Legislature(2003 - 2004)
03/25/2004 01:50 PM House FIN
* first hearing in first committee of referral
= bill was previously heard/scheduled
= 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 meeting. 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 priorities. 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 benefits. 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 th 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 greater. 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 Account. 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 viable. 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 Committee.