Bipartisan Study Group Says Va. Retirement System Too Far in Debt for Reform

By Bill McMorris, Virginia Statehouse News Tuesday, December 13, 2011

RICHMOND - Gov. Bob McDonnell may have shot his vision of major pension overhaul in the foot when he failed to contribute fully to the state's retirement system in 2010.

A report from the Joint Legislative Audit and Review Commission, or JLARC, a bipartisan study group, said the state should not embark on major pension reforms until the Virginia Retirement System's $19.9 billion debt is under control.

"The options are limited … because of existing unfunded liability," JLARC project leader Tracey Smith said at Monday's JLARC meeting. "Even if changes are made, the existing liability will not be reduced."

JLARC Chairman Sen. Chuck Colgan, D-Manassas, asked JLARC to examine the pension system in February after McDonnell's reform stalled in committee. Smith reviewed several proposals, including raising retirement ages and contributions for state workers, as well as implementing a 401(k)-style system.

The state operates under a defined-benefit plan in which workers earn lifelong paychecks based upon a percentage of their final income. The average state retiree leaves government service at age 62 and earns about $20,000 per year.

The report, titled “Review of Government Benefits for State and Local Government Employees,” found that the General Assembly's poor funding track record would hamper efforts to curb future costs with major reform.

If McDonnell and House Republicans move forward with a plan to replace the traditional system with 401(k)-style accounts, they first would have to pay off the entire $19.9 billion debt and incur start-up costs, said Smith. And raising employee contribution rates could make for an unhappy workforce given the state's own history.

"Employees would feel they are not just paying for their accrued benefits, but for the unfunded liability due in part to underfunding" by the state, Smith said, citing a JLARC survey of 5,000 workers, a majority of whom said they would be unwilling to contribute more than 5 percent.

McDonnell required employees to contribute 5 percent toward their retirement in exchange for a 5 percent pay raise for state workers in 2011. State employees previously paid nothing toward their own retirement.

McDonnell repeatedly has touted a 401(k)-style system as a cure-all for the pension system because employees, rather than the state, would take responsibility for investment decisions. JLARC said such a measure, though likely to save the most amount of future debt, is a step ahead of tackling the short-term problems of the system.

"The General Assembly may wish to amend the Code of Virginia to specify a minimum acceptable funded ratio," the JLARC briefing said.

Such a move would bind the hands of lawmakers to come through with additional funding every year on top of the regular pension payments, which will continue to increase from the $1.3 billion the system required in 2011. The report did not specify anticipated start-up costs for the 401(k)-style plans.

Smith told the lawmakers that the General Assembly's consistent inability to fully pay into the system has added $1.6 billion in new pension debt during the past 10 years on top of the money the state should have put into the system.

Since 2000, when the state had more than 100 percent funding in the system, the state has met the full Virginia Retirement System, or VRS, contribution request just one time — a $720 million payment in 2001.

The state system now has about $50 billion in the system, or less than 75 percent of what is needed to cover retirement costs for 600,000 state workers and retirees. A recent report from Boston College economists revealed that the state may have less than 65 percent funding under revised government accounting standards, which would increase short-term pension debt.

A pension fund is considered healthy at 80 percent funding, according to actuarial standards.

The contribution rate has plummeted under McDonnell. Since 2009, Virginia has ranked 37th in the country for state pension contributions, due in part to McDonnell's decision to defer a $620 million payment at 7.5 percent interest, according to JLARC.

Smith said the deferment was an incomplete picture.

"You always hear about this $620 million figure, but the number was closer to $1.1 billion on the year (2010). That's how far below the VRS rate we came in" in 2010, she said.

McDonnell's office did not return calls or emails seeking comment.

Smith said transparency would be the best reform the state could make.

"If the General Assembly and the governor are going to fund the retirement system at rates that are less than what the (VRS) board requests, then they should at least provide a fiscal analysis of the implications," she said.

The General Assembly has total discretion to pay into the system. Under JLARC's recommendation, lawmakers, for the first time, would have to put a price tag on their decision to underfund the pension system, including how much future liability would be created by the deficit. The move would allow taxpayers, state employees and lawmakers to get a better handle on the enormity of pension costs, Smith said.

The funding disparity is built into the way the General Assembly approaches contribution estimates.

The VRS assumes that every dollar put into the system will achieve 7 percent growth over a 30-year period. The General Assembly puts that rate at 8 percent. Since the latter assumes larger growth, the General Assembly can make a smaller contribution into the system and technically still abide by actuarial standards.

Small actuarial variables make a big difference in approaching pension debt. The VRS is $19.9 billion in the red, according to state estimates. That number ballooned to $50 billion when economists looked at the debt through the lens of private-sector accounting standards.

Colgan ordered the commission study after McDonnell's attempt at reform got held up in committee earlier this year. He praised JLARC for its contribution to the debate.

"We had a very difficult time with pensions in committee," he said. "I think these are some good guidelines going forward … when the governor looks at pensions."

McDonnell was in Blacksburg attending the funeral of Virginia Tech Police Officer Deriek Crouse, who was shot and killed Thursday by a Radford University student.

Delegate Lacey Putney, I-Bedford, who sponsored McDonnell's define-contribution measure last session, said he is unsure if McDonnell will make another attempt.

"He has not talked to me about carrying it through," he said. "If he did, I would like to see it set up as an option."

The JLARC proposal is the most complete reform picture the General Assembly will have when session begins Jan. 11.