Legislature(2003 - 2004)

03/25/2004 01:50 PM House FIN

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
HOUSE JOINT RESOLUTION NO. 26                                                                                                 
     Proposing  amendments to the  Constitution of  the State                                                                   
     of Alaska  relating to and limiting  appropriations from                                                                   
     and  inflation proofing  the  Alaska  permanent fund  by                                                                   
     establishing a percent of market value spending limit.                                                                     
Co-Chair  Williams  introduced  Amendment  #3,  #23-LS1006\V,                                                                   
Cook, 3/22/04.  (Copy on File).   He noted that the amendment                                                                   
would completely  change the  bill.  His  intent was  to take                                                                   
testimony  on  Amendment  #3  and  take  no  action  at  this                                                                   
Representative Hawker  MOVED to DIVIDE the  question proposed                                                                   
in  Amendment  #3,  pointing   out  there  are  two  distinct                                                                   
considerations proposed in the amendment.                                                                                       
Co-Chair Williams  reiterated that  no official action  would                                                                   
be taken on Amendment #3 at this time.                                                                                          
ROBERT D. STORER,  EXECUTIVE DIRECTOR, ALASKA  PERMANENT FUND                                                                   
CORPORATION, DEPARTMENT  OF REVENUE, acknowledged  that there                                                                   
are two components  to the amendment.  He offered  to address                                                                   
the first  component, which would  in effect memorialize  the                                                                   
principal  in  the Alaska  Constitution  by  identifying  the                                                                   
Earnings Reserve Account.                                                                                                       
Mr. Storer provided a "history  lesson" on how the Board came                                                                   
to  the conclusion  that  a Percent  of  Market Value  (POMV)                                                                   
without principal  would be a  better approach.  There  is no                                                                   
question that  the Board recognizes  the merit and  would not                                                                   
be opposed  to the proposed  amendment, which  puts principal                                                                   
into the Constitution.  Three  years ago when identified, the                                                                   
Board did  opt to  leave the principal  in the  Constitution.                                                                   
He  emphasized  that  the  key  is  the  5%  spending  limit.                                                                   
Principal  puts  a  floor  on  what  might  be  appropriated.                                                                   
Following a lengthy discussion  with the Permanent Fund Board                                                                   
of Trustees,  discussing the  merits of continuing  principal                                                                   
versus  the 5% limitation,  the Board  concluded that  having                                                                   
the percentage of market value  payout with 5%, the principal                                                                   
would be their  preferred approach.  The Board  believes that                                                                   
the   5%  does   memorialize   inflation   proofing  in   the                                                                   
Constitution and would not need  a floor.  It recognizes that                                                                   
on some  occasions, there  will be up  and down markets,  but                                                                   
over the  long term, the purchasing  power of the  fund would                                                                   
be maintained.   He noted  that there is companion  language,                                                                   
which gives the  Legislature direction of when  they would be                                                                   
moving below the 5% real rate of return.                                                                                        
Mr. Storer continued, if that  language was maintained, there                                                                   
is a  limited chance that  there could be  a small or  no pay                                                                   
out at all, in  a bear market.  That could  potentially limit                                                                   
how much is available  for payout.  At this time,  there is a                                                                   
cushion  in the fund.   The  principal is  about $23  billion                                                                   
dollars and the  Permanent Fund is approximately  $27 billion                                                                   
dollars.   As the market  progress and the appreciation  fund                                                                   
grows significantly  greater than this concept  of principal,                                                                   
then that would  become less of an issue because  the cushion                                                                   
would become greater  over time.  He observed  that including                                                                   
the  principal,  will  give decision  makers  a  little  more                                                                   
latitude in  terms of  the pay  out, no more  than 5%  in the                                                                   
down markets.   Also,  by paying  out the 5%  in down  & high                                                                   
markets, will treat all generations equally.                                                                                    
Mr. Storer concluded, it is important  to note, but not as it                                                                   
applies  to the proposed  statute, there  are proposals  that                                                                   
would  memorialize  the dividend  in  the Constitution  at  a                                                                   
fixed  rate.   If the  Legislature  is contemplating  putting                                                                   
principal back  into the Permanent  Fund that would  create a                                                                   
limit on how much could be paid  out.  If there is a proposal                                                                   
for a fixed  payout, there would then be  competing formulas.                                                                   
He commented  that could be  worked with, however,  it should                                                                   
be evaluated with other proposals.                                                                                              
BOB BARTHOLOMEW,  CHIEF OPERATING  OFFICER, ALASKA  PERMANENT                                                                   
FUND CORPORATION,  DEPARTMENT OF REVENUE, added,  that he did                                                                   
not  have  anything  additional  to add  to  the  concept  of                                                                   
leaving  in   the  principal   and  the  protection   of  the                                                                   
principal.    He  observed  that   another  change  that  the                                                                   
amendment  proposes  is  to  Section  2,  where  it  actually                                                                   
provides for the dividend and  public education as two of the                                                                   
uses for the money from the Permanent  Fund.  That was not in                                                                   
the previous version.                                                                                                           
Co-Chair   Harris   clarified   that  Section   1   basically                                                                   
establishes  an Earnings  Reserve Account  in the corpus  and                                                                   
under the umbrella of the Constitution.   It also establishes                                                                   
the fact that  the only pot of  money that can be  used under                                                                   
constitutional  protection is  the Earnings Reserve  Account.                                                                   
The second section then would establish in Constitution:                                                                        
   ·    The 5%,                                                                                                                 
   ·    A dividend, and                                                                                                         
   ·    Allows the use of that 5% for public education and                                                                      
        the administration process.                                                                                             
Co-Chair Harris added that if  the public was asking for some                                                                   
sort  of  protection  for a  dividend,  the  amendment  would                                                                   
provide that  and protects it  from going into  the principal                                                                   
of  the  fund.    He  knew  that  was  the  public's  highest                                                                   
Mr. Storer agreed  that there is interest in  those subjects.                                                                   
He pointed out that it would also  memorialize the concept of                                                                   
the dividend.  The public definitely  understands the concept                                                                   
of principal protection,  which he thought was  a good thing.                                                                   
He urged  members to keep  in mind the  concept of  the worse                                                                   
case  scenario  and  that  the   amendment  memorializes  the                                                                   
concept  of the dividend  but  does not say  that a  dividend                                                                   
would not  be paid, but if  the market value was  eroded, the                                                                   
floor  would disappear.    He  emphasized that  the  language                                                                   
creates both  a discipline and a  floor.  There is  a limited                                                                   
chance that there could be a small or no dividend.                                                                              
Mr.  Bartholomew  added  that  under the  Board  of  Trustees                                                                   
proposal,  they merged  principal and  Earnings Reserve  into                                                                   
one account.   From the  administrative perspective,  part of                                                                   
the benefit from  that action would be only  the records from                                                                   
the generally  accepted accounting principals would  tell the                                                                   
Legislature the size  of the fund and the market  value times                                                                   
5%.   Into the future, the  Permanent Fund Corporation  would                                                                   
continue to report  as they are at this time.   There are two                                                                   
sets  of  accounting  records used,  the  generally  accepted                                                                   
accounting  principal  and the  accounting  for the  realized                                                                   
income.     He  assumed  that   was  a  difficult   piece  to                                                                   
understand.  The existing process  will remain in place.  The                                                                   
protection  of principal  is out-weighing  some of the  other                                                                   
Co-Chair Williams  agreed that it is difficult  to understand                                                                   
these concepts.   He asked if the proposed  legislation would                                                                   
put that  language into  the Constitution.   Mr.  Bartholomew                                                                   
acknowledged  that  it  would   and  that  the  principal  is                                                                   
included  in  the  Constitution   at  this  time.    Co-Chair                                                                   
Williams questioned  why the Legislature would  want to place                                                                   
that language into the Constitution.                                                                                            
JOE  BALASH,  STAFF,  SENATOR GENE  THERRIAULT,  presented  a                                                                   
history on the  proposal, which dates back to 2001.   At that                                                                   
time,  Senator Therriault  was  Chairman  of the  Legislative                                                                   
Budget and Audit (LBA) Committee,  which has oversight of the                                                                   
Permanent  Fund,  and  was responsible  for  introducing  the                                                                   
first proposal  by the Trustees  to switch to the  percent of                                                                   
market  value  (POMV)  methodology.   Then  Senate  President                                                                   
Halford rewarded Senator Therriault  for that introduction by                                                                   
referring  it  to  his Committee  in  Senate  State  Affairs.                                                                   
During the  next fourteen months,  public hearings  were held                                                                   
statewide.   During subsequent and current  legislatures have                                                                   
spent much of the interim taking  public testimony on current                                                                   
POMV language.  The concept of  principal keeps coming around                                                                   
to "haunt" the notion of POMV  and why it is not the public's                                                                   
first choice  as a  way to preserve  the fund.   In  order to                                                                   
preserve the notion  of principal, the rest of  the fund must                                                                   
be accounted for  in some manner.  By doing  so, the decision                                                                   
was to create an Earnings Reserve  Account similar to what is                                                                   
around  today.   He  added  that realized  versus  unrealized                                                                   
income has not been distinguished in the bill.                                                                                  
Co-Chair  Williams  recommended  that Senator  Therriault  be                                                                   
present at the  next scheduled meeting for Monday,  March 29                                                                    
at 9 a.m.  Mr. Balash indicated that he could arrange that.                                                                     
Representative Hawker  asked if the amendment  was attempting                                                                   
to create  two buckets  of money  within the Permanent  Fund.                                                                   
Mr. Bartholomew  responded  that there  have been many  legal                                                                   
discussions  over  how  many  buckets  of  money  there  are.                                                                   
Currently,  the  Permanent Fund  is  accounted  for in  three                                                                   
separate  pools.     The   principal  pool,  the   unrealized                                                                   
earnings, and  the realized earnings.   Language on  Line 13,                                                                   
of the proposed amendment addresses  depositing earnings into                                                                   
the reserve.  He understood that  language would require them                                                                   
to continue as  presently done and account for  the Permanent                                                                   
Fund in  the three buckets.   The spending is driven  by what                                                                   
is available in the realized earnings account.                                                                                  
Representative  Hawker inquired why  new language  was needed                                                                   
to accomplish something already  being done.  Mr. Bartholomew                                                                   
stated that the constitutional  amendment does achieve the 5%                                                                   
spending limit,  which is the  most significant  action being                                                                   
taken  by  using  the  5%  spending   limit,  which  protects                                                                   
purchasing  power into the  future.   However, the  manner in                                                                   
which it is accounted for will change.                                                                                          
Representative Hawker voiced his  confusion regarding placing                                                                   
the 5% limit  into constitutional language.   Mr. Bartholomew                                                                   
reiterated that it  was in original bill.   He explained that                                                                   
on Line 10,  leaves the word "principal" in  the Constitution                                                                   
and requires  that the  principal not be  spent.   Mr. Storer                                                                   
added that it was true that the  5% limit existed before.  It                                                                   
is consistent with the Permanent  Fund's objective, putting a                                                                   
limit on  how much could be  appropriated at any  given time.                                                                   
The amendment creates  a floor, and if the value  of the fund                                                                   
falls  below that  floor, no money  could be  used below  the                                                                   
principal floor.  Over time, as  the profits of the fund grow                                                                   
and the  difference  between the  value of  the fund and  the                                                                   
principal  become   wider  and  wider,  then   the  point  of                                                                   
principal becomes less important  because the cushion becomes                                                                   
Representative Hawker understood  that the 5% does not change                                                                   
and would only  apply to a portion of the money  in the fund.                                                                   
Mr.  Storer replied  that the  5%  limit would  apply to  the                                                                   
entire  fund.   The definition  of  how much  could be  used,                                                                   
would be 5% of the 5-year moving  average of the entire fund.                                                                   
The next step would be how much  would be available above the                                                                   
floor, which  is the second  message clarifying if  there are                                                                   
sufficient  funds in  order to  reach the  5% requirement  in                                                                   
excess of  that floor.   If not, then  they cannot  take more                                                                   
than the floor.                                                                                                                 
Representative Hawker  thought that the policy  call would be                                                                   
the 5%  of the  entire value of  the fund  but only  making a                                                                   
portion available to draw the  5%.  He believed that language                                                                   
was inconsistent.   Mr.  Bartholomew agreed.   Representative                                                                   
Hawker  questioned limiting  the source  of that  fund.   Mr.                                                                   
Storer advised  there are  ways to  provide insight  when the                                                                   
fund  does  not  earn  the  5%.   He  pointed  out  that  the                                                                   
Permanent  Fund has  been working  with a  number of  elected                                                                   
officials,  who could  evaluate  whether or  not  to use  the                                                                   
entire 5% or instead make less of a policy decision.                                                                            
Representative Hawker  thought if there was  inadequate money                                                                   
in the  bucket, then nothing could  be drawn.   He questioned                                                                   
if that  would be  the same  effect as  using the  "sidebar".                                                                   
Mr. Bartholomew explained that  if the sidebars or guardrails                                                                   
were placed  into statute, there  would always be  the option                                                                   
of  the  Legislature  to  not  follow them.    If  the  extra                                                                   
protection  were placed  into the  Constitution, there  would                                                                   
never be the option of not following it.                                                                                        
Representative  Hawker suggested  that was  an "all  or none"                                                                   
attitude.  Mr. Bartholomew attempted  to clarify, noting that                                                                   
had been the debate the Board  went through when making their                                                                   
decision.   As the Constitution  is written today,  there are                                                                   
market scenarios,  where there can be short-term  declines in                                                                   
the  financial  markets,  which   reduce  the  value  of  the                                                                   
earnings reserve.   If  that scenario  was to repeat  itself,                                                                   
when  there is  a  principal limitation,  which  is hard  and                                                                   
fast, there  is a line  or value of  the Permanent  Fund that                                                                   
can not be spent below, and is  how it currently is and would                                                                   
continue with the  amendment.  He reiterated that  there is a                                                                   
hard  and  fast  line, which  the  Legislature  cannot  spend                                                                   
below.    When  the  Trustees  evaluated  whether  to  remove                                                                   
principal or not, they recommended  that the benefits must be                                                                   
evaluated  from having  a  predictable,  sustainable pay  out                                                                   
from the  Permanent Fund  versus the  risk taken by  removing                                                                   
the principal protection and saying  that there are near turn                                                                   
down markets, spending down into  the Permanent Fund with the                                                                   
intention  that it  would be  paid  back in  the future  good                                                                   
years.   That was the  discussion.  From  the sponsor  of the                                                                   
amendment   and  what   the  public  wants,   the  Board   is                                                                   
comfortable using  the word principal. The experience  of the                                                                   
Permanent Fund  is that  with time to  educate and  work with                                                                   
the public, the  public then tends to support  the concept of                                                                   
a sustainable and predictable payout.                                                                                           
Representative  Hawker understood  that the  amendment was  a                                                                   
trade off and would provide some  inherent predictability and                                                                   
stability   to  the  previous   version   of  the  bill   for                                                                   
preservation of the  notion of principal.  He  commented that                                                                   
the word  "notion"  troubled him  and that  he did not  think                                                                   
that  the State  really wanted  to  trade predictability  and                                                                   
sustainability for such a vague thought.                                                                                        
Co-Chair  Harris  stressed  that  the  reality  is  that  the                                                                   
amendment would  protect a  value of the  principal set  at a                                                                   
certain  period of  time when  it is  voted on.   That  value                                                                   
could never  be taken  away.  Any  earnings of the  Permanent                                                                   
Fund above and  beyond that time would be deposited  into the                                                                   
second account  called the Earnings Reserve Account.   Today,                                                                   
that account is  not protected at all.  Under  the amendment,                                                                   
it would be  entirely protected under the Constitution.   The                                                                   
Earnings Reserve  Account is the  only pot of money  that the                                                                   
5% could be  taken from.  If  there were a down market  for a                                                                   
considerable period of time, it  would not prohibit taking 5%                                                                   
of the  fund.  However, if  the Earnings Reserve  Account was                                                                   
depleted,  then no  more could  be drawn  from the  Permanent                                                                   
Fund,  as  it would  be  constitutionally  protected  as  the                                                                   
principal.  He emphasized that  there is no "notion" involved                                                                   
at all in the proposed language  and emphasized that there is                                                                   
absolute value protected.  He  asked Mr. Storer if that was a                                                                   
correct interpretation.   Mr. Storer responded  that the only                                                                   
distinction  would be when  that point is  hit, and  then the                                                                   
citizens of Alaska would have to vote.                                                                                          
Co-Chair  Harris pointed  out that  they would  only have  to                                                                   
vote  on the  constitutional  question,  which would  require                                                                   
two-thirds of  both Bodies's in  order to place  the question                                                                   
before the voters.                                                                                                              
Co-Chair   Harris  noted   that  two   concerns  were   being                                                                   
addressed.   One  is  the  constitutional protection  of  the                                                                   
corpus or principal value at a  certain point.  The Permanent                                                                   
Fund will have  to determine whatever that number  is at that                                                                   
point in time.  Any amount above  and beyond that is Earnings                                                                   
Reserve Account  money.  Mr.  Bartholomew indicated  that the                                                                   
question  needing  to  be  answered is  how  to  address  the                                                                   
State's  on-going receipt  of  oil deposits.   The  Permanent                                                                   
Fund understands  that the principal would have  to grow from                                                                   
the on-going oil  deposits; however, all the  earnings of the                                                                   
fund  would  be what  is  placed  into the  Earnings  Reserve                                                                   
Co-Chair  Harris  pointed  out  that  that  the  Constitution                                                                   
already clarifies  that 25%  goes into  the principal  of the                                                                   
fund.  That value  is what is created by the  investments and                                                                   
would become part  of the Earnings Reserve Account.   That is                                                                   
the pot  of money that is  constitutionally protected  by the                                                                   
5%.   Mr.  Storer  stated that  there  is approximately  $4.7                                                                   
billion  dollars  of realized  and  unrealized  money in  the                                                                   
account at this time.                                                                                                           
Co-Chair  Harris  added  that   the  Legislature  still  must                                                                   
determine  how much  of that  5%  comes out  of the  Earnings                                                                   
Reserve  Account that  could be used  for dividends,  general                                                                   
operations  of the  departments  and education.   Mr.  Storer                                                                   
agreed.   Co-Chair Harris  added that  the Legislature  could                                                                   
adopt 100% for  dividends and could be changed  at any period                                                                   
in time  by the  Legislature if  they wanted  to face  public                                                                   
scrutiny.   He noted that the  public is concerned  about the                                                                   
erosion  of the  principal.   They  need  assurance that  the                                                                   
principal is  not going away.   The  only way that  they will                                                                   
get that  assurance is if  it is constitutionally  protected.                                                                   
Under the proposed  amendment, the Legislature  would have no                                                                   
power,  only  the public  would  have  that authority.    Mr.                                                                   
Storer agreed.                                                                                                                  
Vice Chair Meyer  asked the highest and lowest  amount earned                                                                   
by the  fund over  the past  twenty-five years.   Mr.  Storer                                                                   
stated that  in March 2000, the  principal was between  $19 &                                                                   
$20  billion dollars  and now  the principal  is $23  billion                                                                   
dollars.   Mr. Bartholomew responded  that there is  a return                                                                   
that  the  fund  has  earned  under  the  generally  accepted                                                                   
accounting principals.  It is  important to consider what the                                                                   
fund has earned under the realized earnings approach.                                                                           
Vice Chair  Meyer thought that  8% had been the  average over                                                                   
that period.   Mr.  Storer commented that  the fund  has been                                                                   
through a  substantial bull market  for about  fifteen years.                                                                   
The real  rate of return for  nineteen years is 6.9%,  and is                                                                   
not sustainable.  In the last  ten years, there has been both                                                                   
bull markets and  a severe down market.  Over  that period of                                                                   
time,  the fund earned  a return  of 7.8%  with inflation  at                                                                   
2.5%, which makes a 5.3% real rate of return.                                                                                   
Vice  Chair Meyer  understood  Co-Chair  Harris' concerns  of                                                                   
eroding into the principal, however,  pointed out that it had                                                                   
gone up  to 5%.  With  inclusion of the proposed  safeguards,                                                                   
it would not go  up to the full 5%.  Given  the POMV concept,                                                                   
it is anticipated  that during the next 50 to  100 years, the                                                                   
average earnings would be 8%.   Mr. Storer interjected that a                                                                   
5% real  rate of return  could be anticipated.   That  is how                                                                   
the 5% has been determined on what should be appropriated.                                                                      
Vice Chair  Meyer asked  if the  Permanent Fund supports  the                                                                   
amendment.    Mr. Storer  responded  that  historically,  the                                                                   
Permanent  Fund supported the  constitutional amendment  with                                                                   
principal  remaining  in.    After   a  long  study,  it  was                                                                   
determined that there  could be a better way  to approach it.                                                                   
The Board has  concluded that the percentage  of market value                                                                   
pay out, as it  now stands, is the recommended  way, and will                                                                   
allow the  Legislature to determine  whether or not it  is in                                                                   
the best  interest to  sustain the  full 5%  pay out  or less                                                                   
depending on the market.  At no  time, has the Permanent Fund                                                                   
claimed  that leaving  the principal in  would be  inherently                                                                   
bad.  That  approach is considered  to be second best  and is                                                                   
Representative  Hawker commented  on the statement  regarding                                                                   
the  principal in  as being  the  second best  approach.   He                                                                   
asked if  that was  a decision made  from a financial  policy                                                                   
point  of  view  or a  political  perspective.    Mr.  Storer                                                                   
responded  that he  hoped it  was  a decision  made from  his                                                                   
financial  hat  perspective so  as  to insure  the  long-term                                                                   
viability.  Discipline  must be created to provide  a cushion                                                                   
for both  the good and bad  times, which has  been consistent                                                                   
for the Permanent Fund.  They  do recognize the importance of                                                                   
the principal to the citizens of Alaska.                                                                                        
Representative  Hawker  heard  that the  bill  as  originally                                                                   
presented  was   the  first   best  approach,  however,   the                                                                   
Legislature wears a more political  hat first.  The political                                                                   
debate is one of preserving the  notion of the principal.  He                                                                   
recommended exploring  how to manage it, while  continuing to                                                                   
accomplish distribution  of the wealth  to all Alaskans.   He                                                                   
asked if the  Permanent Fund considered using  the old three-                                                                   
column trust account system.                                                                                                    
TAPE HFC 04 - 67, Side B                                                                                                      
Representative  Hawker  continued,  that system  consists  of                                                                   
three  columns,  principal,  earnings   and  expenses.    The                                                                   
realized  earnings   would  be  shifted  between   the  three                                                                   
columns.   He  acknowledged that  the  methods of  accounting                                                                   
have evolved and  changed.  He pointed out that  the fund has                                                                   
gone from the  notion of principal to an  accounting standard                                                                   
that  measures funds  by  value instead  of  principal.   Mr.                                                                   
Bartholomew explained that in  1997, the accounting standards                                                                   
that  oversee all  generally accepted  accounting  principals                                                                   
require  the Permanent  Fund to  mark  all of  its assets  to                                                                   
current daily price  to guarantee knowing if  value was being                                                                   
gained or lost.   At the end of each month,  a report is made                                                                   
available to the Legislature from the Permanent Fund.                                                                           
Representative  Hawker  knew  that  accounting  changes  have                                                                   
evolved during the 1990's.  In  1997, pronouncements mandated                                                                   
to take  a new approach  to the fund.   He asked if  that was                                                                   
the  basis  of the  first  best  value  based approach.    He                                                                   
thought  that the  second best  approach appears  to be  more                                                                   
outdated  and  does  not  reflect  these  flucuations.    Mr.                                                                   
Bartholomew  agreed.   He  added that  under  the concept  of                                                                   
principal,  the  Permanent Fund  will  maintain  two sets  of                                                                   
accounting  records.   That  is  what is  done  today.   That                                                                   
methodology  would  have  gone   away  under  a  pure  market                                                                   
approach.   Representative  Hawker commented  that would  put                                                                   
the burden back on the Legislature.                                                                                             
Co-Chair  Williams  stated  that  HJR  26 would  be  HELD  in                                                                   

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