Legislature(2015 - 2016)HOUSE FINANCE 519

04/13/2016 01:30 PM FINANCE

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Audio Topic
01:40:28 PM Start
01:41:54 PM HB245
03:25:16 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ Electronic Tax Returns & Motor Fuel Tax, TELECONFERENCED
Fisheries Taxes, Mining Lic. Tax & Fees
<Above Item Removed from Agenda>
+= HB 245 PERM. FUND:DEPOSITS;DIVIDEND;EARNINGS TELECONFERENCED
Heard & Held
+ Bills Previously Heard/Scheduled TELECONFERENCED
+= HB 249 ELECTRONIC TAX RETURNS & MOTOR FUEL TAX TELECONFERENCED
<Bill Hearing Canceled>
HOUSE BILL NO. 245                                                                                                            
                                                                                                                                
     "An  Act   relating  to  the  Alaska   permanent  fund;                                                                    
     relating  to  appropriations   to  the  dividend  fund;                                                                    
     relating  to  income  of  the  Alaska  permanent  fund;                                                                    
     relating to  the earnings reserve account;  relating to                                                                    
     the Alaska  permanent fund dividend;  making conforming                                                                    
     amendments; and providing for an effective date."                                                                          
                                                                                                                                
1:41:54 PM                                                                                                                    
                                                                                                                                
ANGELA  RODELL, EXECUTIVE  DIRECTOR,  ALASKA PERMANENT  FUND                                                                    
CORPORATION, informed  the committee that she  was available                                                                    
to answer  any questions from  members. She had  no prepared                                                                    
remarks.                                                                                                                        
                                                                                                                                
Representative Munoz  asked if  the targeted rate  of return                                                                    
of 6.9 percent was realistic.  Ms. Rodell explained that 6.9                                                                    
percent  was   forecasted  based  on   current  expectations                                                                    
calculated  by the  PF  consultant,  Callan Associates.  She                                                                    
reported  that the  board of  trustees had  a targeted  real                                                                    
return  rate in  place  of 5  percent  without an  inflation                                                                    
assumption.  She thought  that  unless  the mandate  changed                                                                    
APFC would continue without  different policy direction. The                                                                    
Alaska   Permanent  Fund   Corporation  would   continue  to                                                                    
construct asset  allocations that achieved a  5 percent real                                                                    
return for the fund.                                                                                                            
                                                                                                                                
Representative Munoz asked if  Ms. Rodell was concerned with                                                                    
the model  that used a  rate of  return of 6.9  percent. Ms.                                                                    
Rodell was  concerned with expectations  and wanted  to make                                                                    
sure they were managed. The  corporation did not control the                                                                    
market;  the  market would  perform  the  way it  performed.                                                                    
Looking at  FY 16, which  started July 1, 2015,  the state's                                                                    
return for the fiscal year  through the previous day was 0.4                                                                    
percent.  The corporation  had started  to recover  from its                                                                    
many losses  taken in December,  January, and  February when                                                                    
the market  performed poorly. She  reported that  the equity                                                                    
market had  taken a  substantial hit. She  did not  mind the                                                                    
challenge of trying  to hit the 6.9 percent  target rate but                                                                    
there  was a  possibility  that in  some  years 6.9  percent                                                                    
might  not be  reached. She  emphasized that  it was  just a                                                                    
forecasted number.                                                                                                              
                                                                                                                                
Representative Munoz asked  how a lower rate  than 5 percent                                                                    
would affect  the ability to  inflation proof the  fund. Ms.                                                                    
Rodell was  not sure  she understood  Representative Munoz's                                                                    
question.                                                                                                                       
                                                                                                                                
1:45:47 PM                                                                                                                    
                                                                                                                                
Representative  Munoz  wondered  if inflation  proofing  was                                                                    
included in the  model or if the fund  was inflation proofed                                                                    
sufficiently.  Ms.   Rodell  relayed  that   when  inflation                                                                    
proofing was put into statute  the fund could only invest in                                                                    
fixed  income assets.  In order  to preserve  the purchasing                                                                    
power  of  the  fund   inflation  proofing  was  adopted  in                                                                    
statute.  Overtime the  list was  expanded  and lifted.  The                                                                    
board  of trustees  had an  asset  allocation that  targeted                                                                    
everything in the investment spectrum.  She reported that 80                                                                    
percent of the portfolio  was naturally inflation proofed by                                                                    
the  type  of  assets  invested. It  could  be  argued  that                                                                    
inflation proofing  was not  as important as  it was  in the                                                                    
past because  so many investments naturally  built inflation                                                                    
into their  valuation. However, inflation proofing  had been                                                                    
one of  the mechanisms the  state used to continue  to build                                                                    
and grow the  corpus of the Permanent Fund (PF).  As soon as                                                                    
any value over the cost  was recognized and received, it was                                                                    
moved  into  the  earnings  reserve   account  (ERA)  to  be                                                                    
available for appropriation. She  stressed that if the state                                                                    
wanted to see the corpus continue  to grow, it would need to                                                                    
place some  of the gain into  the fund. The way  it had been                                                                    
done in  the past  was through inflation  proofing presently                                                                    
totaling $16 billion.                                                                                                           
                                                                                                                                
Co-Chair Neuman  noted that the  legislature was  looking at                                                                    
moving the  management of the Constitutional  Budget Reserve                                                                    
(CBR) to APFC for investment.  He asked how the change would                                                                    
work and  what the  investment return  might be.  Ms. Rodell                                                                    
highlighted that there were  specific limitations in statute                                                                    
defining how  the CBR  could be invested  and the  amount of                                                                    
allowable  risk.  The  statutes   reflected  the  state  had                                                                    
historically  relied on  the CBR  for  cash flow  assistance                                                                    
when there  were revenue shortfalls.  She suggested  that if                                                                    
the statutory limitations were  not removed, the corporation                                                                    
would  have the  same limitations  on making  investments as                                                                    
the   Department   of   Revenue  did   currently.   If   the                                                                    
restrictions  were lifted  and  APFC was  allowed to  invest                                                                    
similarly to the Alaska PF, it  would also be similar to how                                                                    
APFC  invested  the  Alaska Mental  Health  Trust  Authority                                                                    
dollars.  They would  receive a  share of  the same  returns                                                                    
that the fund and the ERA received.                                                                                             
                                                                                                                                
1:49:51 PM                                                                                                                    
                                                                                                                                
Co-Chair  Neuman thought  that generally  APFC made  prudent                                                                    
investment decisions. He asked  if the same sideboards would                                                                    
be used  in investing the  CBR. Ms. Rodell responded  in the                                                                    
affirmative.                                                                                                                    
                                                                                                                                
Co-Chair Neuman commented that some  of the estimates of the                                                                    
ERA would  be about  6.0 percent.  He wondered  if it  was a                                                                    
practical  number. Ms.  Rodell responded  that if  the state                                                                    
planned  to draw  on  the CBR  in the  next  few years,  the                                                                    
number  might   be  too  high.  The   statutory  constraints                                                                    
currently in place required that if  the fund was to be used                                                                    
within 5  years it had  to stay  in fixed income  and liquid                                                                    
assets,  the  returns  of  which   well  below  6.0  percent                                                                    
presently.                                                                                                                      
                                                                                                                                
Representative  Kawasaki  asked   about  Callan  Associates'                                                                    
prediction  of 6.9  percent. He  relayed that  their report,                                                                    
based  on a  10-year  forecast, showed  the  rate of  return                                                                    
prediction falling  between 6.56  and 7.2  percent. Year-to-                                                                    
date, the  return rate  was -3.72  percent. He  restated Ms.                                                                    
Rodell's conservative estimate of  5 percent. He wondered if                                                                    
the legislature  was receiving information that  she thought                                                                    
was wise.  He had  been hearing  that the  information might                                                                    
not be coming directly from the PF.                                                                                             
                                                                                                                                
Ms.  Rodell  clarified that  5  percent  was a  real  return                                                                    
without   an   inflation   assumption   attached.   Assuming                                                                    
inflation  was going  to be  2 percent,  the nominal  return                                                                    
would  need to  be  7  percent to  reach  a  5 percent  real                                                                    
return. Callan's  numbers included an  inflation assumption.                                                                    
The challenge with forecasting markets  was that it resulted                                                                    
in  a forecast.  Although  Callan had  tremendous access  to                                                                    
research, they reported missing  their target every time. If                                                                    
perfect  information were  available, everyone's  jobs would                                                                    
be much  simpler. She concluded that  the forecasted numbers                                                                    
needed to  be taken with  a grain  of salt. Her  response to                                                                    
Representative  Munoz was  that  in looking  at 6.9  percent                                                                    
there  was an  equal  chance  of going  above  or below  the                                                                    
number.  She  emphasized that  in  the  following years  she                                                                    
would  be  starting  at  .4  percent.  She  thought  it  was                                                                    
unlikely 6.9 percent would be reached for FY 16.                                                                                
                                                                                                                                
1:53:42 PM                                                                                                                    
                                                                                                                                
Representative   Kawasaki   thought  the   information   was                                                                    
important  for the  committee  to hear.  He  noted that  the                                                                    
current assumed  asset allocation (17 percent  US equity, 24                                                                    
non-US  equity, etc.)  was of  significance. Ms.  Rodell had                                                                    
also mentioned  policy changes  coming from  the legislature                                                                    
in terms of  the 6.9 percent rate. He wondered  if she could                                                                    
speak more on the subject of what could be done.                                                                                
                                                                                                                                
Ms. Rodell responded that there  were specific directions to                                                                    
preserve  purchasing  power  to   maximize  income  in  APFC                                                                    
statutes. There was specific direction  given to the fund to                                                                    
ensure that  the fund was  available for current  and future                                                                    
generations of Alaskans. The associated  portion of the APFC                                                                    
statutes was  not being  amended in  any way  by any  of the                                                                    
bills presented. The  message that APFC was  taking away was                                                                    
to  continue  doing  what  it  had  always  done  until  the                                                                    
corporation  was directed  through statute  to do  something                                                                    
different. She added  that the corporation was  not going to                                                                    
do anything  differently to meet  the 6.9 percent  mark. She                                                                    
had not  seen anything  about 6.9 percent  in statute  or in                                                                    
the proposed  bill. She reiterated that  the corporation had                                                                    
not  been   directed  or  seen   anything  in   the  current                                                                    
legislation to change the way it was doing business.                                                                            
                                                                                                                                
Representative  Kawasaki asked  if Ms.  Rodell would  change                                                                    
the   way  in   which  the   corporation  operated   if  the                                                                    
legislature wanted  to change  the statutes  surrounding the                                                                    
PF to maximize  the return. Ms. Rodell replied  that to some                                                                    
degree  she would.  She furthered  that obtaining  a maximum                                                                    
return  was  different  from  maximizing  income.  It  would                                                                    
change  to a  degree  and would  be the  subject  of a  long                                                                    
conversation with the  board of trustees in terms  of how to                                                                    
achieve maximum  returns. Additional risk  assumptions would                                                                    
likely have  to be taken  that might not be  acceptable. The                                                                    
Alaska Permanent Fund Corporation  tried to balance the need                                                                    
for income with the need for measured risk.                                                                                     
                                                                                                                                
1:56:59 PM                                                                                                                    
                                                                                                                                
Vice-Chair Saddler  asked if HB  245 raised any  concerns as                                                                    
to whether the PF status  under the Internal Revenue Service                                                                    
(IRS) was  tax-free. He wondered  if the  legislature should                                                                    
have any concerns.  Ms. Rodell replied in  the negative. She                                                                    
thought  the   bill  would  potentially  make   the  state's                                                                    
arguments with the IRS more straight forward.                                                                                   
                                                                                                                                
Vice-Chair  Saddler  asked  about the  significance  of  the                                                                    
change in Section 4 specifying  the definition of net income                                                                    
and  outlining when  the income  was realized  and received.                                                                    
Ms. Rodell  reported she  had spoken with  the staff  of the                                                                    
chairs  in  both  bodies  about  the  language.  The  Alaska                                                                    
Permanent Fund  Corporation preferred  that the  language be                                                                    
changed  back  to  the language  currently  in  statue.  The                                                                    
corporation  was concerned  about  how the  action would  be                                                                    
interpreted  by auditors.  She suggested  that  it was  much                                                                    
cleaner  to  keep the  current  language  as it  existed  in                                                                    
statute  based  on  the   historical  opinions  on  realized                                                                    
income.                                                                                                                         
                                                                                                                                
Vice-Chair Saddler wanted to have  a better understanding of                                                                    
the potential issues the auditors  might take up. Mr. Rodell                                                                    
replied  that when  the PF  was  created the  constitutional                                                                    
amendment creating  the fund stated  that income  "shall go"                                                                    
to the GF. At the  time, under generally accepted accounting                                                                    
principles, income  was only realized income.  Subsequent to                                                                    
that time, GAP  changed the definition of  income to include                                                                    
realized income,  unrealized income,  and loses.  The Alaska                                                                    
Permanent  Fund Corporation  had to  get a  number of  legal                                                                    
opinions  from the  attorney general  to  determine what  it                                                                    
could  and could  not  recognize in  the  ERA. The  auditors                                                                    
relied on  the legal interpretations when  auditing the fund                                                                    
to ensure  that the state  was booking income  correctly and                                                                    
getting  a  clean  audit opinion.  Potential  confusion  was                                                                    
created in changing  the language about what it  meant to be                                                                    
received. Under GAP,  income was recognized not  when it was                                                                    
received, hence  why there was  unrealized income.  The idea                                                                    
was that once  the income was receive it  would be available                                                                    
for  appropriation. Under  GAP,  income  was unrealized  and                                                                    
realized.  She reemphasized  that the  PF Corporation  would                                                                    
prefer  to   leave  the  language   alone  to   prevent  any                                                                    
confusion.                                                                                                                      
                                                                                                                                
2:00:53 PM                                                                                                                    
                                                                                                                                
Vice-Chair Saddler noted  there was a section  on the charts                                                                    
from  the Legislative  Finance  Division  (LFD) that  talked                                                                    
about  the percent  of the  investment  return realized.  He                                                                    
also asked  about the  absorption of  the Amerada  Hess fund                                                                    
into the  corpus or the  earnings reserve account  (he could                                                                    
not  remember which  account) and  whether they  created any                                                                    
concerns for her regarding  legal, accounting, or management                                                                    
issues. Ms.  Rodell responded in  the negative.  She thought                                                                    
that  absorbing  the Amerada  Hess  fund  would make  things                                                                    
cleaner for many people.                                                                                                        
                                                                                                                                
Vice-Chair  Saddler referred  to  the first  section of  the                                                                    
bill where it talked about  a 3-year reevaluation clause. He                                                                    
wondered if it raised any  concerns for Ms. Rodell regarding                                                                    
the durability  of the new regime.  He asked if she  had any                                                                    
comment on  that section of  the bill. Ms.  Rodell responded                                                                    
in  the negative.  Her  expectation was  that  she would  be                                                                    
before the  legislature every year  to discuss  the earnings                                                                    
and  the performance  of  the PF  fund.  She suspected  that                                                                    
there would  be a  significant amount  of ongoing  review of                                                                    
the fund. She did not have any problems with the language.                                                                      
                                                                                                                                
2:02:29 PM                                                                                                                    
                                                                                                                                
Representative Edgmon  referred to  the models  presented in                                                                    
the previous  day. He wanted to  discuss inflation proofing.                                                                    
Three of the  four models the committee  had were predicated                                                                    
on a 6.9 percent investment  return and the fourth was based                                                                    
on  a return  of 7.45  percent. He  note that  the inflation                                                                    
rate built into the models  was 2.25 percent. He referred to                                                                    
her comment  that a 6.9  percent return might  be ambitious.                                                                    
Based  on  that  comment,  he  asked her  to  speak  to  the                                                                    
potential difficulties of inflation  proofing the fund going                                                                    
forward.                                                                                                                        
                                                                                                                                
Ms.  Rodell   stated  that  if  a   2.25  percent  inflation                                                                    
assumption was removed from a  6.9 percent return rate about                                                                    
4.7 percent would be left  and would fall under the targeted                                                                    
real return  of 5  percent. She  offered that  the challenge                                                                    
was  recognizing  reality  versus  forecasted  numbers.  The                                                                    
state would do  its best to achieve  its targeted percentage                                                                    
return  under   current  market  conditions.   However,  the                                                                    
legislature  could   appropriate  inflation   proofing.  The                                                                    
corporation   could   also   seek  an   inflation   proofing                                                                    
appropriation if it was integral  to the corpus of the fund.                                                                    
For  instance,  if  the  fund  earnings  were  significantly                                                                    
higher  than  anticipated  they could  be  placed  into  the                                                                    
corpus. She thought there would  be ongoing discussions when                                                                    
the annual evaluations were completed.                                                                                          
                                                                                                                                
Representative  Edgmon talked  about half  of the  funds for                                                                    
the PFD  being tied to  royalty payments under  the proposed                                                                    
legislation.   In   essence,   the  legislature   would   be                                                                    
redirecting some  of the  volatility to  the funding  of the                                                                    
PFD.  The dividend  would be  based on  annual royalty,  the                                                                    
price of oil, and production.  He invited her to discuss the                                                                    
change and whether someone one  the street should be worried                                                                    
their PFD was being placed  in front of traffic versus being                                                                    
funded by the fund itself.                                                                                                      
                                                                                                                                
2:06:34 PM                                                                                                                    
                                                                                                                                
Ms. Rodell thought it was  an interesting debate about where                                                                    
the  PFD  was  tied  -  tied to  the  fund  versus  tied  to                                                                    
royalties.  She relayed  that payments  over the  previous 4                                                                    
years -  dividends paid  since 2011 -  there had  been great                                                                    
volatility  in the  dividend  because  of market  volatility                                                                    
affecting  the fund.  She  was  unclear whether  individuals                                                                    
would  experience   new  or  different   volatility,  having                                                                    
already experienced  it in  the past.  The feedback  for the                                                                    
prior  PFC Director  and as  the  previous DOR  Commissioner                                                                    
people understood  the volatility and understood  that there                                                                    
were  market  losses  resulting   in  lower  dividends.  She                                                                    
reported  that 2  years  prior the  dividend  was less  than                                                                    
$1000 and in  the previous year, it was up  to $2000, a huge                                                                    
swing.  She  suspected that  the  dividend  amount might  be                                                                    
smaller but  steadier with a  portion of the  payment coming                                                                    
from royalties.  The Alaska  Permanent Fund  Corporation did                                                                    
not run any  models on the dividend and  was not responsible                                                                    
for  the  dividend  program itself  other  than  making  one                                                                    
transfer annually.                                                                                                              
                                                                                                                                
Representative Guttenberg  suggested that if  something went                                                                    
wrong  with the  modeling Ms.  Rodell would  feel some  heat                                                                    
regardless of  her actions  or the success  of the  fund. He                                                                    
wondered if she had concerns with the bill or the modeling.                                                                     
Ms. Rodell struggled  to answer the question  because it was                                                                    
difficult to know  where and how the heat  would be applied.                                                                    
She thought  that it was the  nature of the beast.  Her plan                                                                    
sitting before the  committee in the present was  to be able                                                                    
to  explain what  the  corporation was  doing  and why.  The                                                                    
legislature might not  like her responses, but  the fund was                                                                    
known globally for its transparency  and was often commended                                                                    
on its translucence. She thought  it was the best counter to                                                                    
any heat  the corporation might receive.  The potential heat                                                                    
could  result from  spending  the  earnings reserve  account                                                                    
faster  than the  corporation could  earn money  due to  low                                                                    
market conditions for extended  periods. The fact that there                                                                    
were provisions of a 3-year  review and that the legislature                                                                    
had  the  power  of  appropriation   gave  her  comfort.  He                                                                    
indicated he would address  his questions regarding modeling                                                                    
with the Department of Revenue.                                                                                                 
                                                                                                                                
2:11:04 PM                                                                                                                    
                                                                                                                                
Co-Chair  Neuman referred  to  a letter  dated December  24,                                                                    
2015 that  suggested an earnings  target of 7.5  percent (or                                                                    
7.45 percent) for the PF  in a deterministic model. He asked                                                                    
if  she   agreed  with  the   percentage  rate   using  that                                                                    
particular model.  Ms. Rodell  was uncomfortable  using that                                                                    
high   of   a   number.   She   understood   modeling,   and                                                                    
deterministic  and   probabilistic  models  and   the  risks                                                                    
incorporated  into  such  models.  However,  her  individual                                                                    
personal  experience was  that no  matter how  well modeling                                                                    
was  done  it was  inaccurate  most  of  the time.  She  was                                                                    
uncomfortable with that high of a return.                                                                                       
                                                                                                                                
Co-Chair Neuman  asked her to propose  a conservative number                                                                    
or goal. Ms.  Rodell relayed that she kept her  focus on the                                                                    
real return of  5 percent. In looking at  the current year's                                                                    
inflation of 0.12 percent, the  nominal return would be just                                                                    
over 5 percent. If the  inflation rate was 2.25 percent, she                                                                    
would be looking  at 7.25 percent. She  was most comfortable                                                                    
with  the  targeted real  return  assumption  that had  been                                                                    
executed and resolved  by the board of  trustees rather than                                                                    
what  the  potential might  be  even  though capital  market                                                                    
indicators predicted certain returns over a 10-year period.                                                                     
                                                                                                                                
Co-Chair  Neuman  was  looking   for  a  suggested  modeling                                                                    
number.  He would  rather use  more conservative  numbers in                                                                    
modeling.  Ms. Rodell  was uncomfortable  with providing  an                                                                    
exact number outside of 5 percent.                                                                                              
                                                                                                                                
Vice-Chair Saddler  asked her to provide  circumstances that                                                                    
would  justify limiting  the  PF  appropriation capping  the                                                                    
total amount  of the earnings  reserve balance. He  asked if                                                                    
an automatic  limit on the  dividend distribution,  based on                                                                    
the  balance  would kick  in  after  several years  of  poor                                                                    
returns. Ms. Rodell responded in the Affirmative.                                                                               
                                                                                                                                
Vice-Chair  Saddler asked  if she  had seen  the model  with                                                                    
inflation proofing  included. He  mentioned that  the charts                                                                    
he had seen  were reflective of nominal  numbers. Ms. Rodell                                                                    
had  not seen  the model  run  with real  target returns  as                                                                    
opposed to nominal target returns.                                                                                              
                                                                                                                                
Co-Chair Thompson thanked Ms. Rodell for her testimony.                                                                         
                                                                                                                                
2:15:23 PM                                                                                                                    
                                                                                                                                
CRAIG RICHARDS,  ATTORNEY GENERAL,  DEPARTMENT OF  LAW, made                                                                    
himself  available  to  the   committee  for  questions.  He                                                                    
referenced    a   letter    handed    out   regarding    the                                                                    
administration's   comments   on  the   proposed   committee                                                                    
substitute  (CS).  He  relayed  that  he  would  be  walking                                                                    
through   the  short   PowerPoint   presentation  from   the                                                                    
Department  of Revenue  on some  modeling results  and would                                                                    
discuss the major  points in the letter. He  wondered if the                                                                    
chair was agreeable to his agenda.                                                                                              
                                                                                                                                
Co-Chair  Thompson encouraged  Attorney General  Richards to                                                                    
continue.                                                                                                                       
                                                                                                                                
Attorney   General   Richards  introduced   the   PowerPoint                                                                    
Presentation: "Analysis for  House Finance CS for  HB 245 by                                                                    
Department of Revenue's  Economic Research Group 4/12/2016."                                                                    
He explained  that the first  few slides condensed  what the                                                                    
bill did and what assumptions  were used in the modeling. He                                                                    
confirmed that  the administration  had modeled what  was in                                                                    
the  bill.   The  modeling  included  the   dividend  payout                                                                    
calculation  using a  5.25 percent  payout rate.  He relayed                                                                    
the  conclusions from  the Department  of  Revenue in  three                                                                    
senses.  The first  was what  the dividend  would look  like                                                                    
over time  under the  modeling in the  bill. The  second was                                                                    
what the  value of the  PF itself  look like over  time. The                                                                    
third was what  he revenue stream going to  the general fund                                                                    
over  time  look  like.  He  thought  the  conclusions  were                                                                    
relatively similar to what  the Legislative Finance Division                                                                    
(LFD)  came up  with as  expected with  the assumptions.  In                                                                    
particular,  the   assumption  he   thought  had   the  most                                                                    
controversy  around it  in  relation to  the  bill was  what                                                                    
return assumption was used.                                                                                                     
                                                                                                                                
Attorney  General Richards  continued  that the  information                                                                    
presented the  previous day had two  return assumptions: one                                                                    
at  6.9 percent  total  geometric returns  and  one at  7.45                                                                    
percent. He  relayed that the  administration had  used, and                                                                    
would continue to  use 6.9 percent because one  of the major                                                                    
things  the  state asked  McKinsey  and  Company, a  private                                                                    
consulting  firm, to  provide its  best opinion  as to  what                                                                    
return  assumption  should be  used.  He  reported that  the                                                                    
company had spent several weeks  going through the different                                                                    
options,  forecasts,  historical  data,  and  the  different                                                                    
models  of  returns  and  return  assumptions  used  by  the                                                                    
Department of  Revenue and  Callan Associates.  McKinsey and                                                                    
Company  concluded that  the best  available information  to                                                                    
use  for modeling  purposes was  Callan Associates'  10-year                                                                    
forecast  in  its deterministic  model  at  6.9 percent.  He                                                                    
relayed  that  using 7.45  percent  was  not recommended  by                                                                    
experts who evaluated the problem for the administration.                                                                       
                                                                                                                                
Attorney General  Richards scrolled to  slide 6: "HB  245 CS                                                                    
at 5.25 percent POMV Per  Person Dividend Size." He reported                                                                    
that when  DOR modeled  the dividend  using the  6.9 percent                                                                    
total return,  the dividend  stayed flat  at about  $1000 at                                                                    
the  mean. He  highlighted the  yellow and  blue bars  where                                                                    
they intersected. The  intersection represented the fiftieth                                                                    
percentile  outcome; the  average  outcome for  each of  the                                                                    
years represented  in the  chart. In  reference to  the blue                                                                    
bar, he relayed that there was  a 25 percent chance that the                                                                    
outcome would  be above the average  to the top of  the blue                                                                    
bar.  There was  also about  a  25 percent  chance that  the                                                                    
outcome would go all the way  to the top line above the blue                                                                    
bar.  Similarly, there  was  a 50  chance  that the  outcome                                                                    
would go  in the yellow  box and  the line below  the yellow                                                                    
box.  He  explained  that  the  reason  there  was  so  much                                                                    
variability was  that even though  6.9 percent was  the mean                                                                    
on  the returns  it would  vary  widely over  time with  the                                                                    
stock market  potentially the stock  market performing  in a                                                                    
number of  different ways.  He remarked that  it was  a long                                                                    
way of saying  the mean expectation of DOR was  that the PFD                                                                    
would  be  about  $1000 flat  overtime  under  the  proposed                                                                    
committee   substitute.   He   noted  that   the   committee                                                                    
substitute met the governor's targets.                                                                                          
                                                                                                                                
2:20:23 PM                                                                                                                    
                                                                                                                                
Attorney  General  Richards  pointed  to  there  being  more                                                                    
upside in  the dividend over  time than there  was downside.                                                                    
In  other words,  the chance  of the  dividend amount  being                                                                    
higher was  more likely based  on two components.  The first                                                                    
component of  the dividend was that  it would be based  on a                                                                    
POMV. Due to the expectation  of the fund value growing over                                                                    
time,  the dividend  would also  grow  for one  half of  the                                                                    
component. The other  half of the component  was the royalty                                                                    
component,  which  was  likely  to be  larger  than  it  was                                                                    
presently because  of low oil prices.  Currently, 20 percent                                                                    
of royalties  was a relatively conservative  number compared                                                                    
to what it  would be if oil  prices increased significantly.                                                                    
In  response  to   Representative  Edgmon's  question  about                                                                    
whether  the  proposed  dividend formulation  more  or  less                                                                    
volatile  than the  current on,  the administration  had not                                                                    
modeled it. He would ask someone  from DOR to look at it. He                                                                    
suspected  it  would  be  less  volatile  than  the  current                                                                    
dividend. He  explained that by  basing the dividend  on the                                                                    
POMV  versus  on the  earnings,  the  number was  much  less                                                                    
volatile.                                                                                                                       
                                                                                                                                
Attorney General  Richards turned to  slide 7: "HB 245  CS @                                                                    
5.25  percent POMV  Total EOY  Fund  Balance." He  suggested                                                                    
that  if the  6.9 percent  return assumption  was used,  the                                                                    
5.25 percent  POMV draw was  too aggressive if the  goal was                                                                    
to maintain the real value of  the fund. He conveyed that on                                                                    
an inflation  adjusted basis the 5.25  percent would degrade                                                                    
the purchasing  power of  the fund over  time in  the median                                                                    
case. He  emphasized that  he stated  "the median  case." It                                                                    
was possible that things would  change substantially and the                                                                    
fund  would  grow  considerably.  Conversely,  things  could                                                                    
change negatively  such that the stock  market could perform                                                                    
poorly and  the fund  could shrink substantially.  The chart                                                                    
showed a  range of what the  fund might look like.  He noted                                                                    
that the  mean value of the  fund under a 5.25  percent draw                                                                    
was projected not to meet  up with inflation. However, there                                                                    
was still much more of an  upside in growth than there was a                                                                    
downside  due to  interest turning  compound  over time.  If                                                                    
there  were  a  good  series  of  runs,  there  would  be  a                                                                    
compounded growth effect.                                                                                                       
                                                                                                                                
Attorney General  Richards turned to  slide 8: "HB 245  CS @                                                                    
5.25 percent  POMV: Net Payout  to GF plus  Production Taxes                                                                    
and  Royalties not  dedicated  to the  PF  or Dividend."  He                                                                    
explained that  with a  basis of  6.9 percent  total returns                                                                    
the  administration did  not believe  the growth  of the  PF                                                                    
would be equal  to inflation. It also meant  that the amount                                                                    
of money that  went to government would  decrease over time.                                                                    
He  concluded that  by degrading  the value  of the  fund in                                                                    
real  terms, it  would also  degrade the  value of  the cash                                                                    
flow that went to the government over time.                                                                                     
                                                                                                                                
Attorney General Richards mentioned  there were other things                                                                    
worth  looking  at  in  terms  of  modeling  that  would  be                                                                    
provided  in  the  following  couple  of  days.  Some  items                                                                    
included  looking  at  how  the  modeling  would  work  with                                                                    
certain revenue limits and at  volatility in relation to the                                                                    
current dividend.                                                                                                               
                                                                                                                                
2:24:12 PM                                                                                                                    
                                                                                                                                
Representative  Edgmon commented  that  if he  were to  take                                                                    
what Attorney  General Richards presented at  face value, it                                                                    
contradicted  what  the  director   of  APFC  had  told  the                                                                    
committee earlier  about rate of  returns. However,  he knew                                                                    
it was more  complicated. He asked if  the model encompassed                                                                    
in HB  245 was  based on  a 6.9 percent  rate of  return. He                                                                    
wondered  if the  number captured  the variability  with oil                                                                    
production  and  oil  prices and  therefore,  provided  more                                                                    
comfort to  rising above  the 5 percent  the Ms.  Rodell had                                                                    
stated  she  was more  comfortable  with  based on  her  own                                                                    
experiences.  Attorney General  Richards indicated  that the                                                                    
board  had  set a  real  rate  of  return expectation  of  5                                                                    
percent  -  the return  not  counting  inflation. The  total                                                                    
return rate  of 6.9  percent included  both the  real return                                                                    
component and  the inflation return  component. If  the real                                                                    
return target  was 5 percent  and inflation  was anticipated                                                                    
to be 2.25  percent then the total  return expectation would                                                                    
be 7.25 percent. If 2.25  percent was a reasonable inflation                                                                    
estimate  then  the 6.9  percent  total  return that  Callan                                                                    
Associates used was more conservative  than the board's real                                                                    
expectation.                                                                                                                    
                                                                                                                                
Representative  Edgmon was  grappling with  the question  of                                                                    
variability  of  oil  price   and  oil  production.  He  was                                                                    
concerned  with  the  performance  of  the  endowment  fund.                                                                    
Attorney General  Richards relayed  that the  modeling being                                                                    
reviewed did not  account for the variability  of oil prices                                                                    
because the current CS did  not deal with volatility, as the                                                                    
administration would  suggest was  appropriate. He  noted he                                                                    
would be making some recommendations  on how to amend the CS                                                                    
to  handle  volatility.  That  modeling  would  include  oil                                                                    
prices. He  noted, however, that  under the  constitution 25                                                                    
percent  of royalties  were going  to the  corpus under  any                                                                    
plan.  The  modeling took  into  account  oil prices  as  it                                                                    
influenced  the 25  percent  of  the constitutional  royalty                                                                    
influx into the corpus.                                                                                                         
                                                                                                                                
2:27:34 PM                                                                                                                    
                                                                                                                                
Attorney General  Richards reported that  the administration                                                                    
was  pleased with  the  committee  substitute. He  commented                                                                    
that it was  a well thought out and  well-designed bill that                                                                    
adopted an  approach that the administration  could support.                                                                    
He suggested  there had been  a great collaboration.  One of                                                                    
pieces  of  the  bill  that  the  administration  wanted  to                                                                    
highlight   that   made   sense    was   talking   about   a                                                                    
sustainability  target in  the  same kind  of  way that  the                                                                    
state should maintain,  at a minimum, the real  value of the                                                                    
fund over  time. One of  the governor's core goals  was that                                                                    
the  value of  the PF  not be  degraded. The  administration                                                                    
thought that  the original Alaska Permanent  Fund Protection                                                                    
Act (APFPA)  had proposed  drawing a  fixed amount  of $3.33                                                                    
billion  versus a  POMV.  The  administration had  indicated                                                                    
from the beginning  that the POMV was a  great approach that                                                                    
worked.  He  thought  adopting  a  POMV  approach  was  very                                                                    
reasonable.  The governor  was in  support of  the royalties                                                                    
being  tied to  the dividend.  He thought  it made  sense to                                                                    
have  Alaskans rewarded  when the  state's natural  resource                                                                    
economy was  doing well. As  Alaska did well and  the budget                                                                    
did,  the dividend  would  go  up. On  the  other hand,  the                                                                    
administration recognized  that there was utility  and value                                                                    
in  having the  people of  Alaska staying  connected to  the                                                                    
direct  performance   of  the  fund  itself.   The  dividend                                                                    
calculation achieved both. It tied  people to the success of                                                                    
Alaska's resource economy and it  tied people to the success                                                                    
of the PF. In terms of  the absolute amount of the dividend,                                                                    
the governor  has said that  a dividend of around  $1000 was                                                                    
an appropriate amount. The specific  calculation in the bill                                                                    
was projected to provide.                                                                                                       
                                                                                                                                
Attorney General Richards reported  that another item in the                                                                    
committee  substitute  that made  sense  was  to repeal  the                                                                    
Emerita  Hess  provisions.  They  were an  artifice  of  old                                                                    
litigation  and  were  not  necessary  legally  or  from  an                                                                    
accounting perspective. He  thought the administration would                                                                    
support a  statutory change that  would allow the CBR  to be                                                                    
invested more long-term to achieve  higher returns. He noted                                                                    
the  administration  would  likely pass  on  some  technical                                                                    
comments  regarding the  language of  the bill,  which would                                                                    
not be  substantive. (Attorney General Richards  referred to                                                                    
a  letter addressed  to Co-Chair  Thompson  dated April  13,                                                                    
2016 - Copy on File).                                                                                                           
                                                                                                                                
Representative  Wilson  wanted   to  understand  better  why                                                                    
citizens would  favor benefiting  when oil  prices increased                                                                    
and  not benefiting  when oil  prices decreased.  Government                                                                    
already benefited  because the  state had its  highest years                                                                    
when  oil  was  over  $100 per  barrel.  The  state  already                                                                    
experienced  large spending  years.  Currently, things  were                                                                    
reversed  and the  state  had to  come  into check.  Alaskan                                                                    
residents would  benefit from  the PFD  but at  present, the                                                                    
state wanted to  change the game. She asked  if the attorney                                                                    
general saw  an issue.  Attorney General  Richards responded                                                                    
that he did not see an  issue. He understood that having the                                                                    
dividend system  tied to  the earnings  was really  a system                                                                    
designed  to  incent Alaskans  to  protect  the fund,  which                                                                    
included not  spending the fund and  encouraging its growth.                                                                    
He did  not believe  there was anything  inappropriate about                                                                    
tying  the   dividend  to   the  natural   resource  economy                                                                    
currently or in the future.  He thought either was rationale                                                                    
and  that  a  policy  decision was  required.  He  suggested                                                                    
policy makers  needed to consider  what made sense  in terms                                                                    
of incenting and rewarding Alaskans going forward.                                                                              
                                                                                                                                
2:32:48 PM                                                                                                                    
                                                                                                                                
Representative  Wilson commented  that the  attorney general                                                                    
had obviously  not gone door-to-door.  She stressed  that it                                                                    
would  be  very difficult  to  explain  to constituents  the                                                                    
state taking their money when the  price of oil was high and                                                                    
changing the rules. Currently, the  price of oil was low and                                                                    
it did not appear that  it would rebound. She suggested that                                                                    
instead of  reducing its  spending, the  state was  going to                                                                    
take  what belonged  to the  people. She  asserted that  the                                                                    
bill sought to  fill the gap using a  different formula. The                                                                    
model showed the public  contributing indefinitely while the                                                                    
state continued to  spend. She opined that she  would have a                                                                    
tough time selling the plan to her constituents.                                                                                
                                                                                                                                
Attorney  General Richards  responded  that  there were  two                                                                    
parts to  the conversation.  The first part  had to  do with                                                                    
what formulaic method  to use to calculate  the dividend. He                                                                    
thought  it would  reflect the  volatility in  the dividend.                                                                    
The other  part of  the conversation was  about the  size of                                                                    
the dividend. His answer was  that it was rational to change                                                                    
the method of  calculating the dividend. He  claimed that in                                                                    
moving to  a POMV  it was  not possible  to do  an earnings-                                                                    
based dividend, as  it did not make sense.  He remarked that                                                                    
Representative Wilson's  question went  to not just  how the                                                                    
dividend  was  calculated but  also  how  much the  dividend                                                                    
should be.                                                                                                                      
                                                                                                                                
Representative Wilson  clarified that she  was uncomfortable                                                                    
in deciding the amount of the  dividend. She did not want to                                                                    
choose a random  number to fill the state's gap.  It was the                                                                    
people's  money.  She  wondered  how to  justify  picking  a                                                                    
number.  Attorney General  Richards answered  that from  the                                                                    
administration's point of  view the state had  a system that                                                                    
was unsustainable.  The governor  believed that in  order to                                                                    
move to a sustainable system,  the state would need to press                                                                    
down evenly. He had tried  to balance reducing the dividend,                                                                    
increasing  revenue  measures,  reducing  oil  and  gas  tax                                                                    
credits, and  introducing spending cuts. He  tried to design                                                                    
a system that  spread the pain. Reducing the  dividend was a                                                                    
necessary component  because of  its magnitude. In  order to                                                                    
protect  the dividend  in the  future there  needed to  be a                                                                    
plan  that reduced  the  cost of  the  system and  increased                                                                    
revenues. As Mr. Teal has  stated before, without a plan the                                                                    
state would be broke by FY 21.                                                                                                  
                                                                                                                                
Representative Wilson responded that  the only reason Alaska                                                                    
would be  broke was if the  state continued to spend  at the                                                                    
same level as  it did presently. She  mentioned hearing from                                                                    
Mr. Keithly earlier in the  day and Mr. Goldsmith previously                                                                    
that there was another path  to a sustainable budget. It was                                                                    
suggested that  the state use a  portion of the ER  and some                                                                    
of the other  state savings. However, the state  had to save                                                                    
money   for   the  plan   to   work.   She  asked   if   the                                                                    
administration's plan had triggers  such as oil prices going                                                                    
up placing  a limit  on the  amount government  could spend.                                                                    
Attorney General  Richards asked  to postpone the  answer to                                                                    
her question.  He would be  covering it later in  the slide.                                                                    
Representative Wilson agreed to wait.                                                                                           
                                                                                                                                
2:37:42 PM                                                                                                                    
                                                                                                                                
Attorney General Richards reported  having reviewed what the                                                                    
administration considered positive  aspects of the committee                                                                    
substitute. The administration  would provide some suggested                                                                    
small  technical  amendments.  However,  the  administration                                                                    
identified  three   aspects  of  the  bill   that  could  be                                                                    
improved. First, the administration  thought 5.2 percent was                                                                    
slightly too aggressive in the  current form of the bill. He                                                                    
relayed that  a POMV  percentage of 4.9  or less  would meet                                                                    
the sustainability requirement.                                                                                                 
                                                                                                                                
Attorney  General  Richards'  second   point  was  that  the                                                                    
administration believed  it was good policy  and appropriate                                                                    
to  have  an  inflation  proofing  mechanism  in  place.  He                                                                    
explained that  in the  current system  all of  the realized                                                                    
gains  came out  of the  corpus of  the PF  into the  ER. By                                                                    
statute,  an  amount  dedicated to  inflation  proofing  was                                                                    
placed back into  the corpus of the fund.  He suggested that                                                                    
without a  system, not necessarily  the present  system, the                                                                    
growth in  the PF  over time  would occur  in the  ER rather                                                                    
than  in  the corpus.  The  administration  believed it  was                                                                    
appropriate  to have  a durable  earnings  reserve that  was                                                                    
large enough to  be able to make the  sustainable draws that                                                                    
would be  expected of it.  Any excess funds would  return to                                                                    
the corpus  to protect the  principle and the corpus  of the                                                                    
fund, which would grow over time for future Alaskans.                                                                           
                                                                                                                                
Attorney General  Richards continued that the  original bill                                                                    
recommended getting  rid of the existing  inflation proofing                                                                    
mechanism. However,  it added  a provision  stipulating that                                                                    
once  the ER  got four  times larger  than the  current year                                                                    
expected draw, anything in the  ER above that amount - about                                                                    
$10  billion in  the proposed  bill -  would be  transferred                                                                    
back  to the  corpus. It  provided for  a type  of inflation                                                                    
proofing that grew  the corpus over time but  left the state                                                                    
with a  durable ER. He  further explained that Mr.  Teal and                                                                    
Mr.  Dell  talked   about  the  change  in   the  nature  of                                                                    
allocations and  PF investments. The change  included moving                                                                    
away from  investment bonds to holding  stocks, real estate,                                                                    
and private  equity; things that  appreciated in  value, but                                                                    
were not  recognized as income right  away. Eventually, over                                                                    
time the state  would realize its gain on all  of the assets                                                                    
when they were sold.  The occurrence of capital appreciation                                                                    
in investments  currently reflected in the  corpus upon sale                                                                    
would go to  the ER. If the  state was going to  have the ER                                                                    
continue to grow, and maintain  its size over time there had                                                                    
to be some mechanism that would  allow money to go back from                                                                    
the ER  to the  corpus. Otherwise,  the ER  would experience                                                                    
the growth over time and  the corpus would not. He concluded                                                                    
that  it was  better  policy to  protect generationally  the                                                                    
money by  having the  growth in the  corpus rather  than the                                                                    
ER.                                                                                                                             
                                                                                                                                
Representative Pruitt  asked how long  it would take  to get                                                                    
to  the  $10  billion   figure.  Attorney  General  Richards                                                                    
responded that he had not  seen the modeling for the current                                                                    
CS. However,  under the original proposal  the best estimate                                                                    
was about  4 years.  If things turned  out better,  like the                                                                    
stock  market jumping  significantly, it  would only  take a                                                                    
couple of  years. The  same applied  if oil  revenues jumped                                                                    
up. In boom times, it was  a way of capturing the excess and                                                                    
transferring it to the corpus.                                                                                                  
                                                                                                                                
2:42:22 PM                                                                                                                    
                                                                                                                                
Representative  Munoz  asked  if  it was  a  combination  of                                                                    
having a  larger draw from  the CBR  into the corpus  of the                                                                    
account,  thus  generating  more revenue.  Attorney  General                                                                    
Richards  responded affirmatively.  The governor's  original                                                                    
proposal in  the APFPA was to  take $3 billion from  the CBR                                                                    
and place it  in the ERA. By doing so,  it allowed the state                                                                    
to invest the  $3 billion for a longer period  to get better                                                                    
returns  and increasing  the  state's  sustainable take.  It                                                                    
also buttressed the  size of the ER to make  it stronger. He                                                                    
relayed  the  governor's  plan was  not  necessary,  but  it                                                                    
provided a higher degree of  confidence. Under the committee                                                                    
substitute, because the draws were  smaller, it made it less                                                                    
necessary  to  do  so.  Having  a  $3  billion-transfer  was                                                                    
favorable, but it was not necessary to have a durable ER.                                                                       
                                                                                                                                
Attorney General  Richards mentioned that over  the previous                                                                    
6 months  the administration had  talked about the  issue of                                                                    
volatility.  In particular,  he noted  volatility associated                                                                    
with the state's three major  sources of cash flow including                                                                    
earnings  of the  PF, production  taxes, and  royalties. The                                                                    
plan managed the volatility associated  with the earnings of                                                                    
the  PF by  adopting a  POMV approach.  The state  would not                                                                    
spend the  earnings every year,  but rather a proxy  for the                                                                    
earnings, which  was a  percentage of the  market value  - a                                                                    
steady number.  The governor's plan had  proposed applying a                                                                    
similar  approach  to  production  taxes  and  royalties  by                                                                    
placing those  cash flow streams  into the  earnings reserve                                                                    
account  and   spending  a  fixed  amount   every  year.  He                                                                    
suggested  that  with this  approach  when  oil prices  were                                                                    
high,  the  state  would save  more.  Conversely,  when  oil                                                                    
prices   were  low,   the  state   would  spend   more.  The                                                                    
administration  thought it  was a  good approach  and worked                                                                    
with a POMV.  Whereas, the governor's plan  stated that $3.3                                                                    
billion was a sustainable  amount if petroleum revenues were                                                                    
placed in  the ERA.  The petroleum  revenues could  still be                                                                    
placed in the  ERA and the POMV draw could  be increased. It                                                                    
was another way  of having a steady cash flow  coming out of                                                                    
the PF  to fund  government while harnessing  the volatility                                                                    
of  the  three  cash  flow systems.  The  economic  modeling                                                                    
showed  the  sustainable  POMV  percentage  at  roughly  6.5                                                                    
percent if  production taxes and royalties  were placed into                                                                    
the ERA.                                                                                                                        
                                                                                                                                
Attorney  General Richards  reported  that another  approach                                                                    
the  administration supported  was  the  revenue limit  that                                                                    
resulted   from  an   amendment  to   SB  114   [Legislation                                                                    
introduced  in  2015 -  Short  Title:  PERM FUND:  EARNINGS,                                                                    
DEPOSITS,  ACCOUNTS]   out  of  the  Senate   State  Affairs                                                                    
Committee. He  explained that if oil  prices rebounded, then                                                                    
to the extent they rebounded  the state would not be drawing                                                                    
from its  financial assets.  It was  another logical  way of                                                                    
handling the  real problem of  volatility. The  problem with                                                                    
volatility was twofold. First, state  revenues jumped up and                                                                    
down, which  propagated government growth in  good years and                                                                    
significant government  shrinkage in bad years.  He surmised                                                                    
that the revenue  limit adopted by the  Senate State Affairs                                                                    
Committee addressed  the issue. It also  addressed the other                                                                    
piece  of  volatility,  which  was   a  pure  POMV.  In  the                                                                    
committee substitute,  the state  would be  able to  turn on                                                                    
the PF faucet to move money  into the GF. If oil prices were                                                                    
to rebound,  the state could  potentially build  budgets not                                                                    
only on  high oil prices  but also  on large draws  from the                                                                    
PF.  It  would  be  akin  to  doubling  down  on  oil  price                                                                    
volatility. In  the next period  of oil price  collapse, the                                                                    
government would have built a  larger and more unsustainable                                                                    
budget  then  without  PF   revenues  being  accessible.  He                                                                    
concluded that the governor thought  the inflation piece and                                                                    
the volatility piece (the lack  of a revenue limit) could be                                                                    
improved substantially.                                                                                                         
                                                                                                                                
Representative  Thompson welcomed  Commissioner Hoffbeck  to                                                                    
the meeting.                                                                                                                    
                                                                                                                                
2:47:41 PM                                                                                                                    
                                                                                                                                
Attorney  General Richards  addressed the  issue of  a rule-                                                                    
based system around a revenue  limit. He noted that Mr. Teal                                                                    
had mentioned the previous day  that a revenue limit was not                                                                    
necessary because funding was  subject to appropriation. Mr.                                                                    
Teal had  indicated that the  rules could be changed  by the                                                                    
legislature, although he was  uncertain they were necessary.                                                                    
Instead, Mr.  Teal offered that everything  could be handled                                                                    
by a yearly appropriation.                                                                                                      
                                                                                                                                
Attorney General  Richards pointed to a  chart titled "Long-                                                                    
Term  Problem" from  the  Alaska  Permanent Fund  Protection                                                                    
Act: Defining the Problem (one-page  handout from a previous                                                                    
presentation - labeled  page 10). He offered  that the chart                                                                    
demonstrated   the  state's   unrestricted  budget   graphed                                                                    
against unrestricted  petroleum revenues.  It showed  a high                                                                    
statistical correlation  to the  amount the state  spent and                                                                    
the amount of petroleum revenues  that were collected in the                                                                    
prior  year. He  furthered that  when petroleum  levels were                                                                    
high,  the state  spent a  significant amount  of money.  He                                                                    
continued that  when petroleum revenues  were low  the state                                                                    
spent  less  money. It  was  an  extremely high  statistical                                                                    
correlation. He  furthered without  a rules-based  system it                                                                    
was  likely  the  legislature   would  spend  the  petroleum                                                                    
revenues available if history  repeated itself. He suggested                                                                    
comparing his handout  to the history of the  PF. He thought                                                                    
members could see the value  of a rules-based revenue limit.                                                                    
In roughly 35  plus years, the legislature  had never broken                                                                    
a rule  regarding the PF.  The state had  inflation proofed,                                                                    
paid dividends, and kept from  spending the ER, all of which                                                                    
could  be  done by  a  majority  vote by  appropriation.  He                                                                    
claimed where  a rule-based system  was not in  place, there                                                                    
was an extremely  high tendency to spend money.  In a rules-                                                                    
based system,  there was incredible discipline  in following                                                                    
the  rules. He  furthered that  when a  system needed  to be                                                                    
changed,  if  there  was a  rules-based  revenue  limit  the                                                                    
discussion would  not be  about taking money  out of  the PF                                                                    
but about  changing the  rules in  a sustainable  manner. He                                                                    
surmised that by  having the rules in place the  topic of ad                                                                    
hoc spending  would be  avoided. He  advised that  the state                                                                    
would  want to  avoid  ad hoc  spending  with its  financial                                                                    
savings and sovereign wealth funds  because it would prevent                                                                    
the  state  from   growing  its  savings  over   time  in  a                                                                    
sustainable system.                                                                                                             
                                                                                                                                
Representative Wilson  asked if there had  been any modeling                                                                    
done with the  entire package. She indicated  that the bills                                                                    
were being heard  separately. She did not have  a picture of                                                                    
the  impact  of  a  total   package.  She  wondered  if  the                                                                    
department  had  done  modeling   for  different  groups  in                                                                    
different demographics. She wanted  to have a bigger picture                                                                    
of the impacts of the total plan.                                                                                               
                                                                                                                                
RANDALL  HOFFBECK,  COMMISSIONER,   DEPARTMENT  OF  REVENUE,                                                                    
replied  that the  department had  not done  a model  of the                                                                    
cumulative   impact  of   the  various   components  on   an                                                                    
individual  taxpayer.  The  department  had  modeled  it  in                                                                    
aggregate. Gunnar Knapp had done  the modeling and presented                                                                    
it to the committee. The  department had not drilled down to                                                                    
the  level   Representative  Wilson   queried,  such   as  a                                                                    
particular fisherman in a certain community.                                                                                    
                                                                                                                                
Representative  Wilson  asked  how  long it  would  take  to                                                                    
produce a model. Commissioner Hoffbeck  thought some kind of                                                                    
modeling  could  be  done  with a  selection  of  six  proxy                                                                    
individuals in the state with a certain occupation.                                                                             
                                                                                                                                
Representative  Wilson  stated  that  the  legislature  kept                                                                    
hearing  about  being fair  to  everyone  in the  state  and                                                                    
sharing the pain. She wanted  to have a better understanding                                                                    
of the full  impact of what was being  proposed. She thought                                                                    
more people would leave the state.  She did not have a grasp                                                                    
of  how  everything  that  was on  the  table  would  affect                                                                    
people's  choices to  stay  in Alaska  or  leave the  state,                                                                    
especially those  folks in areas  with higher  energy costs.                                                                    
Commissioner  Hoffbeck could  produce a  model, but  thought                                                                    
there was a much larger  picture to consider. There would be                                                                    
an impact  if the  state cut  an amount  from the  budget, a                                                                    
certain number  of people lost  their jobs, people  left the                                                                    
state, and house  prices dropped. He could  provide a simple                                                                    
model but it would be very  difficult to model fully how the                                                                    
changes would affect an individual  in the state. Everything                                                                    
the state did would have  some impact whether it reduced its                                                                    
expenditures or increased its revenues.                                                                                         
                                                                                                                                
2:55:50 PM                                                                                                                    
                                                                                                                                
Representative Wilson  understood the  commissioner's point.                                                                    
She thought  private businesses were  already doing  it. She                                                                    
was concerned with taxes stacking  up. She commented that it                                                                    
[the  plan] would  have a  huge  impact: it  would not  only                                                                    
impact  a family's  income, but  would  also affect  Alaskan                                                                    
communities. She  was trying to measure  the different items                                                                    
in the last few days [of the legislative session].                                                                              
                                                                                                                                
Representative Munoz returned to  the rules-based system and                                                                    
the importance  of having rules pertaining  to spending. She                                                                    
wondered if the  POMV approach was a  rules-based system. If                                                                    
it  was not,  she  wondered  what the  state  would need  to                                                                    
recalculate the spending amount to  put the rules into place                                                                    
in  the  current   legislation.  Attorney  General  Richards                                                                    
replied that  the POMV was definitely  a rules-based system.                                                                    
He asserted that  the bill did not contain all  of the rules                                                                    
he thought  it needed. The  committee substitute had  a rule                                                                    
for how much could be drawn  from the PF. He remarked it was                                                                    
a good  rule, but perhaps slightly  too high. It had  a rule                                                                    
for how  dividends were paid  and rules  for how the  PF was                                                                    
managed consistent  with existing rules. They  were all part                                                                    
of a  rules-based framework. He  expounded that it  lacked a                                                                    
rule to  address a revenue  limit in the  volatility issues.                                                                    
He  was  not  suggesting  that  it  was  not  a  rules-based                                                                    
framework. However, it  left out one of  the necessary rules                                                                    
for the  framework to be robust  that did not result  in the                                                                    
state just spending  PF earnings if oil  prices increased to                                                                    
previous levels.                                                                                                                
                                                                                                                                
Representative Edgmon asked Mr.  Teal the previous day about                                                                    
how Alaska  would stand with  the rating agencies.  He noted                                                                    
the governor  and members  of his  cabinet meeting  with the                                                                    
rating agencies on the East  Coast. He wondered how the plan                                                                    
being proposed stacked up with  the rating agencies in terms                                                                    
of  Alaska  getting  its  fiscal   house  in  order  if  the                                                                    
legislature  did not  include other  sources of  new revenue                                                                    
such as  income, fishing, or  mining taxes. He  wondered how                                                                    
the legislation  would be  received back  East. Commissioner                                                                    
Hoffbeck stated that the bond  rating agencies were in favor                                                                    
of  the state  using  its earnings  reserves. However,  they                                                                    
would negatively  view the state leaving  a large structural                                                                    
deficit  in which  it  continued to  draw  down savings.  He                                                                    
thought  the state  needed  to close  its  deficit with  the                                                                    
revenue packages before the bond  rating agencies would view                                                                    
the plan  as sustainable over  the long-term. He  reported a                                                                    
comment offered by Moodys. There  was a discussion about the                                                                    
downgrade  from AAA  to  AA+.  He had  shown  how using  the                                                                    
earnings  reserves would  stabilize  the  state. Moodys  was                                                                    
unsure that using just the  earnings reserves would create a                                                                    
stable enough fiscal environment for the state.                                                                                 
                                                                                                                                
2:59:51 PM                                                                                                                    
                                                                                                                                
Representative  Edgmon  indicated  that  it  had  just  been                                                                    
mentioned that the three largest  sources of revenues to the                                                                    
state included  production tax, royalties, and  the earnings                                                                    
from  the  PF.  If  current oil  prices  stayed  within  the                                                                    
current low  realm, $50  to $60 into  the future,  the state                                                                    
would not have  production tax revenue or would  have a very                                                                    
limited amount the way SB  21 [Oil tax legislation passed in                                                                    
2013]  was  structured. The  question  was  how it  impacted                                                                    
modeling. He  was aware the  commissioner could  not provide                                                                    
the exact  results, but it  seemed to  him that it  played a                                                                    
substantial  role if  the variables  he  had just  described                                                                    
stayed in place  going into perpetuity. He  thought 2040 was                                                                    
perpetuity. He  wanted the commissioner to  provide a bigger                                                                    
picture  view. Commissioner  Hoffbeck affirmed  that if  the                                                                    
state  had sustained  low oil  prices in  the $40  range the                                                                    
state would  build a credit  liability. If the price  of oil                                                                    
ranged from  $50 to $60, the  state would no longer  build a                                                                    
net operating  loss liability with the  producers. Depending                                                                    
upon what  the legislature  decided on the  oil and  gas tax                                                                    
credit  reform it  would  make sense  to  model whether  the                                                                    
state  would  have a  tail  of  liability. It  would  become                                                                    
another component against the  oil price in production until                                                                    
it was  paid off. The  department modeled the  current price                                                                    
points and  did not anticipate  a major shift. If  the price                                                                    
remained  at low  levels for  4 or  5 years,  the department                                                                    
would need to remodel. Hence,  there was a systematic review                                                                    
in the plan.                                                                                                                    
                                                                                                                                
Representative Gara  relayed that historically POMVs  used a                                                                    
4.5 percent payout. He understood  that most trust funds did                                                                    
not have  a royalty  as well.  He thought  royalties allowed                                                                    
for  an aggressive  payout.  He asked  if  he was  accurate.                                                                    
Attorney General  Richards replied  that he was  correct. He                                                                    
added  that if  an  average lagging  number  were used,  the                                                                    
percentage would be slightly higher  because of averaging in                                                                    
the lower value  from 5 years prior with  the current value.                                                                    
If only the current value was  used as the percent, then 4.5                                                                    
percent  was the  accepted number.  However,  if an  average                                                                    
were used, then a slightly higher percentage would be used.                                                                     
                                                                                                                                
3:03:58 PM                                                                                                                    
                                                                                                                                
Representative  Gara  wondered  about the  potential  for  a                                                                    
higher   dividend  payout.   He  thought   that  under   the                                                                    
governor's  plan   the  payout  percentage  allowed   for  a                                                                    
dividend. He asked about royalties  adding to the percentage                                                                    
of  the  PF at  $30,  $40,  or $50  per  barrel  of oil.  He                                                                    
remarked that most trust funds  did not have an extra income                                                                    
stream  such as  a  royalty. Alaska  was somewhat  different                                                                    
because it  had royalties  that offset  the worry  of eating                                                                    
into  the principle  of the  PF.  Attorney General  Richards                                                                    
responded   that    25   percent   of    royalties   equaled                                                                    
approximately $200 million.                                                                                                     
                                                                                                                                
Vice-Chair  Gara  wondered if  $200  million  was about  1.5                                                                    
percent.  Attorney  General  Richards  responded  that  $200                                                                    
million divided by  $50 billion equaled about  .4 percent of                                                                    
the  value of  the PF.  He added  that it  was $200  million                                                                    
every year.  If the  state treated it  like an  annuity, the                                                                    
value of an annuity would be roughly $2 billion.                                                                                
                                                                                                                                
Representative Gara  asked if it  was safe to move  the POMV                                                                    
payout rate higher than 5.25  percent to achieve the desired                                                                    
revenue  and a  better dividend.  Attorney General  Richards                                                                    
replied  that  as  the bill  was  currently  constructed,  a                                                                    
percentage rate of 5.25 was  considered a little aggressive.                                                                    
He explained that the POMV  percentage would not change, but                                                                    
the relative amount that went  to government versus dividend                                                                    
checks would  change through  adjusting the  POMV percentage                                                                    
as drafted  in the  CS. He  reiterated that  one of  the two                                                                    
revenue  limits  that  the  administration  supported  would                                                                    
change the POMV sustainable percentage.                                                                                         
                                                                                                                                
Representative Gara referred to  raising the dividend payout                                                                    
from $1000 to $1500, which  he thought would cost about $350                                                                    
million.    Commissioner   Hoffbeck    responded   in    the                                                                    
affirmative.                                                                                                                    
                                                                                                                                
Representative  Gara   discussed  the  variability   of  oil                                                                    
prices. He  stated that one  of the reasons the  model being                                                                    
presented in  the CS was  more flexible than  the governor's                                                                    
model was  because of a  relief valve being present  in case                                                                    
oil prices  rose. The governor's  model had much  more money                                                                    
going  towards  the principal.  He  asked  if there  was  an                                                                    
objection to  moving the PFD  to $1500 the first  year, then                                                                    
revisiting the  amount to  judge if  it was  sustainable the                                                                    
following  year   under  the  proposed   plan.  Commissioner                                                                    
Hoffbeck stated that the reason  for the $1000 figure had to                                                                    
do  with the  underlying math.  If  $500 were  added to  the                                                                    
dividend,  it  would  take away  $350  million  from  monies                                                                    
available for other expenditures.                                                                                               
                                                                                                                                
3:08:52 PM                                                                                                                    
                                                                                                                                
Representative  Gara advised  that he  was asking  questions                                                                    
while  not yet  being in  support of  the proposed  plan. He                                                                    
relayed that  it would  be difficult  tell the  public there                                                                    
was a balanced  plan without an oil tax  credit reform bill.                                                                    
He mentioned  a number of wealthy  individuals had expressed                                                                    
not needing their PFD. He  reported that unclaimed PFDs were                                                                    
spread amongst  other applicants  was the  current practice.                                                                    
He asked  if there was a  way for Alaskans to  decline their                                                                    
dividend having  the funds go  back to the ERA.  He wondered                                                                    
if the administration would consider  such an option so that                                                                    
individuals could opt out of the dividend and grow the ERA.                                                                     
                                                                                                                                
Commissioner Hoffbeck  suggested that  Representative Gara's                                                                    
idea would  require a  statutory change,  and most  likely a                                                                    
ruling by the  Internal Revenue Service (IRS)  to settle tax                                                                    
issues. He thought  there might be a tax liability  if a PFD                                                                    
applicant was  considered to be  in control of  the dividend                                                                    
funds through making a choice to direct them to the ERA.                                                                        
                                                                                                                                
Representative  Gara asked  if  Commissioner Hoffbeck  would                                                                    
look into  the matter.  He had considered  the circumstances                                                                    
surrounding an  employee who received  a bonus  but declined                                                                    
it. He thought  the idea could result in  extending the ERA.                                                                    
Commissioner Hoffbeck agreed to look in to the matter.                                                                          
                                                                                                                                
Representative  Pruitt believed  that Representative  Gara's                                                                    
idea would be more difficult  to implement. He thought there                                                                    
would  be  a  tax  liability as  mentioned  by  Commissioner                                                                    
Hoffbeck. He  agreed with Attorney General  Richards that it                                                                    
was important to  find an appropriate way to  make sure that                                                                    
there  were revenue  limits and  stability in  the bill.  He                                                                    
referred to the two options  that AG Richards had discussed,                                                                    
and asked for more  detail. Attorney General Richards stated                                                                    
that the idea of a  rules- based revenue limit was extremely                                                                    
important  to the  administration  in  handling some  budget                                                                    
problems.  He furthered  that the  limit was  a way  to make                                                                    
sure  that if  oil  prices recovered,  the  state would  not                                                                    
increase spending to a degree and diminish the PF earnings.                                                                     
                                                                                                                                
Attorney  General  Richards   addressed  the  two  proposals                                                                    
mentioned  by   Representative  Pruitt  starting   with  the                                                                    
revenue  limit  that  was  put   into  SB  114  [Legislation                                                                    
proposed  in  2015  -  Short  Title:  PERM  FUND:  EARNINGS,                                                                    
DEPOSITS, ACCOUNTS]  in the Senate State  Affairs Committee.                                                                    
He  prefaced his  comment by  informing  the committee  that                                                                    
production taxes  and royalties were  estimated collectively                                                                    
to  be  approximately $800  million  to  $1 billion  in  the                                                                    
future. The proposal  would include accessing the  PF in the                                                                    
short-term  and building  a sustainable  budget plan  around                                                                    
the petroleum  revenue assumption. If revenues  were greater                                                                    
than anticipated, the revenue  limit would reduce the amount                                                                    
that came  from the  ERA above $1  billion. If  oil revenues                                                                    
turned out  to be $1.2  billion, the state would  reduce the                                                                    
POMV  draw by  the excess  $200 million.  The revenue  limit                                                                    
would prevent  a budget  built upon high  oil prices  and PF                                                                    
earnings in a high oil price environment.                                                                                       
                                                                                                                                
Representative Pruitt asked the  attorney general to provide                                                                    
a stable dollar  amount based on how the  bill was currently                                                                    
constructed.  Attorney  General  Richards referred  back  to                                                                    
three  volatile   cash  flows   that  were   being  managed:                                                                    
production taxes,  royalties, and the  draw from the  PF. He                                                                    
relayed  that  together the  funds  were  expected to  total                                                                    
about $3.5  billion; assuming a  5 percent POMV from  the PF                                                                    
and  approximately $1  billion in  revenues from  production                                                                    
taxes and royalties.  The revenue limit of  $3.5 billion was                                                                    
a baseline from the three  various cash flows. As oil prices                                                                    
rose, the  state would  not use PF  earnings to  inject more                                                                    
than the $3.5 billion into the GF.                                                                                              
                                                                                                                                
3:17:08 PM                                                                                                                    
                                                                                                                                
Representative Pruitt  asked about  the second  option being                                                                    
considered. Attorney General  Richards explained that option                                                                    
2  (initially  contained  in the  original  version  of  the                                                                    
APFPA)  combined production  taxes, royalties,  and earnings                                                                    
from the corpus of the fund  into the ERA. The revenue limit                                                                    
would  include   a  calculation   that  would   determine  a                                                                    
sustainable annual  draw over time  that could  be supported                                                                    
by the three income streams.  The variable cash flow streams                                                                    
would be leveled  to come up with a  sustainable amount that                                                                    
could be  used to  budget upon  annually. He  explained that                                                                    
under  the  PFPA,  the revenue  limit  was  originally  $3.3                                                                    
billion;  he commented  that the  math was  very similar  to                                                                    
adopting a 6.5 POMV approach.  He restated that if all three                                                                    
income streams were housed in  the ERA, the sustainable POMV                                                                    
would be  about 6.5  percent, which  would provide  a steady                                                                    
annuity-like  payment coming  from  the PF  every year  that                                                                    
would act as the revenue limit.                                                                                                 
                                                                                                                                
Representative Pruitt  wanted to  understand the  benefit of                                                                    
moving the income  streams into the ERA. He  wondered if the                                                                    
configuration  gave opportunities  for the  state to  invest                                                                    
the  funds in  a  more  beneficial way  than  they would  be                                                                    
otherwise.  He  assumed  the  higher  rate  of  6.5  percent                                                                    
accounted for the fact that  the state would be sending more                                                                    
money towards the PF. Attorney  General Richards stated that                                                                    
the sustainable  POMV draw percentage (without  putting more                                                                    
income into the  PF) was calculated by  DOR as approximately                                                                    
4.9 percent. If royalties and  production taxes or any other                                                                    
cash  flow  was  put  into  the  PF,  the  sustainable  draw                                                                    
percentage  on a  POMV  basis  would rise.  In  the case  of                                                                    
putting production  taxes and  royalties in  to the  PF, DOR                                                                    
calculated  the sustainable  draw  percentage  at about  6.5                                                                    
percent. The 1.6 percent difference  in what was possible to                                                                    
draw  from the  PF  was a  reflection of  the  value of  the                                                                    
income streams.                                                                                                                 
                                                                                                                                
Representative Pruitt restated his  question about the value                                                                    
of and  reasoning for  moving the  revenue streams  into the                                                                    
fund. Commissioner  Hoffbeck explained  that there  was some                                                                    
advantage in  moving the revenues  to the ERA  because there                                                                    
would be an intermittent cash flow  in the form of a monthly                                                                    
payment coming  in. If the  funds were  housed in the  GF to                                                                    
pay for  government services,  not much  could be  done with                                                                    
the funds beyond  short, low-return investments. Conversely,                                                                    
if the  funds were  flowing into the  larger PF,  the monies                                                                    
could  go  into the  standard  investment  portfolio and  be                                                                    
invested more aggressively.                                                                                                     
                                                                                                                                
Representative  Pruitt  asked  if   the  scenario  could  be                                                                    
compared  to  using  a  checking  account  or  money  market                                                                    
account with  a higher opportunity  to make more  money from                                                                    
the funds.                                                                                                                      
                                                                                                                                
3:22:14 PM                                                                                                                    
                                                                                                                                
Vice-Chair  Saddler  asked  about  the  option  of  citizens                                                                    
declining  a  PFD. He  asked  how  often the  Department  of                                                                    
Revenue  had received  checks from  citizens  to reduce  the                                                                    
public debt.  Commissioner Hoffbeck  stated he had  not seen                                                                    
such a check recently.                                                                                                          
                                                                                                                                
Vice-Chair  Saddler asked  if such  an  occurrence would  be                                                                    
likely. Commissioner Hoffbeck answered  that it would not be                                                                    
likely.                                                                                                                         
                                                                                                                                
Representative  Wilson  spoke  of  a  constituent  that  was                                                                    
interested  in donating  his  PFD to  help  with the  budget                                                                    
deficit. The individual had donated  money to the university                                                                    
and then had to pay taxes  on the PFD despite having donated                                                                    
the funds.  She recounted  that the constituent  had written                                                                    
to the legislature  inquiring as to how he  could donate his                                                                    
PFD without being taxed on it.                                                                                                  
                                                                                                                                
Representative  Gara  emphasized   that  the  committee  was                                                                    
trying to  find a  way for individuals  to donate  PFD funds                                                                    
without being taxed, rather than engaging in arguments.                                                                         
                                                                                                                                
Co-Chair Thompson called a point  of order and surmised that                                                                    
Commissioner  Hoffbeck could  work on  the issue  of a  non-                                                                    
taxable donation of the PFD. He set the bill aside.                                                                             
                                                                                                                                
HB  245  was  HEARD  and   HELD  in  committee  for  further                                                                    
consideration.                                                                                                                  
                                                                                                                                
Co-Chair  Thompson reviewed  the  agenda  for the  following                                                                    
day.                                                                                                                            
                                                                                                                                

Document Name Date/Time Subjects
HB 245 - Modeling for HFIN CS 041216.pdf HFIN 4/13/2016 1:30:00 PM
HB 245
Page 10 from HB 245 - Alaska Permanent Fund Protection Act (Feb 15 2016 HF).pdf HFIN 4/13/2016 1:30:00 PM
HB 245
HB 245 CS revenue limit (4.13.16).pdf HFIN 4/13/2016 1:30:00 PM
HB 245
HB 245 DOR Letter.PDF HFIN 4/13/2016 1:30:00 PM
HFIN 4/19/2016 8:30:00 AM
HB 245