Long-Term VRS Performance Not Looking So Good

by James A. Bacon

Governor Terry McAuliffe announced Thursday that Virginia faces a budget shortfall of roughly $1.5 billion in the current biennial budget. That’s a big short-term problem, one of the worst in recent Virginia history — and possibly the worst ever during a period of economic expansion.

However, the long-term picture doesn’t look any better. The prime culprit is unfunded liabilities in an era of chronic low interest rates.

The official actuarial estimate is that the Virginia Retirement System faces a liability of $22.6 billion. As I have noted on many an occasion recently, that assumes that the VRS manages to generate an average 7% return on its $68 billion investment portfolio for the indefinite future. A year ago that didn’t look like such an outrageous proposition. Here’s what VRS’s portfolio performance looked like compared to national benchmarks:


Here’s what the VRS’s most recent (June 2016) comparisons look like:


What a difference a year makes. The average 10-year return is significantly below the assumed 7% figure. The five- and three-year returns do look better, but are they a better representation of likely long-term performance than the 10-year average?

The answer largely depends on which base year we choose to make our comparisons. The three- and five-year comparisons cover periods that were pure bull markets for stocks and bonds. The base year for the 10-year comparison was 2006… just before the Great Recession… thus including a major bear market correction as well as the subsequent bull market. I would argue that the 10-year comparison is more useful because it measures performance from the peak of the early-2ooos business cycle to the peak (or near-peak) of the current business cycle.

If we accept that logic, VRS is not achieving the portfolio growth it needs to meet its own 7% return-on-investment standard. While we can applaud VRS for out-performing its peer pension funds, we should not delude ourselves that 7% growth is a reasonable assumption. In all likelihood, VRS will fall short, and Virginia taxpayers will be called upon to make up the difference.

Perhaps my view is excessively pessimistic, but it is not implausible. The very least we can do is to conduct a sensitivity analysis. If VRS returns are only 5.6% over the next 10 years, then unfunded liabilities will increase to what level? $40 billion? $50 billion? We need to know our potential exposure should things not work out as we hope. It’s better to know this now, when we can plan for it, than get bushwacked by reality a decade from now.

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12 responses to “Long-Term VRS Performance Not Looking So Good”

  1. What is the relevance of “in an era of chronic low interest rates” at the same time as there were “bull markets for stocks and bonds”? The bottom line is, there were ways to achieve overall returns on investments during the past few years, even the past 10 years embracing the recession, far in excess of 7% — and VRS failed in that task. The question I’d like to know the answer to, is, were they constrained by overly-conservative investment guidelines (and if so, from what source), or did they simply “blow it” through inadroit or incompetent management?

    1. Acbar, low interest rates contributed to the bull markets in stocks and bonds. That is self-evident, is it not?

      As for VRS’s performance, it’s hard to be critical. (1) VRS pension managers have out-performed their peers fairly consistently. (2) VRS’ 7% assumption is actually more conservative than the return-on-investment assumptions of most states. I did raise an issue in a previous post whether VRS needs to pay such high management fees. But, again, I don’t think VRS practice is any different than other state pension funds.

      Bottom line: VRS didn’t blow it. It just needs to revise its return-on-investment assumption to a more realistic level. As Les notes below, that will entail unpleasant choices — either more taxpayer dollars or lower benefits for state and local employees. The sooner we make those choices, the less draconian they will have to be. But if we’re not careful, we’ll end up like Petersburg.

      1. Cville Resident Avatar
        Cville Resident

        I agree. Though I might ask that all take a look at the performance of the VWINX fund. This is a very conservative Vanguard fund that has an 0.23% expense. I’ve had the conservative side of my portfolio in this fund for decades. I agree that comparing rate of return of VRS’s portfolio to index funds isn’t wise. But VWINX isn’t a bad benchmark when you examine how conservative they’ve been…

  2. Les Schreiber Avatar
    Les Schreiber

    The traditional way of increasing yield is either extend out on the yield curve or go down in credit quality. Neither looks to good in the current environment. I agree we need to model out several interest rate possibilities ,examine the demographics and then make what are sure to be unpopular decisions.These are basically cutting payouts or increased funding. This is really not politics but basic math.

  3. LarrytheG Avatar

    People are living longer than the original actuarial assumptions also and it’s affecting more than just public pensions… private ..and social security…

    we’ve been living high on the hog with the size of our homes and the number of cars we own compared to other countries.

    perhaps it’s time for a little downsize… we certainly cannot afford fo taxpayers to keep picking it up…

    My last trip to Canada – I was struck by the modest size of folks homes – they looked like the homes we had back in the 1960’s and to remind – they had no subprime meltdown or had to bail out their banks or take terrible hits on their retirement.

    and… they don’t have to worry about health insurance…

    it’s still a wonderful life compared to most of the world but not jaded.

    we could learn a thing or two along these lines ….

  4. LarrytheG Avatar

    and actually when one drives out in the hinterlands of Virginia and away from the urbanizing areas with their upscale subdivisions – many folks in Va live in quite modest homes… and on quite modest incomes especially after they’ve retired.

    There is a huge – difference between the suburbs of the urban areas and the hinterlands beyond the suburbs.

    In many of these places – these days – with the demise of textiles, ad other small town industries – its’ farming, logging, commercial that serves locals and govt – schools, law enforcement, post office, social services and other govt.

    Most of the towns are shells of bygone times… some of the spaces – reused for eateries and antique, second -hand, etc, 7-11 type gas and grub places.. … and if a Walmart or Lowes within 25-35 miles.. that’s it.

    “industry” is largely “bygone” and each town usually has some industrial complex that is now overgrown with weeds or converted to a “youth” or “senior” center, etc.

    If it were not for public schools, state Constitutional presence, and post office – these places would be “out there”.

  5. Almost every segment of the economy has the same long term out look. The Fed prints electronic money to keep interest rates down and pushing people to invest their savings in the stock market when they cannot get any return in savings accounts etc. Print money, push interest rates down, boost the housing market with virtually no interest rates and people will try to get some return by buying into the stock market. There has to be an end to this and we are approaching it….watch out Mr. Trump.
    And as far as VRS goes I remember back at the end of his term as governor Gilmore saying the state did not need to contribute to the VRS because he/we could make enough playing the stock market to make it financially stable. Interestingly the federall govenment has not invested SS etc in the stock market while it has been at all time highs as they just leave paper IOUs in the SS account and thus it has not benefited from the faux rise in the stsock market.
    Watch out Mr. Trump.

  6. LarrytheG Avatar

    social security is not financed from General Revenues. It has always been financed from FICA taxes. It has a separate line item entry in the Federal Budget and approaches a trillion dollars (902 billion) separate and apart from income taxes and other taxes.

    see page 45: https://www.fiscal.treasury.gov/fsreports/rpt/finrep/fr/14frusg/FR_02252015_Final.pdf

    By law – if the FICA taxes cannot cover scheduled SS benefits -then the benefits have to be reduced and are scheduled to be reduced in 2030 or so if nothing else is done to shore it up.

    The only General Fund money that ever goes to SS is the money to REPAY FICA tax money originally borrowed when it exceeded payouts and the govt borrowed it rather than issue Tbills.

  7. Yes in theory the SS tax goes to support the SS into the decades ahead. However, W cut the SS tax to “stimulate the economy” and put IOUs in the trust fund. And O extended it. So instead of real economy assets the SS trust fund has W and O IOUs.
    And, assuming the IOUs are real then SS can be extended for 20 years by cutting the benefits by 10%. So if the Gov puts the borrowed money back in SS then the crisis will be very mild compared to expenditure pockets.
    We are spending more on the military than the next 17 nations compared in our efforts to control the world. Ike said in his last nataional address to congress that he feared the Industrial and Military complex far more than he did communism..
    And he was right. He was right.
    There is no way to grow out of our debt as international trade increasingly is not in our favor.
    In the decline of the Roman Empire the middle class was put out of the work force with slaves from North Africa and immigrants from Northern Europe. They gave bread and games to the the middle class to suppress their unhappiness but that did not last long.
    Ike was right and so was Jefferson, Washington and John Marshall and most of the founding fathers.
    Oh well!!

    1. LarrytheG Avatar

      the FICA cut was temporary – and was restored – you can verify this by looking at the Social Security Trustees Report –


      skip down to Table 3 Program Income

      the point is that FICA is not income tax and not commingled with income tax – not part of general revenues.

      Now if you want to talk about Medicare Part B – It IS funded from general revenues and in the same table – look at SMI – and you’ll see that 270.7 billion in general revenues for SMI -Medicare Part B.

      I agree with you about the military (more precisely national defense) spending, Medicare Part B (and Advantage) and the overall budget and it’s prospects for the future but lumping FICA/SS into all of it moves it to non-fact commentary.

      FICA has it’s own issues with the sharing economy and the advent of more and more independent contractors who still owe FICA but don’t have it deducted from the paychecks. comes due at tax time and workers often don’t have the money to pay it so some end up not filing taxes.

      Tax Expenditures total a billion – more than enough to cover the deficit and start to buy down the debt. And the biggest categories are employer-provided health insurance and itemized deductions – mortgage, charitable, state taxes, etc.

  8. I remember 2005 when the national debt was below a trillion and Alan Greenspan was afraid that we would pay it down too fast. Don’t think that is a problem now.

  9. LarrytheG Avatar

    we’ve actually reduced the deficit over the last few years – cut it in half.

    and the reality is that we have a lot of fat that can be cut – in National Defense, Medicare and Tax Expenditures.

    I say National Defense because people think the Military when you look at core military numbers is not a problem.

    First off, the military does not count the VA as a military cost, they also do not count Medicare which military retirees get and housing allowances and other benefits which are out of control… bases that the military itself wants to close. weapon systems the military itself does not want…

    and that’s just the military -moving on to National Defense – Homeland Security, FBI, CIA, NSA, NASA military satellites, DOE nuke weapons and ship reactors, Border Patrol, Coast Guard, TSA, Customs and Immigration, NOAA , and dozens of other govt agencies that are “defense”.

    then we have 300 billion dollars of tax expenditures for employer-provided insurance…

    another 300 billion for Medicare

    another 200 billion for Medicare Advantage

    Subsidized National Flood Insurance

    We can cut the deficit to zero and buy down the debt to the tune of 500 billion a year if we JUST got rid of tax expenditures..for health insurance and make folks with 170K of retirement income pay more than $250 a month for health care and make people who go into nursing homes – pay for it with their own homes equity -not tax dollars.

    we’ve got this silly game where people who get their health insurance for about 1/2 what it actually costs while crying about MedicAid for the working poor who get no such tax breaks for their health insurance.

    The middle class whines about college costs for premier colleges for their kids but opposes similar help for kids going to community colleges…

    on and on … we want to blame the poor for our spending problems when, in fact, people who are not poor get significant subsidies also…

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