to other states. A study from The Pew Charitable Trusts last year found public pension systems around the country “may be more vulnerable to an economic downturn than they have ever been.”
The report also found that pension systems in North Carolina and Wisconsin are more likely to weather downturns because those states have been more fiscally disciplined.
Jim Regimbal, an economist who advises Virginia counties and cities, said he’s thinks a prolonged period of lower-than-projected returns is more likely than a market shock like the Great Recession. And he said local governments, which pay a higher share of teacher pension costs than the state, would be severely squeezed trying to make required contributions.
“It would rob money from every other program out there,” he said.
Patricia Bishop, director of the Virginia Retirement System, said her agency has tried to mitigate risk through a diverse portfolio of private equity, real estate and other assets that aren’t tied to a potential stock market drop. But she acknowledged there’s only so much the fund can do to avoid a downturn.
“There’s no magic pill,” she said.
She added that the fund has already reduced the cost of future benefits through a “hybrid” retirement plan that melds traditional defined benefits with a defined contribution plan like a 401(k), which employees direct and which can gain or lose value based on market fluctuations.
The fund’s most recent quarterly report, for the last three months of last year, shows how the fund is tied to market swings. The fund reported losing $4.4 billion between October and December when the stock market suffered big losses. The stock market’s bounced back this year, but the fund has not yet reported its latest earnings. Overall, the fund was down 1.3 percent in 2018.
State lawmakers have spent recent years trying to fix pension problems. They created the hybrid system, made one-time payments aimed to reducing the fund’s unfunded liabilities, and committed themselves to fully funding yearly contribution requirements going forward.
Republican Sen. Emmett Hanger, a co-chair of the Senate Finance Committee, said the worst-case scenarios described in the stress test are “scary,” but he believes the fund is in a relatively “comfortable position” because the General Assembly is more disciplined in pension funding and overall budgeting than in years past.
He said top lawmakers who write the budget are committed to fully funding the pension from now on and have no appetite for using it as a “piggy bank” like in years past.
“We’re on a good trajectory,” Hanger said.