State will dip into pension fund, repay with 7.5% interest

Virginia is taking away more than $620 million that would have been paid toward state employee and teacher pensions, but the state is leaving an IOU.

Beginning in 2013, the state will have to repay the money to the Virginia Retirement System over 10 years, with 7.5 percent interest.

The provision, sought by the state Senate and included in the joint budget adopted by the General Assembly yesterday, is aimed at easing jitters over the decision to defer state and local payments to pension plans for the portion of future retirement liabilities that aren't funded by the system.

Sen. Walter A. Stosch, R-Henrico, called the provision the most important step taken by the assembly to protect the retirement system, even as it relies on deferred pension contributions for almost one-fourth of the money used to balance the two-year budget.

"I don't want anybody to feel that their pension is in jeopardy, because it isn't," Stosch said yesterday. "But we're recognizing the unfunded liability and requiring it to be repaid."

But that wasn't the only important step taken by the legislature to guard the $48 billion retirement system. It also adopted a package of changes that will lower the cost of pensions for future employees by more than $50 million in the next two years and $3 billion over a decade.

Those changes, proposed by House Appropriations Committee Chairman Lacey E. Putney, I-Bedford, will raise retirement ages and recalculate benefits for future employees, who also will be required to pay their share of 5 percent of payroll in annual pension contributions.

Current state employees won't have to pay 1 percent in contributions next year and 2 percent the next, as the Senate and then-Gov. Timothy M. Kaine had proposed. The state will continue to pay the employee share for current workers, as it has since a budget deal in 1983.

Local governments will have the opportunity to decide whether to continue paying that share for teachers, or shift the cost as way to close their budget gaps.

But the retirement system's biggest role in solving the state's budget dilemma was the deferral of payments for future liabilities that are not covered by current assets -- or unfunded liabilities.

The compromise adopts the rates proposed by the House in the first year for state employees and teachers, representing the so-called normal cost payment for the current liabilities. In the second year, the state would pay the same rate for state employees, but an additional 20 percent of the unfunded liabilities for teacher pensions, as both the Senate and Gov. Bob McDonnell had recommended.

In addition to deferring state costs, the reductions will save hundreds of millions of dollars for local school systems, which share in teacher pension costs with the state. The House had estimated more than $275 million in local savings, but the compromise in the second year will lower the total.

Local officials regard the reduced payments with mixed feelings because the money eventually will have to be made up or potentially put bond credit ratings at risk.

"I think they're walking a tightrope here," Chesterfield County Administrator James J.L. Stegmaier said last week. "I probably would tend to lean a little toward caution."

On the other hand, they are relieved that the state found a way other than further cutting to make up the budget shortfall. "The relief provided by the lowering of retirement system contributions provides a short-term solution to the continued ravaging of public services," Hanover County School Superintendent Stewart D. Roberson said last week.

House budget officials had argued that the deferral would not harm the retirement system because of benefit changes that would reduce long-term costs and a likely recovery of stock market investments.

They point to an updated estimate of the funded status of the retirement plans based on investment gains through the end of last year. The estimates show the state employee plan funded at almost 86 percent and teacher pensions at about 78 percent.

But the new analysis did not update the plans' liabilities or estimate their funding in the outlying years, as normal VRS valuations do. At the end of June, the state employee plan was funded at 84 percent but declined to below 62 percent in 2013, based on current rates. The teacher plan stood at 76 percent last year but declined about 59 percent in 2013.

The rates adopted as part of the budget are 36 percent lower for state employees than current contributions and 20 percent to 30 percent lower for teachers. The rates are 40 percent to 50 percent lower than the VRS Board of Trustees recommended last fall.

VRS estimates that it will receive more than $1.5 billion in contributions each year, compared with $2.1 billion in the current year. The system already is losing $340 million in contributions because of the deferral of fourth-quarter payments to balance this year's budget.

"Either way you look at it, you've got to pay it back," Sen. John Watkins, R-Powhatan said last week.

Contact Michael Martz at (804) 649-6964 or mmartz@timesdispatch.com.