Legislature(2017 - 2018)HOUSE FINANCE 519

02/08/2018 01:30 PM FINANCE

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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
Moved CSHB 213(FIN) Out of Committee
Moved CSHB 142(FIN) Out of Committee
+ Bills Previously Heard/Scheduled TELECONFERENCED
HOUSE BILL NO. 213                                                                                                            
     "An Act relating to the investment, appropriation, and                                                                     
     administration of the public school trust fund."                                                                           
1:56:33 PM                                                                                                                    
Co-Chair  Foster indicated  that  the  committee last  heard                                                                    
HB 213  on  January  30,  2018 at  which  time  a  committee                                                                    
substitute,  version R,  was adopted,  and public  testimony                                                                    
was taken.  His office  had received  one amendment  for the                                                                    
bill. He  asked the bill  sponsor and  his staff to  come to                                                                    
the table.                                                                                                                      
1:57:22 PM                                                                                                                    
REPRESENTATIVE JUSTIN PARISH, SPONSOR,  spoke to the benefit                                                                    
of  the bill.  The bill  was  a way  of bringing  additional                                                                    
revenue to the State of  Alaska through better management of                                                                    
one of the  state's large investment funds.  The state would                                                                    
be able  to continue to achieve  the mission of the  trust -                                                                    
to maintain  its inflation-adjusted  value and do  better at                                                                    
spinning off  money to support  public education. He  had no                                                                    
fundamental objections to the amendment being offered.                                                                          
Representative Wilson  wanted to better understand  how much                                                                    
money the state  was making on the account based  on the way                                                                    
it was currently being managed,  versus the amount the state                                                                    
would make if  it was managed in the way  it was proposed in                                                                    
the bill.                                                                                                                       
Representative Parish  referred to  a Department  of Revenue                                                                    
(DOR) spreadsheet  "DOR 10-Year  'What if' Payout"  (copy on                                                                    
file). He pointed  to the 3rd and 4th lines  below the table                                                                    
under "Notes."  The status quo  endowment returned  a little                                                                    
under  6  percent  (the  projection).  He  deferred  to  Mr.                                                                    
Barnhill to explain further.                                                                                                    
1:59:51 PM                                                                                                                    
MIKE BARNHILL,  DEPUTY COMMISSIONER, DEPARTMENT  OF REVENUE,                                                                    
sent  a letter  to  the committee,  dated  February 3,  2018                                                                    
(copy on  file). Attached  to the letter  were the  rates of                                                                    
return for the Public School  Trust 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  would be  happy  to                                                                    
review  them to  give members  the historical  sense of  the                                                                    
performance of the fund.                                                                                                        
Mr. Barnhill continued that the  primary intent of the bill,                                                                    
from the department's perspective,  was not to generate more                                                                    
income for public schools. It  was to convert the trust fund                                                                    
from  an  old-style  principle-and-income trust  fund  to  a                                                                    
modern  style  endowment fund.  In  making  the change,  the                                                                    
purpose  would  evolve  from  protecting  the  principle  to                                                                    
protecting  the inflation-adjusted  value of  the fund  over                                                                    
time. The  old principle and income  fund did a fine  job of                                                                    
protecting   the  inflation-adjusted   value.  However,   he                                                                    
thought the  endowment approach did it  more precisely. Once                                                                    
the fund  was converted  to an  endowment style  trust fund,                                                                    
DOR would feel comfortable changing the asset allocation.                                                                       
Mr.  Barnhill reported  that currently  DOR  had roughly  55                                                                    
percent  invested in  equities  and 45  percent invested  in                                                                    
fixed income.  He explained  that because  it was  under the                                                                    
principle  and income  style of  accounting, the  department                                                                    
weighted  it  more  heavily  to fixed  income  in  order  to                                                                    
generate more  cash. Under the  statute for the  trust fund,                                                                    
only cash could be expended.  Once the fund was converted to                                                                    
an  endowment  fund, the  department  would  weight it  more                                                                    
heavily to equities - approximately  70 percent equities, 30                                                                    
percent  fixed  income.  The fund  could  be  invested  more                                                                    
aggressively,  and  over  time,  the fund  was  expected  to                                                                    
generate  more  income.  The  reason   for  changing  to  an                                                                    
endowment fund  was two-fold.  First, the  department wanted                                                                    
to  protect the  inflation-adjusted value  of the  fund over                                                                    
time so  that the real value  of the fund would  not change.                                                                    
Secondly,  the  department   wanted  to  prudently  maximize                                                                    
income  to  current  beneficiaries. It  would  maintain  the                                                                    
fairness of  the trust  by providing  the same  benefit over                                                                    
various  periods of  time.  He referred  to  the concept  as                                                                    
"intergenerational equity."                                                                                                     
2:02:59 PM                                                                                                                    
Representative  Wilson  was   concerned  with  spending  the                                                                    
principle.  She understood  that  rules disallowing  dipping                                                                    
into  the fund  were no  longer in  place. She  wondered why                                                                    
4.75 for a Percent of  Market Value (POMV) was chosen rather                                                                    
than  4 percent  or 4.25  which would  lessen the  chance of                                                                    
eating into the principle. Mr.  Barnhill thought a review of                                                                    
Amendment   1  might   help   answer  the   representative's                                                                    
question. He referred to page 2 of the amendment.                                                                               
Representative  Guttenberg suggested  that the  amendment be                                                                    
moved.   Representative  Wilson   preferred   to  hear   Mr.                                                                    
Barnhill's explanation first.                                                                                                   
Mr. Barnhill continued with his  explanation. He referred to                                                                    
page 2 of Amendment 1,  lines 7-8. He highlighted that words                                                                    
"not more  than" were inserted  before 4.75.  Currently, the                                                                    
bill read: "4.75  can be appropriated of  the 5-year average                                                                    
market value  of the fund."  He explained that  by inserting                                                                    
the words "not  more than" it would give  the department the                                                                    
ability to correct  its course. He suggested  there might be                                                                    
investment environments  in which, in an  effort to maintain                                                                    
the  inflation-adjusted  value  and to  maximize  income  to                                                                    
current   beneficiaries,  the   department  would   want  to                                                                    
appropriate  less  that  4.75   percent.  For  example,  the                                                                    
department might recommend 4.5 percent  for one year and the                                                                    
wording would  allow for the adjustment.  From an investment                                                                    
management  perspective,   the  department  was   trying  to                                                                    
maintain  the   inflation-adjusted  value   over  successive                                                                    
periods of time.                                                                                                                
Mr. Barnhill  pointed to  Amendment 1,  page 2,  lines 10-12                                                                    
which  eliminated  the  distinction  between  principle  and                                                                    
income. He acknowledged  Representative Wilson's concern was                                                                    
fair. In every transition from  a principle and income trust                                                                    
to an endowment trust, the  question was always raised about                                                                    
being able to  protect the principle of a  fund. The concern                                                                    
was the principle  being invaded and spent in  a down market                                                                    
when  the trust  was  under water.  He  explained that  what                                                                    
modern trust law permitted trustees  of endowments to do was                                                                    
spend the endowment when it  was under water. The notion was                                                                    
about trying to balance  competing concerns - protecting the                                                                    
inflation-adjusted value  and meeting  the needs  of current                                                                    
beneficiaries.  He  reiterated   that  in  substantial  down                                                                    
markets  modern trust  law  permitted  expenditures from  an                                                                    
underwater   trust.  However,   the  expectation   was  that                                                                    
management would do everything  possible to return the value                                                                    
to  the  inflation-adjusted  value. He  clarified  that  the                                                                    
department included  the course correction language  of "not                                                                    
more  than 4.75  percent" so  that the  trust administrators                                                                    
could make the recommendation  to appropriate something less                                                                    
than 4.75  percent when the  trust was underwater.  He added                                                                    
that the benefit  to having the "not more"  language was the                                                                    
analysis would be  made annually and would  allow for course                                                                    
2:07:08 PM                                                                                                                    
Representative Wilson  appreciated Mr.  Barnhill's comments.                                                                    
She  asked  for  further clarification  regarding  the  4.75                                                                    
number,  which she  thought  was a  number  used in  general                                                                    
practice. She  queried the use  of language  that stipulated                                                                    
not using  any of  the principle. She  wanted to  ensure the                                                                    
health of the fund.                                                                                                             
Mr. Barnhill  thought her concern  was fair.  The department                                                                    
called  her   concern,  "The  blow  through   concern."  The                                                                    
question   was  whether   the   department   would  make   a                                                                    
recommendation  or   whether  the  legislature   would  blow                                                                    
through the principle.  He could not offer  a guarantee that                                                                    
the  principle  would  not  be spent.  He  spoke  about  the                                                                    
"Prudent Expenditure  Rule." He  explained that  the experts                                                                    
in trust  law married  a prudent  expenditure rule  with the                                                                    
prudent investment  rule. The idea  was that  the department                                                                    
would be subjecting an expenditure  to a prudency evaluation                                                                    
and  the fiduciary  standard of  care, the  highest standard                                                                    
under   law.  The   department's  hope   was  that   if  the                                                                    
legislature  embraced  the   endowment  approach,  when  the                                                                    
department  made a  recommendation to  spend less  than 4.75                                                                    
percent  and provided  justifying analysis,  the legislature                                                                    
would  respect  its  recommendations. He  relayed  that  the                                                                    
department would provide the factors  used in its evaluation                                                                    
to support spending  less. He noted that if  an analysis was                                                                    
done  pursuant   to  a  fiduciary  standard   of  care,  the                                                                    
department would  be rigorous in  its analysis and  give the                                                                    
legislature its  best guess as  to the prudent way  to spend                                                                    
from the trust.                                                                                                                 
2:10:15 PM                                                                                                                    
Vice-Chair Gara MOVED to ADOPT Amendment 1 (copy on file):                                                                      
     Page 1, lines 4 - 10:                                                                                                      
          Delete all material and insert:                                                                                       
          "*  Section 1.  AS 3  7.10.07 1(d)  is amended  to                                                                    
          (d)  In   exercising  investment,   custodial,  or                                                                    
          depository  powers or  duties under  this section,                                                                    
          the  fiduciary  or  the  fiduciary's  designee  is                                                                    
          liable for a breach of  a duty that is assigned or                                                                    
          delegated   under  this   section,  or   under  AS                                                                    
          14.40.255,    14.40.280{c),    14.40.400(b),    AS                                                                    
          37.10.070,   AS37.14.160    [AS   37.14.l   lO(c),                                                                    
          37.14.160], or  37.14.170. However,  the fiduciary                                                                    
          or the  designee is not  liable for a breach  of a                                                                    
          duty that has been  delegated to another person if                                                                    
          the  delegation is  prudent  under the  applicable                                                                    
          standard of prudence set out  in statute or if the                                                                    
          duty is assigned by law  to another person, except                                                                    
          to the extent that the fiduciary or designee                                                                          
               (1) knowingly  participates in,  or knowingly                                                                    
          undertakes  to  conceal,  an act  or  omission  of                                                                    
          another person  knowing that  the act  or omission                                                                    
          is  a breach  of that  person's duties  under this                                                                    
               (2) by  failure to  comply with  this section                                                                    
          in the administration of                                                                                              
          specific responsibilities,  enables another person                                                                    
          to commit a breach of duty; or                                                                                        
               (3)  has knowledge  of a  breach  of duty  by                                                                    
          another person,  unless the fiduciary  or designee                                                                    
          makes reasonable  efforts under  the circumstances                                                                    
          to remedy the breach."                                                                                                
     Page 2, lines 3 - 4:                                                                                                       
          Delete "in separate  principal and income accounts                                                                    
          Insert  "into [IN  SEPARATE  PRINCIPAL AND  INCOME                                                                    
          ACCOUNTS FOR]"                                                                                                        
     Page 2, lines 5 - 6:                                                                                                       
          Delete  "that  distinguish between  the  principal                                                                    
          and income of the fund"                                                                                               
          Insert  "[THAT DISTINGUISH  BETWEEN THE  PRINCIPAL                                                                    
          AND INCOME OF THE FUND]1"                                                                                             
     Page 2, line 13, following "appropriate":                                                                                  
          Delete "AS 37.14.140 is"                                                                                              
          Insert 11AS 37.14.110(c) and 37.14.140 are"                                                                           
Representative Wilson OBJECTED for discussion.                                                                                  
Vice-Chair Gara  spoke to the  amendment. He  mentioned that                                                                    
he  and Representative  Pruitt  had  expressed concerns  and                                                                    
thought an amendment  was needed for the  bill. He explained                                                                    
that without  the amendment, if  the stock  market performed                                                                    
poorly  the fund  would not  generate  revenue. The  current                                                                    
trust  would spin  off $25  million.  The legislature  would                                                                    
have to  come up  with $25 million  from another  source. He                                                                    
furthered that if the next  year was another bad year, there                                                                    
would  be  no  money  again. The  prudent  expenditure  rule                                                                    
stated that trusts were managed  for the long-term. In other                                                                    
words,  the principle  would be  fully  maintained over  the                                                                    
long-term. The point of the  Public School Trust was to spin                                                                    
off a consistent amount of money in a careful way.                                                                              
Vice-Chair  Gara  spoke  to  the  flexibility  of  a  modern                                                                    
endowment model. He also noted  that the bill in its current                                                                    
form  tried to  balance generating  income while  protecting                                                                    
the principle. Based  on a 5-year look-back  and after about                                                                    
10 years 2.5  percent of the principle  would disappear. The                                                                    
sponsor  of  the bill  originally  had  a 10-year  look-back                                                                    
which  limited   revenue  too  much.  The   changes  in  the                                                                    
amendment would  facilitate spinning off roughly  $8 million                                                                    
in  revenue  and  allowed  the  department  to  invest  more                                                                    
prudently to generate better returns  over the long-term. He                                                                    
thought it  was a  safe way of  producing more  revenue from                                                                    
the trust  fund which  was the  sponsor's intent  along with                                                                    
protecting the principle over the  long-term. He invited Mr.                                                                    
Barnhill to comment.                                                                                                            
Mr.  Barnhill  responded that  the  amendment  was fine.  He                                                                    
noted that  in looking at  the chart containing  the various                                                                    
adding  methodologies ["What  if Payouts]  that with  the 5-                                                                    
year average  POMV, the inflation-adjusted value  at the end                                                                    
of the 10-year period was less  than 100 percent. At the end                                                                    
of a  20-year period it  remained less than 100  percent but                                                                    
was  incrementally better.  He explained  that by  inserting                                                                    
the  "not  more  than"  language, the  department  would  be                                                                    
required to  do better by course  correcting periodically in                                                                    
order  to stay  closer to  100 percent.  He added  that over                                                                    
long  periods of  time  hitting 97  percent  to 100  percent                                                                    
would mean managers were doing a good job.                                                                                      
2:14:48 PM                                                                                                                    
Representative Wilson asked someone  to explain Section 1 of                                                                    
the  amendment. Mr.  Barnhill  asked whether  Representative                                                                    
Wilson was  referring to  the first  part of  the Amendment.                                                                    
Representative Wilson responded affirmatively.                                                                                  
Mr. Barnhill replied  that the first part  of the amendment,                                                                    
lines  1-19,  simply  had conforming  changes.  The  deleted                                                                    
language   included  reference   to   AS  37.14.110(c)   and                                                                    
AS 37.14.160.  All that  was being  done was  conforming the                                                                    
language  to   the  amendment.  The  last   section  of  the                                                                    
amendment  deleted AS  37.14.110(c) which  was what  created                                                                    
the distinction  between principle and income  in the trust.                                                                    
The bill was deleting  the distinction between principle and                                                                    
income or the  requirement to account for  it. The amendment                                                                    
simply removed AS 37.14 110(c) from statue.                                                                                     
Representative Wilson  asked for further  clarification. She                                                                    
thought  the   person  that  made  the   determination,  the                                                                    
commissioner, was  being removed.  She asked who  would make                                                                    
the determination. Representative  Parish directed attention                                                                    
to  page  2, lines  9-10.  The  duties of  the  commissioner                                                                    
included  determining the  monthly average  market value  of                                                                    
the fund for the 5  fiscal years preceding the previous year                                                                    
on July 1st of each year. There was a calculation in place.                                                                     
Mr. Barnhill explained  that the repeal of  Section 1, lines                                                                    
1-10 took  place in 2  parts of the amendment:  the deletion                                                                    
of  all material  (lines  4-10)  and the  last  part of  the                                                                    
amendment, the repealer.  In lieu of Section 1,  there was a                                                                    
new  conforming  Section  1.  Representative  Wilson  asked,                                                                    
"Conforming  to  what?"  Mr.   Barnhill  responded  that  it                                                                    
deleted  reference  to  AS   37.14.110(c)  which  was  being                                                                    
repealed.  Representative  Wilson  did  not  understand  the                                                                    
amendment. She relayed her understanding of the amendment.                                                                      
Vice-Chair  Gara  explained  the  lines  in  section  1.  He                                                                    
thought  the amendment  could have  been  written with  more                                                                    
clarity. Representative Wilson read  from the amendment. She                                                                    
wondered  if  the  amendment  was  referring  to  a  person.                                                                    
Vice-Chair  Gara responded  from  line 4-19  was already  in                                                                    
statute.   The  only   change  was   the   deletion  of   AS                                                                    
37.14.110(c)  which  addressed  the  issue  of  whether  the                                                                    
principle could  be tapped. The  only change had to  do with                                                                    
the  one statutory  reference. Representative  Wilson asked,                                                                    
if the statute  was kept in the bill,  whether the principle                                                                    
would remain  untouched. Vice-Chair Gara replied  that if AS                                                                    
37.14.110(c)the  system  would   remain  a  principle  trust                                                                    
instead of a prudent expenditure rule trust.                                                                                    
2:20:32 PM                                                                                                                    
Representative Wilson relayed  she did not want  to keep the                                                                    
trust  as  a principle  trust.  She  wanted to  protect  the                                                                    
principle. She  was fine with  the changes and was  glad the                                                                    
"up  to"  language  was  included. She  did  not  trust  the                                                                    
legislature not  to use  the entire  4.75 percent,  as times                                                                    
were  unpredictable.  She  indicated she  had  seen  similar                                                                    
decisions made by the legislature  about other funds such as                                                                    
the Power Cost  Equalization (PCE) fund. She  wanted to make                                                                    
sure that the money was  protected for students. She did not                                                                    
like  that there  was  the possibility  that,  even after  a                                                                    
recommendation from  the department for a  smaller draw, the                                                                    
legislature would take a higher amount.                                                                                         
Representative Wilson WITHDREW her OBJECTION.                                                                                   
There being NO OBJECTION, Amendment 1 was ADOPTED.                                                                              
Co-Chair Foster  asked Vice-Chair Gara to  review the fiscal                                                                    
Vice-Chair Gara indicated there were  3 fiscal notes for the                                                                    
bill. The first fiscal note  with an OMB component number of                                                                    
2804 by DEED listed the  department and the appropriation as                                                                    
fund   capitalization.  The   allocation   was  the   public                                                                    
education  fund.  The  second   fiscal  note  by  DEED,  OMB                                                                    
component   number   1060,   listed   the   allocation   and                                                                    
appropriation as Mt. Edgecumbe  Boarding School. There was a                                                                    
fiscal  impact of  $4.6 million  for operating  expenditures                                                                    
which  was included  in the  governor's  budget request.  He                                                                    
continued  that the  third DEED  fiscal note,  OMB component                                                                    
number  141, had  an  appropriation of  K-12  aid to  school                                                                    
districts and an allocation of  foundation program. The bill                                                                    
had a  fiscal impact  listing the  governor's FY  19 request                                                                    
for operating expenditures.                                                                                                     
2:23:49 PM                                                                                                                    
AT EASE                                                                                                                         
2:24:19 PM                                                                                                                    
Representative   Wilson  was   truly   concerned  with   the                                                                    
possibility of going into the  principle. Although she liked                                                                    
the  possibility of  the fund  earning more  money, she  was                                                                    
very  concerned about  touching the  principle. She  thought                                                                    
that someone  from the  Legislative Finance  Division should                                                                    
2:25:37 PM                                                                                                                    
ALEXEI  PAINTER,  ANALYST,   LEGISLATIVE  FINANCE  DIVISION,                                                                    
explained   that  by   removing   the  distinction   between                                                                    
principle and income,  it was possible to dip  into what was                                                                    
considered the principle. It was  his understanding that the                                                                    
addition of the  words "up to" in the  amendment would allow                                                                    
the legislature to choose not  to do so. He reconfirmed that                                                                    
the  legislature could  dip into  the current  value of  the                                                                    
Representative  Parish thought  that,  while the  management                                                                    
structure  was designed  to maintain  the inflation-adjusted                                                                    
value of  the fund,  having separate accounts  for principle                                                                    
and income did  not achieve the objective.  He thought, over                                                                    
the long-term, the most real  representation of the value of                                                                    
the  fund was  not  principle income  but rather  inflation-                                                                    
adjusted  value  and  being  able  to  maximize  the  amount                                                                    
available to public education in  the current year and years                                                                    
to come.                                                                                                                        
Vice-Chair  Gara  asked Mr.  Barnhill  about  moving to  the                                                                    
Prudent  Expenditure   Rule.  He  asked,  by   allowing  the                                                                    
department  to  manage  the   fund  for  long-term  returns,                                                                    
whether  the  bill  would  have  any  impact  on  investment                                                                    
returns possibly leading to better returns.                                                                                     
Mr. Barnhill replied that if  the legislature switched to an                                                                    
endowment  methodology (the  prudent  expenditure rule)  the                                                                    
department would  change the asset  allocation from  a 55/45                                                                    
equity  fixed income  allocation to  a 70/30  allocation. He                                                                    
commented  that  over  periods of  time  the  change  should                                                                    
generate  enhanced growth  over  a  portfolio weighted  more                                                                    
heavily towards fixed income. Over  specific periods of time                                                                    
the  equity  markets  were  more   volatile.  He  could  not                                                                    
guarantee  that   it  would  produce  more   income  in  any                                                                    
particular  year but  thought  that over  longer periods  it                                                                    
Co-Chair  Seaton  MOVED to  report  CSHB  213 (FIN)  out  of                                                                    
Committee   with   individual    recommendations   and   the                                                                    
accompanying fiscal notes.                                                                                                      
There being NO OBJECTION, it was so ordered                                                                                     
HB 213  was REPORTED out  of committee with three  "do pass"                                                                    
recommendations, three  "no recommendation" recommendations,                                                                    
and three  "amend" recommendations and with  one zero fiscal                                                                    
note and with  two fiscal impact notes by  the Department of                                                                    
Education and Early Development.                                                                                                
Co-Chair Foster reviewed the agenda for the following day.                                                                      

Document Name Date/Time Subjects
HB 142 Testimony.pdf HFIN 2/8/2018 1:30:00 PM
HB 142
HB 213 Letter to House Finance Co-Chairs.pdf HFIN 2/8/2018 1:30:00 PM
HB 213
HB 142 Amendment #1 Foster.pdf HFIN 2/8/2018 1:30:00 PM
HB 142
HB 213 Letter to House Finance Co-Chairs.pdf HFIN 2/8/2018 1:30:00 PM
HB 213
HB 213 Amendment 1 Gara.pdf HFIN 2/8/2018 1:30:00 PM
HB 213
HB142 Support Document - Support Letters 2.7.18.pdf HFIN 2/8/2018 1:30:00 PM
HB 142
HB 213 - DOR 10yr what if payout.pdf HFIN 2/8/2018 1:30:00 PM
HB 213
DOR Response to Amendments to HB 213 2-14-2018.pdf HFIN 2/8/2018 1:30:00 PM
HB 213
HFSC Follow Up Public Libraries Receiving OWL Support in FY2018.pdf HFIN 2/8/2018 1:30:00 PM
DEED Response Qs HFIN
HFSC Follow Up FY2018 School BAG Awards by School.pdf HFIN 2/8/2018 1:30:00 PM
DEED Response Qs HFIN
HFSC Follow Up FY2017 E-Rate Overview.pdf HFIN 2/8/2018 1:30:00 PM
DEED Response Qs HFIN
HFSC Follow Up FY15-FY18 Funding by District.pdf HFIN 2/8/2018 1:30:00 PM
DEED Response Qs HFIN