SVB Failure Shows the Need for Public-Pension Reform

T he failure of Silicon Valley Bank could cause trouble for public pension funds. Reports indicate multiple public pension funds held stock in SVB Financial Group, the parent company of the bank.

“Pension funds are also going to be exposed to potential stock losses in companies that have substantial banking at SVB, like Roku and Etsy,” tweeted Anthony Randazzo, executive director of the Equable Institute. “Plus, valuation markdowns for private companies that suffer because of the bank failure will trickle down to state pension funds, too. But there is a transparency problem. State pension funds are not great at publishing their entire holdings for taxpayers, retirees, or plan members to see.”

He’s right. We know about SVB, but what other stocks will be affected negatively by the bank’s collapse? And which public pension funds will take a hit because of it?

The Illinois Municipal Retirement Fund, for one. The IMRF covers local-government workers in all Illinois cities except Chicago. It has 457,000 active, inactive, and retired members.

The latest report of detailed investments available from the IMRF shows the fund had over $4.5 million invested in 12,621 shares of SVB Financial Group. Those shares had a fair market value of $8.6 million at the end of 2021 when the stock had a value near $700 per share.

The most recent SEC filings from IMRF indicated the fund had at least 2,251 shares of SVB Financial Group at the end of 2022, though that number could be higher. It is also possible IMRF and other Illinois pension systems had exposure to SVB through index funds or ETFs. IMRF also had millions invested in funds with exposure to FTX, a digital currency exchange that went bankrupt in late 2022.

While these two examples might not be a big deal in the grand scheme of things, unsuccessful investments such as SVB and FTX highlight a fundamental problem with public pension systems: All public-pension risk is borne by taxpayers. Just like bank bailouts, when pension funds take a hit, more tax dollars have to be poured into public pension funds to make up any shortfalls.

If an individual puts a small portion of his or her 401(k) in high-growth, riskier assets and it doesn’t work out, it’s not as big of a deal because that person eats the cost. But when it happens in a defined-benefit system, taxpayers are on the hook to make up for the lost investment, not the fund or the individual. Illinois’ five state-run retirement systems have accumulated $12.3 billion in unfunded liabilities because of underperformance between fiscal years 1996 and 2022. This doesn’t account for an increased deficit because of weak markets since last July or Illinois’ local pension funds, such as IMRF, which manage hundreds of billions in assets and have more than $70 billion in unfunded liabilities separate from the state.

Illinois’ pension systems are treading on tenuous financial terrain, meaning that they have to be very careful about their investment choices. They currently carry $210 billion in state-and-local pension debt, although ratings agencies such as Moody’s Investors Service using more realistic assumptions estimate at least the state pension deficit to be many times larger.

Risky investments by the state’s deeply troubled pension funds highlight the need for pension reform. Both taxpayers and state workers must be protected from the potential for poor investment decisions to aggravate huge unfunded liabilities and increase the odds that the systems might face insolvency.

The first step in protecting public retirement systems from a serious turn in the markets is to shore up funding ratios and eliminate unfunded liabilities to reduce the chances that poor investments might threaten overall solvency. That means making sure plans have reasonable retirement-age requirements, true cost-of-living adjustments instead of an arbitrary, compounding raise each year, and other common-sense tweaks, many of which have been employed in states across the country, including Arizona.

Many states, as well as the federal government, have moved to hybrid systems that are part defined-contribution (such as 401(k) plans) and part defined-benefit (pensions). There are signs of this even in Illinois. The retirement fund for state university workers has had a hybrid plan since 1998, and the teachers’ retirement fund just introduced an optional hybrid plan last year. Still, the majority of Illinois state and local workers are in defined-benefit systems.

Ultimately, the best way to protect public-sector retirees and taxpayers is to transition away from defined-benefit plans into defined-contribution plans. Individuals should have more control over their retirements, be able to choose how they want to invest, and then shoulder the responsibility for those choices — without burdening others.