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Posted at 3:30 PM ET, 07/13/2010

Virginia pension fund assumes too much return

By Paige Winfield Cunningham

As states act out the National Pension Scandal, Virginia's on stage but trying to stay out of the spotlight.

Seven states are on track for their pension funds to run dry by 2020. But while Virginia's not in deep water like Illinois and New Jersey, the state is still wading in problems.

The recession has cost Virginia 21 percent of its portfolio over the past few years. Sixty percent more employees are retiring now than did last year. Virginia has to pay back the $620 million that legislators withheld from the fund this year in order to balance the budget. And the stock market is still shaky.

At least Virginia Retirement System officials are now realizing they allow too much risk and are making changes. Yesterday, the board of trustees voted to:

- Assume a lower rate of return on investments, dropping expectations from 7.5 percent to 7 percent.

- Invest in less risk and more stability, expanding bond investments from 30 percent to 40 percent and reducing equities from 70 to 60 percent.

Is the VRS pulling back enough?

Perhaps not, if you compare expectations to those made for private-sector plans. Assumed rates of return for private plans are regulated federally, meaning corporate investors are prohibited from assuming rates of return higher than the going rate for corporate bonds.

Recently, that rate has equaled 6.5 percent -- meaning that's the riskiest assumption permitted. At the same time, the VRS was still assuming 7.5 percent.

It's time for the VRS to stop taking liberties unheard-of in the private sector.

Paige Winfield Cunningham is an investigative reporter and managing editor at Old Dominion Watchdog. The Local Blog Network is a group of bloggers from around the D.C. region who have agreed to make regular contributions to All Opinions Are Local.

By Paige Winfield Cunningham  | July 13, 2010; 3:30 PM ET
Categories:  HotTopic, Local blog network, Va. Politics, Virginia  
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Comments

While I am concerned about State Pension plans, I am more concerned that the link to this article concludes with the phrase, "virginia_pension_officials_ass". Clearly an editorial staff bias.

Posted by: radioalarm | July 13, 2010 4:26 PM | Report abuse

What about the other actuarial assumptions in the plan? Specifically, what assumption does the plan make about salary increases? For example, on page 99 of the 2009 Report posted on the VRS website (http://www.varetire.org/Pdf/Publications/2009-Annual-Report.pdf), the actuaries assume that teachers are receiving between 3.75 and 6.2 percent salary increases every year. If actual salaries are increasing less rapidly in this economic environment, the system is overprojecting the growth of its liabilities. This would offset the impact of underprojecting investment return on assets. In other words, both the assets and the liabilities are likely to grow at a slower rate than the actuaries project.
VRS was prudent to make a slight adjustment in its assumption; these are long-term actuarial models, benefit obligations, and funding streams.

Posted by: AnnapolisReader | July 14, 2010 8:23 AM | Report abuse

Reading this article reminds one of when the Treasury ran the D.C. Teachers Pension Fund and stuffed it with "flower bonds." Although it was clear the Treasury had blantly mismanaged the fund, similar voices decried the cost of funding the pension.

As the recent WP article shows, however, the discount rate used by portfolio managers to value liablities has been consistent with the market returns. The move to change the rate is therefore inconsistent with market performance. Had state pension funds fully funded their liabilities each year their pensions would not be underfunded. In sum, changing (lowering) the discount rate for liabilities does nothing to discourage underfunding because it is inconsistent with historical rates of return, market profit expectations (be they debt of equity cash flows, or mature or emeringing markets.

Moreover, your resort to the "NEW" 6.5% long term rate begs the question of returns during the recent meltdown, long term returns vary but not as rapidly as you suggest (have you ever managed a fund of are you just talk), and there appears to be only one direction for rates to go and thats up.

Rather lowering the discount rate is merely a public opinion ploy to excuse the undefunding, lower pension benefits, and blame the victum - pension recipients. The arbitrary lowering of the rate dramatically creates or increases an unfunded liablity to the point where it is so large it is impossible to pay.

Conversely, lowering the discount rate will, if states fulfill their obligation to fund them, lead to overfunding of the pension, i.e. the state will pay to much. If a pension earns 9% and the liabilities are priced at 3.5% the pension is overfunded by the amount equal to 5.5% of the liabilities present value. Just as such situations encouraged corporate raiders or funded acquisitions, it will be nothing less than a new political slush fund for the states.

Fianlly, the fact lowering the liability discount rate is a political ploy is reinforced by the misapplication of certain theroetical understandings - especially risk, arbitrage, and equity cash flow pricing.

The best testimony as to the use of theory devoid of reality comes from the GASB itself:

"It should be noted that the Preliminary Views relates solely to accounting and financial reporting and does not apply to how governments approach the funding of their pension plans. At present, there generally is a close connection between how governments fund pensions and how they account for and report information about them in audited financial reports. The principles and concepts in the Preliminary Views would separate how the accounting and financial reporting is determined from how pension benefits are funded."
reporting is determined from how pension benefits are funded.

Posted by: CarlMarks | July 14, 2010 11:42 AM | Report abuse

Reading this article reminds one of when the Treasury stuffed th D.C. Teachers Pension with "flower bonds."Although it was clear the Treasury had blantly mismanaged the fund, similar voices decried the cost of funding the pension.

As the recent WP article shows, however, the discount rate used by portfolio managers to value liablities has been consistent with the market returns. The move to change the rate is therefore inconsistent with market performance. Had state pension funds fully funded their liabilities each year their pensions would not be underfunded. In sum, changing (lowering) the discount rate for liabilities does nothing to discourage underfunding because it is inconsistent with historical rates of return, market profit expectations (be they debt of equity cash flows, or mature or emeringing markets.

Moreover, your resort to the "NEW" 6.5% long term rate begs the question of returns during the recent meltdown, long term returns vary but not as rapidly as you suggest (have you ever managed a fund of are you just talk), and there appears to be only one direction for rates to go and thats up.

Rather lowering the discount rate is merely a public opinion ploy to excuse the undefunding, lower pension benefits, and blame the victum - pension recipients. The arbitrary lowering of the rate dramatically creates or increases an unfunded liablity to the point where it is so large it is impossible to pay.

Conversely, lowering the discount rate will, if states fulfill their obligation to fund them, lead to overfunding of the pension, i.e. the state will pay to much. If a pension earns 9% and the liabilities are priced at 3.5% the pension is overfunded by the amount equal to 5.5% of the liabilities present value. Just as such situations encouraged corporate raiders or funded acquisitions, it will be nothing less than a new political slush fund for the states.

Fianlly, the fact lowering the liability discount rate is a political ploy is reinforced by the misapplication of certain theroetical understandings - especially risk, arbitrage, and equity cash flow pricing.

The best testimony as to the use of theory devoid of reality comes from the GASB itself:

"It should be noted that the Preliminary Views relates solely to accounting and financial reporting and does not apply to how governments approach the funding of their pension plans. At present, there generally is a close connection between how governments fund pensions and how they account for and report information about them in audited financial reports. The principles and concepts in the Preliminary Views would separate how the accounting and financial reporting is determined from how pension benefits are funded."
reporting is determined from how pension benefits are funded.

Posted by: CarlMarks | July 14, 2010 11:45 AM | Report abuse

It is time to end bureaucrat pensions and stop the rape of future generations. If bureaucrats want a happy retirement, try putting off buying an iPhone or BMW for once in your life.

Posted by: jiji1 | July 15, 2010 5:10 PM | Report abuse

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