Legislature(2017 - 2018)HOUSE FINANCE 519

01/30/2018 09:00 AM FINANCE

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HOUSE BILL NO. 213                                                                                                            
     "An Act relating to  the investment, appropriation, and                                                                    
     administration of the public school trust fund."                                                                           
10:25:37 AM                                                                                                                   
Co-Chair  Foster  noted  the committee  had  heard  a  brief                                                                    
introduction on the bill on January 25.                                                                                         
Co-Chair  Seaton  MOVED  to  ADOPT  the  proposed  committee                                                                    
substitute  for  HB  213, Work  Draft  30-LS0765\R  (Glover,                                                                    
Co-Chair  Foster  OBJECTED  for  discussion.  He  asked  the                                                                    
sponsor to address the changes in the work draft.                                                                               
REPRESENTATIVE  JUSTIN  PARISH,  SPONSOR, provided  a  brief                                                                    
introduction  of the  bill.  The bill  changed  the way  the                                                                    
state managed the  Public School Trust Fund  and would allow                                                                    
it  to realize  capital gains  as income  where appropriate,                                                                    
always  preserving the  principal of  the fund  and allowing                                                                    
for  growth  into  the  future.  Moving  to  a  more  modern                                                                    
management system  would mean continued growth  in the fund,                                                                    
realize higher dividends, and a  higher rate of earning. The                                                                    
CS  had several  changes -  one  practical and  a couple  of                                                                    
substantive  changes. He  deferred to  his staff  to address                                                                    
the details.                                                                                                                    
LISA  WORL, STAFF,  REPRESENTATIVE JUSTIN  PARISH, addressed                                                                    
the summary of changes:                                                                                                         
     Page 2, line 10:                                                                                                           
     Delete "previous 10 fiscal years"  and add "five fiscal                                                                    
     years preceding he previous fiscal year."                                                                                  
     Page 2, line 31:                                                                                                           
     Add  "Section  6.  This Act  Takes  effect  immediately                                                                    
     under AS 01.10.070(c).                                                                                                     
Ms. Worl addressed  the bill in its entirety  by providing a                                                                    
sectional analysis:                                                                                                             
     Section 1  (page 1, line  4):  Amends AS  37.14.110 (c)                                                                    
     to state  the commissioner  of revenue  shall determine                                                                    
     the  net   income  of  the  fund   in  accordance  with                                                                    
     accounting principles  and that the principal  shall be                                                                    
     perpetually  retained   in  the  fund   for  investment                                                                    
     purposes.    The   distinction  between  principal  and                                                                    
     income  and  defining  and maintaining  the  difference                                                                    
     between the funds is deleted.                                                                                              
     Section  2.  (page  2,  line 9):    AS  37.14.160  adds                                                                    
     section (5)  to the  duties to direct  the commissioner                                                                    
     to  determine  the  average  monthly  balance  for  the                                                                    
     public school  trust fund based on  the monthly average                                                                    
     market value  of the  fund for  the previous  10 fiscal                                                                    
Ms. Worl  elaborated that  Section 2  added a  lag-year with                                                                    
the word  preceding. She continued  to review  the sectional                                                                    
     Section 3. (page  2, line 11   16):   Adds new section,                                                                    
     AS 37.14.165  relates to  the use  of the  public trust                                                                    
     fund  allowing  the  legislature  to  appropriate  4.75                                                                    
     percent of the amount determined by the commissioner.                                                                      
     Section  4.  (page  2,  line  19  and  line  23):    AS                                                                    
     37.14.170 further defines investment  of the trust fund                                                                    
     Section  5.  (page  2,  line  30):    AS  37.14.140  is                                                                    
     repealed.  This section had  stated that the net income                                                                    
     of  the fund  could  not be  appropriated or  expended.                                                                    
     This section was repealed as  it did not allow for fund                                                                    
     to be managed with the POMV method.                                                                                        
     Section 6.  (page 2, line  31): Adds section 6  for Act                                                                    
     to take effect immediately.                                                                                                
Ms. Worl  communicated she was  available for  questions and                                                                    
listed others available in the room and online.                                                                                 
10:31:01 AM                                                                                                                   
Representative  Guttenberg relayed  that  he had  previously                                                                    
asked  for the  history of  the fund.  He requested  to hear                                                                    
from the Legislative Finance Division (LFD).                                                                                    
ALEXEI  PAINTER,  ANALYST,   LEGISLATIVE  FINANCE  DIVISION,                                                                    
asked  if Representative  Guttenberg would  like information                                                                    
on the history of the fund.                                                                                                     
Representative Guttenberg answered in the affirmative.                                                                          
Mr.  Painter obliged.  He  relayed that  the  fund had  been                                                                    
established in  1913 as  a land  trust from  a congressional                                                                    
grant to the territory of  Alaska for public schools. In the                                                                    
1970s the land  trust had been converted into  a cash trust,                                                                    
creating the  fund as it is  at present. At that  point, all                                                                    
the  public  school trust  lands  were  merged into  general                                                                    
state  lands.  A  cash  trust  had  been  created  that  was                                                                    
invested and 0.5 percent of  royalties from minerals were to                                                                    
be deposited into the trust in  an attempt to make the trust                                                                    
whole.  Since then,  the fund  had initially  been used  for                                                                    
capital projects,  but was now  mainly used in  the formula.                                                                    
Given investment  strategies in  the 1970s  at the  time the                                                                    
statute was  written, there was deleted  language in Section                                                                    
1, such that the only  spendable amount coming from the fund                                                                    
was  dividends  and other  income.  He  stated that  capital                                                                    
gains could not be spent.                                                                                                       
Mr.  Painter  explained  that dividends  and  capital  gains                                                                    
(gains  from selling  stocks) went  into the  Permanent Fund                                                                    
Earnings  Reserve Account  (ERA).  The  Public School  Trust                                                                    
Fund did not  allow capital gains to be spent.  As a result,                                                                    
less was spendable every year  and the Department of Revenue                                                                    
(DOR)  managed  the fund  in  a  way  that perhaps  did  not                                                                    
maximize the  total return of  the fund since  stocks tended                                                                    
to be where  much of the value resided  at present. Changing                                                                    
the  management of  the fund  to a  percent of  market value                                                                    
(POMV)  would likely  increase the  expected returns  of the                                                                    
fund because the management could  be shifted away from some                                                                    
of  the dividend  earning  investments that  may  not be  as                                                                    
strong.  Additionally, the  change  would allow  more to  be                                                                    
spent  every year  because  the state  could  not spend  the                                                                    
dividends but could spend a  more stable market value of the                                                                    
fund. He noted there were also several lawsuits.                                                                                
10:34:13 AM                                                                                                                   
Representative  Neuman  referenced Mr.  Painter's  testimony                                                                    
that the fund had changed from  a land trust to a cash fund.                                                                    
He asked about the process.                                                                                                     
Mr.  Painter answered  that at  the  time in  the 1970s  the                                                                    
lands were managed as school  trust lands and when the sales                                                                    
happened the  revenue was  spent by  schools. At  that point                                                                    
the new sales from land were  deposited into a new fund. The                                                                    
land trust had been liquidated  and the lands had been added                                                                    
to  general state  land. There  was  no distinction  between                                                                    
school  and other  state lands,  except  for some  post-1980                                                                    
that were  transferred. The royalty deposit  was intended to                                                                    
take the place  of trust lands that no longer  belong to the                                                                    
trust. He explained  it had been the subject of  part of the                                                                    
Kasayulie  law suit.  At the  time  as part  of the  court's                                                                    
ruling (which had  been preempted by a  consent decree later                                                                    
on), the  judge had determined  that it was not  possible to                                                                    
determine whether the  trust had been made  whole by putting                                                                    
the royalties instead  of the lands unless the  value of the                                                                    
lands was known.  The value of the lands was  not known - it                                                                    
was impractical to survey hundreds  of thousands of acres in                                                                    
small parcels  across the state.  The trust would  remain in                                                                    
perpetuity as long as the value  of the lands was not known,                                                                    
but if  the state could  spend in  a sustainable way  on the                                                                    
correct  things,  it seemed  to  be  fulfilling the  trust's                                                                    
purpose. He remarked that the  Department of Law (DOL) could                                                                    
provide further detail on the legal aspects.                                                                                    
Representative  Neuman  referenced  the first  paragraph  in                                                                    
section changes that  read: "language that was  removed in a                                                                    
manner that preserves the  distinction between principal and                                                                    
income and  excludes capital  gains." He  believed it  was a                                                                    
major  change  in  the  way management  had  been  done.  He                                                                    
requested to  hear from  DOL. He  stated the  change allowed                                                                    
the principal to  be used for management  purposes. He asked                                                                    
for more detail.                                                                                                                
10:37:02 AM                                                                                                                   
Representative Parish deferred to DOL.                                                                                          
BRIAN   BJORKQUIST,  SENIOR   ASSISTANT  ATTORNEY   GENERAL,                                                                    
DEPARTMENT  OF  LAW  (via teleconference),  responded  there                                                                    
were  several  mischaracterizations  of  the  Public  School                                                                    
Trust, which  he intended to clarify.  He addressed Co-Chair                                                                    
Neuman's question  about what happened with  eliminating the                                                                    
capital gains  in Section 1  of the bill. He  explained that                                                                    
the  section still  had the  DOR commissioner  determine the                                                                    
net income  and still preserved  the principal of  the fund,                                                                    
which was perpetually retained  for investment purposes. The                                                                    
section  changed  that  the capital  gains  or  losses  were                                                                    
retained as part of the principal  of the fund - the capital                                                                    
gains  would add  to what  could  be spend  or losses  could                                                                    
detract from what could be spent.                                                                                               
Representative  Neuman stated  that the  change would  allow                                                                    
access  to the  principal  for management  of  the fund.  He                                                                    
reasoned  if there  was a  downturn for  several consecutive                                                                    
years  of  -4.75,  it  could   be  taken  out  of  the  fund                                                                    
principal. He  believed it went against  the original intent                                                                    
of the language.                                                                                                                
Mr.  Bjorkquist  disagreed.  He   explained  that  the  bill                                                                    
specified that the  principal of the fund  shall be retained                                                                    
for  investment purposes.  The principal  of the  fund could                                                                    
not be spent for  any purpose including administrative costs                                                                    
of the fund.                                                                                                                    
Representative Neuman  suggested that  the state  would have                                                                    
to use part of the fund  principal to fund the change in the                                                                    
bill  if   the  fund  had  negative   investment  years.  He                                                                    
questioned whether  it was a  change the  legislature wanted                                                                    
to make.                                                                                                                        
10:39:47 AM                                                                                                                   
Representative Pruitt was trying  to understand how the fund                                                                    
was currently managed  and how the change would  be made. He                                                                    
referenced  a handout  in members'  packets provided  by DOR                                                                    
dated January 23, 2018 (copy  on file). The handout showed a                                                                    
table of  projected payouts from FY  19 to FY 25.  He looked                                                                    
at  a column  labeled  "status quo"  and  observed that  the                                                                    
amount in [FY 25] would  be $825 million. Alternatively, the                                                                    
5-year endowment proposed  in the CS, the  fund amount would                                                                    
be $776 million  [in FY 25]. He noted there  was a change of                                                                    
about  $10 million  per  year in  the  amount available  for                                                                    
spending. He asked  how the money was  currently managed. He                                                                    
wanted to  understand how DOR  was currently limited  in its                                                                    
ability to manage the fund and  how the bill would allow the                                                                    
fund to make more money.                                                                                                        
Representative Parish deferred to DOR.                                                                                          
MIKE BARNHILL,  DEPUTY COMMISSIONER, DEPARTMENT  OF REVENUE,                                                                    
provided a background on the  evolving law and theory on the                                                                    
management  of trust  funds and  endowments. He  believed it                                                                    
was fair  to say that  the approach to managing  trust funds                                                                    
and endowments  had changed substantially  over the  past 50                                                                    
years.  The state's  statutes governing  the Permanent  Fund                                                                    
and  the Public  School Trust  Fund reflected  a theory  and                                                                    
common law  of managing trust  funds that had been  in place                                                                    
quite some  time ago.  Since that  time numerous  things had                                                                    
taken  place. First,  was the  recognition that  the overall                                                                    
objective  of managing  a  trust fund  or  endowment was  to                                                                    
preserve   the  inflation   adjusted  value   of  the   fund                                                                    
indefinitely. Previously, the idea  had been to preserve the                                                                    
notional value  of principal indefinitely. The  approach had                                                                    
been modernized to make sure  the principal adjusts with the                                                                    
value of inflation. Preserving the  value of principal alone                                                                    
did not accomplish the objective.                                                                                               
Mr.  Barnhill  elaborated  that  over  time  the  investment                                                                    
theory  regarding investment  of trusts  and endowments  had                                                                    
evolved  from the  notion that  there  should be  relatively                                                                    
risk-free  securities,  meaning   the  investment  portfolio                                                                    
would be  heavily dominated  with fixed  income instruments,                                                                    
had  given way  to  a more  aggressively invested  portfolio                                                                    
more  weighted towards  equities  and growth  in value.  The                                                                    
idea of  what could  be appropriated or  spent from  a trust                                                                    
had evolved from the concept of  income (cash in the case at                                                                    
hand)  delivered through  dividends from  equity instruments                                                                    
and coupons from fixed income  instruments, had given way to                                                                    
the  idea of  delivering some  distribution percentage  from                                                                    
the fund  (in some cases  5 percent,  or 4.75 percent  in HB
213). The idea  was to produce an  inflation adjusted income                                                                    
stream for the trust's beneficiaries.  Over time there was a                                                                    
stream of income that was  relatively consistent and did not                                                                    
erode the inflation adjusted value of the trust.                                                                                
Mr. Barnhill  expounded that much of  the conversation about                                                                    
the Permanent  Fund had  been focused on  how to  evolve the                                                                    
management and the  law governing the fund to  a more modern                                                                    
theory of  endowments, which was  equally applicable  in the                                                                    
case  of HB  213.  The statute  regarding  the exclusion  of                                                                    
capital gains in  the public trust fund was  also similar to                                                                    
the  Permanent Fund  context. In  1981 or  1982, instead  of                                                                    
retaining  net capital  gains in  the  principal, the  gains                                                                    
were allowed to  flow to the income fund. At  that time, the                                                                    
Permanent Fund  had adopted inflation proofing.  He spoke to                                                                    
Representative  Neuman's point  about eroding  the inflation                                                                    
adjusted  value  of  the trust.  The  way  endowments  avoid                                                                    
eroding the  inflation adjusted value  of the trusts  was to                                                                    
set  a distribution  percentage in  a way  that ensured  the                                                                    
payment to beneficiaries was  sufficient without eroding the                                                                    
inflation adjusted value of the trust.                                                                                          
Mr. Barnhill  addressed how the fund  was managed currently.                                                                    
In  general, the  asset allocation  was heavily  weighted to                                                                    
fixed income  compared to other trust  funds administered by                                                                    
DOR (55  percent equity/45 percent  fixed income).  Over the                                                                    
past couple  of years  the allocation  had been  adjusted to                                                                    
add in a  real estate investment trust  (REIT). He explained                                                                    
that  a REIT  is a  cash generating  instrument that  looked                                                                    
like  equities but  delivered cash  like  fixed income.  The                                                                    
department  had  also added  in  a  bit  of high  yield.  He                                                                    
detailed  that  if the  bill  passed,  the department  would                                                                    
shift  the  asset  allocation  to  be  more  heavily  equity                                                                    
weighted in order  to generate a higher  return profile over                                                                    
time.   The  numbers   on  the   DOR   table  mentioned   by                                                                    
Representative  Pruitt reflected  the  idea  that DOR  would                                                                    
shift  closer  to  a  70/30  asset  allocation  (70  percent                                                                    
equity/30  percent fixed  income) with  some adjustments  to                                                                    
have continued exposure to REITs and high yield.                                                                                
10:47:30 AM                                                                                                                   
Representative  Pruitt   spoke  to  the  bill's   intent  to                                                                    
maintain the  trust principal at an  inflationary amount and                                                                    
to allow for the amount to  be spent to also increase at the                                                                    
inflationary amount.  The CS  made a  change from  a 10-year                                                                    
POMV  to  a 5-year  POMV.  He  asked  Mr. Barnhill  for  his                                                                    
opinion on the change.                                                                                                          
Mr.  Barnhill answered  that one  of the  challenges in  the                                                                    
midterm investment environment (the  next ten years) was the                                                                    
current   long  running   bull  market   in  equities.   The                                                                    
department's  advisors, Callan  Associates,  and many  other                                                                    
advisors  were concerned  the market  may  be entering  some                                                                    
period of correction.  He noted it was not  possible to know                                                                    
the  timing -  it could  be any  day or  in three  years. It                                                                    
seemed plausible that at some  point over the next 10 years,                                                                    
the frothy  returns the equity  market had enjoyed  over the                                                                    
past  several   years  would  come   to  an  end   at  least                                                                    
temporarily.  The  department  was being  cautioned  against                                                                    
being optimistic  about continuing  to see  the double-digit                                                                    
equity return over the next 10 years.                                                                                           
Mr. Barnhill  explained that the  10-year averaging  made it                                                                    
easier  for   the  department  to   hit  the   objective  of                                                                    
preserving the  inflation adjusted  value of the  trust over                                                                    
that period.  The 5-year averaging made  it more challenging                                                                    
if there  was a period of  market correction in the  next 10                                                                    
years. He  added that Callan  Associates and  others present                                                                    
their capital  market assumptions  on a 10-year  basis (they                                                                    
were more  optimistic on a  30-year basis). While  there was                                                                    
some pessimism  over the  next 10  years about  whether they                                                                    
could  hit their  numbers with  a 5-year  averaging, over  a                                                                    
longer period  it should be  doable assuming  basic elements                                                                    
and performance of the equity markets persist over time.                                                                        
Mr. Barnhill clarified that as  drafted, the bill did not go                                                                    
all the  way to the  legal structure of what  was considered                                                                    
to be  the modern way  to manage endowments and  trusts. The                                                                    
reason was because it continued  to preserve the distinction                                                                    
between principal and income.  The objective of an endowment                                                                    
is to  preserve the  inflation adjusted  value of  the trust                                                                    
over  time.  The  technical  application  of  principal  and                                                                    
income  may not  succeed in  that objective,  which was  the                                                                    
reason laws  had been updated  to eliminate  the distinction                                                                    
between principal  and income so  the manager  understood it                                                                    
was not  their job  to preserve  principal, but  to preserve                                                                    
the inflation adjusted  value of the trust. He  cited a 2010                                                                    
law passed  by the  legislature as an  example. The  law was                                                                    
called  the  Uniform  Prudent  Management  of  Institutional                                                                    
Funds Act  under AS 13.65.  He detailed  it was a  model law                                                                    
drafted by  a professor  with expertise  in the  legal rules                                                                    
governing the  administration of  endowments and  trusts. He                                                                    
stated  that AS  13.65  made the  transition completely.  He                                                                    
read from statute:                                                                                                              
     If  a   trust  is  created  with   the  distinction  of                                                                    
     principal  and income  for purposes  of  this law,  its                                                                    
     interpreted  to   mean  a  trust  fund   of  indefinite                                                                    
Mr. Barnhill  explained that the distinction  was eliminated                                                                    
in the modern law of trusts.                                                                                                    
10:52:20 AM                                                                                                                   
Representative Pruitt  stated asked  where to put  weight in                                                                    
terms of  a long-term goal  if the objective was  to receive                                                                    
more money at present or preserve the value of the fund.                                                                        
Mr. Barnhill answered that the  policy embedded in laws like                                                                    
the Uniform  Prudent Management  of Institutional  Funds Act                                                                    
was the concept of  balancing the interests of beneficiaries                                                                    
today  with  the interest  of  beneficiaries  in the  future                                                                    
(preserving intergenerational  equities). He  explained that                                                                    
it  preserved  the inflation  adjusted  value  of the  trust                                                                    
while   maximizing   a   stream   of   income   to   current                                                                    
beneficiaries.  He explained  that the  numbers [on  the DOR                                                                    
table]   reflected  the   view   that   by  investing   more                                                                    
aggressively  the  fund  would grow  faster,  the  inflation                                                                    
adjusted  value of  the trust  would be  preserved, and  the                                                                    
stream of revenue to beneficiaries would be maximized.                                                                          
Vice-Chair  Gara referenced  the  DOR  handout. He  observed                                                                    
that  it  did not  look  like  an either/or  scenario  where                                                                    
either  principal  or  rate of  return  were  protected.  He                                                                    
referred to the 10-year endowment  model and noted the value                                                                    
of the fund went from $697  million in FY 19 to $808 million                                                                    
[in FY 25]. He asked if his understanding was accurate.                                                                         
Mr. Barnhill answered in the affirmative.                                                                                       
Vice-Chair Gara  stated that the  other goal of  the sponsor                                                                    
was to  increase the amount  of funding that went  to public                                                                    
education.  While the  fund value  increased, by  FY 24  the                                                                    
annual  payout under  the 10-year  endowment portion  of the                                                                    
bill would  mean $31.5  million compared  to the  status quo                                                                    
payout of $23.9 million per  year. He asked for verification                                                                    
that it  would mean approximately  $7.5 million per  year in                                                                    
additional funds for education.                                                                                                 
Mr. Barnhill answered in the affirmative.                                                                                       
Vice-Chair  Gara stated  that a  $100 increase  in the  Base                                                                    
Student Allocation (BSA) was about  $30 million and an extra                                                                    
$7.5 million  was an increase  to the  BSA of about  $25. He                                                                    
stated that in endowments if  a certain amount was taken out                                                                    
annually,  there may  be some  years where  money had  to be                                                                    
taken  from  the  principal,  but  over  the  long-term  the                                                                    
principal and  payout grew.  He asked why  there would  be a                                                                    
limitation that  prevented dipping  into the principal  in a                                                                    
bad year.                                                                                                                       
10:56:54 AM                                                                                                                   
Mr.  Barnhill  referenced  the table  provided  by  DOR  and                                                                    
replied that  10-year endowment was the  department's way of                                                                    
reflecting  the   averaging  or   lookback.  The   bill  had                                                                    
initially  included  a  10-year  lookback,  which  had  been                                                                    
changed to  a 5-year lookback  in the CS. He  explained that                                                                    
the  3-year  was  the  lookback  for  multiple  trust  funds                                                                    
administered by the department.  Modern endowment theory did                                                                    
not  ask  whether  the  value of  the  principal  was  being                                                                    
invaded,  but whether  the inflation  adjusted value  of the                                                                    
trust  was  being  preserved.  He  pointed  to  the  10-year                                                                    
endowment column  with a starting  balance of  $697 million.                                                                    
He  spoke   to  the   inflation  adjusted   value  preserved                                                                    
indefinitely   through  time.   He   detailed  that   Callan                                                                    
Associates  had  a  10-year  inflation  projection  of  2.25                                                                    
percent, which had recently been  increased to 2.26 percent.                                                                    
He explained  that the 10-year endowment  approach preserved                                                                    
the $697 million  on an inflation adjusted basis  for the 5-                                                                    
year timeline and indefinitely.                                                                                                 
Mr. Barnhill reported  that it was plausible  there would be                                                                    
a down market in the future.  He noted there would be points                                                                    
in  time   when  the  inflation   adjusted  value   was  not                                                                    
preserved.  The overall  objective of  endowment law  was to                                                                    
preserve  the  inflation  adjusted  value  indefinitely.  He                                                                    
stated there were  multiple ways to correct for  a period of                                                                    
time  where there  was a  drawdown  or a  correction in  the                                                                    
markets  and  the  inflation adjusted  value  of  the  trust                                                                    
decreases.  Options included  staying  the  course with  the                                                                    
understanding that the market may  come back, which it often                                                                    
did,  or  the  distribution  percentage  could  be  adjusted                                                                    
temporarily  from  4.75 percent  downward  for  a couple  of                                                                    
years to see  if the inflation adjusted  value corrected. It                                                                    
was not fatal.  There were other ways of  correcting for the                                                                    
issue. The fact  there was a period where  the current value                                                                    
was  less than  the inflation  adjusted value.  He explained                                                                    
the situation was not fatal.                                                                                                    
11:00:16 AM                                                                                                                   
Vice-Chair Gara shared that he was  in favor of the bill. He                                                                    
asked Mr. Barnhill to provide  a written document specifying                                                                    
the impact  of doing  a traditional endowment  model seeking                                                                    
long-term gains and where there  was not significant concern                                                                    
over one or two years of a decline in principal.                                                                                
Mr. Barnhill  answered that  if it was  a legal  question he                                                                    
preferred  to defer  to DOL.  He stated  if it  was a  trust                                                                    
Vice-Chair   Gara   interjected   that  it   was   a   trust                                                                    
administration question.                                                                                                        
Mr.  Barnhill  responded  the easiest  thing  was  to  refer                                                                    
members to AS  13.65, which set out the  factors to consider                                                                    
in distributing  from an endowment.  The model  statute said                                                                    
that  evaluating  the  prudency  of  how  the  factors  were                                                                    
evaluated and applied  in a given year depended  on what was                                                                    
known to the manager at the time.                                                                                               
Vice-Chair Gara asked whether it  would cause DOR concern if                                                                    
he were to  propose an amendment that  removed the provision                                                                    
specifying that  the principal could  never be  dipped into,                                                                    
meaning the fund would just be run as an endowment.                                                                             
Mr.  Barnhill  answered  that  the  committee  could  delete                                                                    
Section 1, which would mean  converting from a principal and                                                                    
income fund  to an endowment  fund, which he  believed would                                                                    
be appropriate.                                                                                                                 
Representative  Parish pointed  to the  language on  page 2,                                                                    
lines   12  and   13:  "Each   year,  the   legislature  may                                                                    
appropriate 4.75  percent..." He  stated that if  there were                                                                    
ever a concern that the growth  of the fund was hindered, it                                                                    
would  be the  legislature's prerogative  to allocate  funds                                                                    
from other sources.  Given the high rate  of returns enabled                                                                    
by  the  legislation  and   the  conservative  4.75  percent                                                                    
proposed  POMV  draw over  a  5-year  lookback, he  did  not                                                                    
anticipate  any  erosion  of  value  except  in  exceptional                                                                    
market   circumstances.   He   reiterated  that   in   those                                                                    
circumstances  the legislature  had  the  option of  drawing                                                                    
11:03:23 AM                                                                                                                   
Representative  Neuman  stated   he  was  having  difficulty                                                                    
because land  was a  real property asset  with a  value that                                                                    
increased  and  decreased. He  recalled  losing  money on  a                                                                    
property  in  the 1980s  because  the  value had  gone  down                                                                    
considerably. He had  no idea when looking  at the forecasts                                                                    
what the prior  performance had been. He asked  how the fund                                                                    
had performed in the past 10 years  - he did not know how to                                                                    
make  the  comparison  without   the  numbers.  He  wondered                                                                    
whether the change would put more  money in the fund or not.                                                                    
He  spoke  to the  value  of  the  land and  understood  the                                                                    
concept of going  to cash, but the committee  had heard from                                                                    
LFD that  the state did not  know the value of  the property                                                                    
when it had  been changed from a land trust  to a cash fund.                                                                    
He wondered  if it  could be a  potential lawsuit.  He asked                                                                    
how the funds currently went  into the system. He questioned                                                                    
whether  the funds  came in  as  unrestricted general  funds                                                                    
(UGF). He  reasoned that it  would be difficult to  see what                                                                    
the funds were if they came  in as UGF and were converted to                                                                    
designated general funds (DGF).                                                                                                 
Representative Parish  relayed that the Public  School Trust                                                                    
Fund was a dedicated fund;  it was a pre-statehood fund that                                                                    
was a federal program. He  deferred to Mr. Painter to answer                                                                    
any concerns  about the  transition from a  land trust  to a                                                                    
cash  trust.  He  asked  Mr.  Barnhill  to  respond  to  the                                                                    
question about long-term earnings.                                                                                              
11:06:13 AM                                                                                                                   
Mr. Barnhill answered that as  indicated by Mr. Painter, the                                                                    
fund had  started out in 1913  as a land trust.  In 1978 the                                                                    
land trust  element was extinguished by  the legislature and                                                                    
it  was  converted  entirely  to  a  cash  asset  portfolio.                                                                    
Currently there  was no land  in the  trust fund -  the fund                                                                    
was  roughly  allocated between  55  percent  equity and  45                                                                    
percent fixed  income. The  fund was  also invested  in REIT                                                                    
securities  (which   was  not  land)  and   high  yield.  He                                                                    
discussed unaudited returns as of  December 31, 2017. The 1-                                                                    
year return  was 13.79 percent,  the 3-year return  was 6.74                                                                    
percent, the 5-year return was 7.36 percent, and the 10-                                                                        
year  return was  6.23 percent.  He offered  to compare  the                                                                    
returns  to the  Power Cost  Equalization (PCE)  Fund, which                                                                    
DOR  administered  more  on an  endowment  approach.  As  of                                                                    
December 31, 2017, the 1-year  PCE return was 16.02 percent,                                                                    
the 3-year  return was  7.7 percent,  the 5-year  return was                                                                    
10.3 percent,  and the 10-year  return was 7.04  percent. He                                                                    
offered  to  provide  a  copy to  the  Co-Chair  Foster  for                                                                    
Representative  Neuman  requested  the past  performance  in                                                                    
writing.  He remarked  on the  difference between  investing                                                                    
the $1 billion  PCE Fund compared to the  $22 million Public                                                                    
School Trust Fund.                                                                                                              
Mr.  Barnhill clarified  that the  Public School  Trust Fund                                                                    
was a $670 million fund.  He recognized the fund was smaller                                                                    
than the PCE Fund, but not that much smaller.                                                                                   
11:08:46 AM                                                                                                                   
Mr.  Painter responded  to Representative  Neuman's question                                                                    
about how funding appeared in  the budget. He explained that                                                                    
the  0.5 percent  of royalties  dedicated to  the fund  were                                                                    
appropriated but  did not appear  in the budget just  as the                                                                    
royalties going to  the Permanent Fund did not  show up. The                                                                    
spending  from the  fund as  a dedicated  fund showed  up as                                                                    
"other," which would not change  in the bill. Both the Mount                                                                    
Edgecumbe  and K-12  formula components  showed up  as other                                                                    
funds.  There  was  no  UGF  because  of  the  pre-statehood                                                                    
Co-Chair Neuman  asked if the  [indecipherable] used  UGF of                                                                    
Mr. Painter answered "other."                                                                                                   
Co-Chair  Seaton referenced  Mr.  Barnhill's testimony  that                                                                    
the   10-year  endowment   model  preserved   the  inflation                                                                    
adjusted value  over a  10-year period. He  asked if  the 5-                                                                    
year  lookback that  was  used by  the  Permanent Fund  also                                                                    
preserve the  inflation adjusted value over  the same amount                                                                    
of time.                                                                                                                        
Mr.  Barnhill answered  that for  the  10-year lookback  the                                                                    
inflation  adjusted  value   at  current  Callan  Associates                                                                    
capital market assumptions was preserved  for all periods of                                                                    
time.  For  the 5-year  approach  and  10-year window  using                                                                    
current  Callan capital  market  assumptions, the  inflation                                                                    
adjusted value of the trust  fund narrowly missed. Inflation                                                                    
adjusted value  was restored in Callan's  30-year projection                                                                    
for capital  markets was closer  to 8 percent as  opposed to                                                                    
6.5 percent.  The pessimism  embedded into  Callan's 10-year                                                                    
projections created  the issue  for the 5-year  approach. He                                                                    
added that the issue was also true for the 3-year approach.                                                                     
11:11:19 AM                                                                                                                   
Representative Guttenberg considered  the interest earned in                                                                    
a year  over the  payout plus  inflation proofing.  He noted                                                                    
that Mr.  Barnhill had discussed  that in some of  the years                                                                    
it was  considerably higher. He  asked if the  interest that                                                                    
went back into the fund was considered principal.                                                                               
Mr. Barnhill replied there were  two paradigms he was trying                                                                    
to  distinguish.   He  referred  to  the   principal  income                                                                    
paradigm  as  the legacy  paradigm.  In  the Permanent  Fund                                                                    
context there  was familiarity and comfort  with the concept                                                                    
of inflation  proofing because  the legislature  had decided                                                                    
to explicitly inflation proof  through an appropriation back                                                                    
from the ERA  to principal. In the Public  School Trust Fund                                                                    
the legacy approach  did not do that  explicitly because the                                                                    
statutory  definition of  principal included  capital gains.                                                                    
He  speculated that  the drafters  of the  approach believed                                                                    
the retention  of capital gains  was some form  of inflation                                                                    
proofing. In  other words,  in the  legacy approach  for the                                                                    
Public  School  Trust  Fund,  there  was  not  any  explicit                                                                    
inflation proofing because capital  gains and principal were                                                                    
retained, which was different than the Permanent Fund.                                                                          
Mr. Barnhill  addressed the modern  paradigm the  bill tried                                                                    
to move towards and  explained that the inflation adjustment                                                                    
was  implied through  the  distribution  percentage of  4.75                                                                    
percent.  The notion  was to  balance the  payouts in  a way                                                                    
that  preserved the  inflation adjusted  value of  the trust                                                                    
over periods of time.                                                                                                           
Representative Guttenberg  asked what Callan  Associates and                                                                    
two of  their competitors would  recommend on the  5-year or                                                                    
10-year endowment concepts.                                                                                                     
Mr. Barnhill  did not want  to put words in  Callan's mouth.                                                                    
He  speculated  that  Callan would  observe  that  that  the                                                                    
principal  and  income structure  to  trust  funds was  long                                                                    
outdated  and  the majority  (if  not  all) endowment  funds                                                                    
operate  on an  endowment methodology  or POMV  approach. He                                                                    
referenced the 10-year, 5-year,  and 3-year lookback periods                                                                    
and  ventured  that Callan  would  observe  that with  their                                                                    
current  capital market  assumptions for  the next  10 years                                                                    
that the  10-year averaging approach worked,  and the 5-year                                                                    
approach narrowly  missed, but  over longer periods  of time                                                                    
would  restore inflation  adjusted  value and  the same  was                                                                    
true for the 3-year approach.                                                                                                   
Representative Guttenberg surmised that  Callan would say it                                                                    
was up to the client.                                                                                                           
11:15:07 AM                                                                                                                   
Co-Chair Foster  WITHDREW his OBJECTION  to the  adoption of                                                                    
the work draft.                                                                                                                 
Representative  Neuman  asked  why  the  approach  had  been                                                                    
changed from 10 to 5 years.                                                                                                     
Representative  Parish  answered   that  he  had  originally                                                                    
proposed the 10-year  lookback. On advice by  Mr. Painter he                                                                    
had included  a lag-year  to provide  greater predictability                                                                    
to  know what  level of  funding was  coming. He  recognized                                                                    
going to  a 5-year  lookback was  a more  aggressive option,                                                                    
but it  was familiar to  the bulk of the  Alaskan population                                                                    
through the Permanent  Fund program and it was  more in line                                                                    
with what the  other body [Senate] may be  supportive of. He                                                                    
stated that  for the past  20 years the Public  School Trust                                                                    
Fund  had  tripled in  nominal  value.  He believed  it  was                                                                    
fantastic and  that robust growth  in the state's  funds was                                                                    
valuable;   however,  he   thought  that   it  fundamentally                                                                    
departed from the purpose of  a trust, which was to preserve                                                                    
the inflation adjusted value,  while maximizing dividends to                                                                    
beneficiaries. He believed either  the 5-year or the 10-year                                                                    
lookback  achieved   the  objective.  There  was   a  strong                                                                    
argument to be made that  the 5-year lookback did a superior                                                                    
job, if at  the expense at limiting the  rate that inflation                                                                    
adjusted value was beat.                                                                                                        
11:18:00 AM                                                                                                                   
Representative Neuman  requested to  see the  numbers behind                                                                    
the  reasoning the  change  had  been made  to  5 years.  He                                                                    
mentioned  perhaps a  7-year or  8-year  approach should  be                                                                    
considered.  He noted  there was  a reason  the sponsor  had                                                                    
changed  to  the  5-year  approach and  he  assumed  it  was                                                                    
because the numbers looked better.                                                                                              
Representative Parish  was sensitive  to the  concern, which                                                                    
was  the  reason  he  had   originally  proposed  a  10-year                                                                    
lookback.  He would  provide  the  requested information  in                                                                    
Co-Chair  Foster wanted  to  make sure  there  was time  for                                                                    
public  testimony.  He  noted  that no  one  was  signed  up                                                                    
Vice-Chair Gara  referenced discussion  about going  back to                                                                    
the Callan  model with  POMV and  no ban  on going  into the                                                                    
principal in one year or another.  He asked if it would mean                                                                    
deleting Section 1 of the bill.                                                                                                 
Mr.  Barnhill  replied that  if  the  legislature wanted  to                                                                    
convert  the trust  from a  principal and  income fund  to a                                                                    
modern endowment fund,  it would mean deleting  Section 1 of                                                                    
the bill.                                                                                                                       
Vice-Chair  Gara  requested  the information  asked  for  by                                                                    
Representative Neuman. He was  interested in the numbers for                                                                    
a 7-year and 8-year approach.                                                                                                   
Representative  Parish replied  that  he  would provide  the                                                                    
11:20:21 AM                                                                                                                   
Representative  Pruitt remarked  that the  CS also  made the                                                                    
changes effective  immediately. He asked if  it would enable                                                                    
DOR to shift the asset allocation immediately.                                                                                  
Mr.  Barnhill believed  the intention  was two-fold.  First,                                                                    
DOR would  shift the asset  allocation as soon  as prudently                                                                    
possible  from a  55  percent  [equities]/45 percent  [fixed                                                                    
income]  to  a  70   percent  [equities]/30  percent  [fixed                                                                    
income] allocation.  There could  be difficulties  in making                                                                    
the shift  immediately depending  on the  market conditions;                                                                    
the shift should not be done  at the wrong time. He believed                                                                    
the other  intention was to  appropriate for purposes  of FY                                                                    
19  pursuant to  the distribution  percentage as  opposed to                                                                    
the current method.                                                                                                             
Representative Parish  added that the primary  objective was                                                                    
realizing  a  high  rate  of return  from  its  assets.  The                                                                    
state's asset managers had  communicated that higher returns                                                                    
could  be achieved  on the  $670 million  fund if  they were                                                                    
provided  more management  discretion.  He  believed it  was                                                                    
better  done sooner  rather than  later.  The difference  in                                                                    
earnings would  be in  the thousands of  dollars per  day if                                                                    
the market  behaved as was expected.  The difference between                                                                    
an  immediate effective  date versus  90 days  after passage                                                                    
would be measured  in the hundreds of  thousands of dollars,                                                                    
which he believed merited  consideration by the legislature.                                                                    
He thanked the committee.                                                                                                       
11:22:53 AM                                                                                                                   
Co-Chair Foster  WITHDREW his OBJECTION  to the  adoption of                                                                    
the work draft.                                                                                                                 
There  being NO  further OBJECTION,  Work Draft  30-LS0765\R                                                                    
(Glover, 1/26/18) was ADOPTED.                                                                                                  
Co-Chair  Foster  OPENED  and CLOSED  public  testimony.  He                                                                    
relayed that amendments were due on Friday.                                                                                     
HB  213  was  HEARD  and   HELD  in  committee  for  further                                                                    
Co-Chair  Foster addressed  the schedule  for the  following                                                                    

Document Name Date/Time Subjects
HB 213HFIN CS WORKDRAFT V.R.pdf HFIN 1/30/2018 9:00:00 AM
HB 213
HB 287 Anchorage School District - Bishop. Deena - Public Testimony 012518.pdf HFIN 1/30/2018 9:00:00 AM
HB 287
HB 213 Summary of Changes Ver. U to Ver. R.pdf HFIN 1/30/2018 9:00:00 AM
HB 213
Sectional Analysis HB 213 - version 30-LS0765-R.pdf HFIN 1/30/2018 9:00:00 AM
HB 213
HB 287 PublicTestimonyPiazza20180125.pdf HFIN 1/30/2018 9:00:00 AM
HB 287
HB 287 NEA-Alaska letter of support HB287.pdf HFIN 1/30/2018 9:00:00 AM
HB 287
HB 213 Response Qs HFIN-DOR re HB 213 2-3-2018.pdf HFIN 1/30/2018 9:00:00 AM
HB 213