Legislature(2015 - 2016)SENATE FINANCE 532

03/26/2015 09:00 AM Senate FINANCE

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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ SB 34 Presentation: Overview FY17 Operating Budget TELECONFERENCED
Heard & Held
Heard & Held
+ Bills Previously Heard/Scheduled TELECONFERENCED
SENATE BILL NO. 34                                                                                                            
     "An Act relating to investment of the power cost                                                                           
     equalization endowment fund; and providing for an                                                                          
     effective date."                                                                                                           
9:04:57 AM                                                                                                                    
PAMELA  LEARY, DIRECTOR,  TREASURY  DIVISION, DEPARTMENT  OF                                                                    
REVENUE,   began   the   presentation  "State   of   Alaska,                                                                    
Department   of   Revenue,   SB  34   PCE   Endowment   Fund                                                                    
Investment," (copy on file). Ms. Leary presented Slide 2:                                                                       
     Fund Purpose:                                                                                                            
        · To fund the Power Cost Equalization & Rural                                                                           
          Electric Capitalization Fund and to reimburse the                                                                     
         costs associated with managing the fund.                                                                               
        · 7% of the monthly average market value of the                                                                         
          fund for the previous 3 fiscal years may be                                                                           
     Fund History:                                                                                                            
        · 2000-Power Cost Equalization Endowment Fund                                                                           
          established from Constitutional Budget Reserve                                                                        
          Appropriation of $100 million                                                                                         
        · 2002-PCE receives $89.6 million from proceeds of                                                                      
          the sale of the four dam pool hydroelectric                                                                           
        · 2007-Additional appropriation of $182.7 million                                                                       
        · 2012-Additional appropriation of $400 million                                                                         
       · February 28, 2015 balance: $986.27 million                                                                             
9:06:50 AM                                                                                                                    
Ms. Leary addressed Slide 3:                                                                                                    
     · Removes the stated nominal return target of at least                                                                     
        7% from the statute.                                                                                                    
     · Allows the commissioner of revenue to invest the                                                                         
        fund in a manner that can meets the objectives of                                                                       
        the fund.                                                                                                               
     · Why? It allows the commissioner of revenue to invest                                                                     
        in less risky investments, when appropriate, that                                                                       
        will still meet the financial needs of the program.                                                                     
     · Zero Fiscal Note                                                                                                         
9:07:30 AM                                                                                                                    
GARY  BADER, CHIEF  INVESTMENT  OFFICER, TREASURY  DIVISION,                                                                    
DEPARTMENT OF REVENUE, commented  that it was fundamental to                                                                    
investment  management to  seek the  highest rate  of return                                                                    
commiserate  with the  appropriate amount  of risk.  He said                                                                    
that current  statute directed  the commissioner  of revenue                                                                    
to attain a 7 percent rate  of return, without regard to the                                                                    
amount  of  risk  that  would be  undertaken.  He  drew  the                                                                    
committee's  attention  to  Slide 4,  "2015  Capital  Market                                                                    
Expectations  -  Return  and  Risk."  He  stated  that  most                                                                    
prepared   assumptions   were    similar;   the   statistics                                                                    
represented  Callan Associates'  projections of  the returns                                                                    
and standard  deviations of many  of the most  popular asset                                                                    
classes for the 10 year  period ending 2024. He relayed that                                                                    
the left  hand column on  the slide reflected  various asset                                                                    
classes, with broad domestic equity  shown at the top of the                                                                    
page. He  elaborated that broad domestic  equity represented                                                                    
United States  stocks. He moved  to the column  labeled, "1-                                                                    
year Arithmetic", which represented  the average of one-year                                                                    
investment returns  Callan might  expect the asset  class to                                                                    
earn  over  the next  ten  years.  He  spoke to  the  column                                                                    
labeled,  "Projected  Risk/Standard  Deviation."  He  shared                                                                    
that standard deviation  was a measure of  volatility of the                                                                    
investment  returns,  roughly  two-thirds  of  the  time  an                                                                    
investment  return  would  be plus  or  minus  one  standard                                                                    
deviation of  the arithmetic  return. He  directed committee                                                                    
attention to the column  labeled, "10-year Geometric", which                                                                    
represented  the  compounded  annual  rate  of  return  that                                                                    
Callan projected an  asset class would return  over the next                                                                    
10  years. He  pointed  out that  the  greater the  standard                                                                    
deviation,  the further  the 10-year  geometric return  grew                                                                    
from  the   arithmetic  return;  the  higher   the  standard                                                                    
deviation, the more difference in the compounded return.                                                                        
9:10:21 AM                                                                                                                    
Mr.  Bader gave  an  example of  how  the investment  return                                                                    
scenario  might work.  He asserted  that volatility  and the                                                                    
amount of risk were important  factors for achieving a long-                                                                    
term  rate of  return. He  relayed that  if the  projections                                                                    
held for  the Power  Cost Equalization (PCE)  of a  ten year                                                                    
rate of return, nearly all  of the PCE investment would need                                                                    
to  be  broad  equities;   approximately  88  percent  under                                                                    
statute. He  related that  domestic equities  had been  in a                                                                    
bull  market  for  6  years, interest  rates  were  low  and                                                                    
expected  to increase  mid-year. He  added that  as interest                                                                    
rates rose, the  value of fixed income  investments fell. He                                                                    
thought  that  the  7  percent  return  would  have  been  a                                                                    
reasonable  expectation   15  years  ago,  when   a  10-year                                                                    
Treasury  bond  was  earning  6  percent;  now  the  10-year                                                                    
Treasury bond  was earning 2  percent. He relayed  that when                                                                    
interest  rates  went  up,  bond values  fell,  and  it  was                                                                    
unlikely that  the stock market  would continue to  rise for                                                                    
another  six  years.  He  concluded   that  passage  of  the                                                                    
legislation  would  allow  the commissioner  of  revenue  to                                                                    
attempt to meet the goals  of the PCE program while managing                                                                    
9:12:19 AM                                                                                                                    
Vice-Chair  Micciche asked  whether  any  of Alaska's  other                                                                    
investment funds had a statutory requirement for return.                                                                        
Ms. Leary replied that this  was the only separately managed                                                                    
investment that had a target return.                                                                                            
9:12:51 AM                                                                                                                    
Vice-Chair Micciche  thought that  the situation  was "laced                                                                    
with unintended consequences."                                                                                                  
Co-Chair  MacKinnon  clarified  that the  bill  proposed  to                                                                    
remove the  7 percent expected  return to a nominal  rate in                                                                    
order  to have  a more  conservative investment  strategy on                                                                    
the  PCE  fund.  She  said  that  the  7  percent  had  been                                                                    
established  because  people  wanted  to grow  the  fund  as                                                                    
quickly  as  possible  in order  for  rural  communities  to                                                                    
receive  greater  dividends.  She  opined  that  the  recent                                                                    
volatility displayed  by the stock  market had  prompted the                                                                    
desire to secure the risk alternatively.                                                                                        
9:14:26 AM                                                                                                                    
Ms. Leary  shared that  the presentation  could be  found on                                                                    
the Treasury Division website:                                                                                                  
9:14:52 AM                                                                                                                    
Senator  Hoffman  recalled  that  the same  topic  had  been                                                                    
discussed  in  committee  the  previous   year  and  he  had                                                                    
requested that  the target be  reduced from 7 to  5 percent.                                                                    
He understood as markets rose  and fell there could be times                                                                    
when  the fund  earned in  excess of  the payout,  which had                                                                    
been the case for several years,  but that did not mean that                                                                    
in the future there would be  draws from the fund that would                                                                    
be larger than  the rate of return, and  overtime they would                                                                    
level out,  which was  why he  supported the  lower interest                                                                    
rate. He felt  that there had been  substantial increases in                                                                    
the  fund and  that during  those times  there was  always a                                                                    
temptation to  draw from and  utilize those funds  for other                                                                    
purposes, but  to remember  that there  would be  times when                                                                    
the earnings would be less than the draw.                                                                                       
9:16:55 AM                                                                                                                    
Co-Chair MacKinnon  extrapolated that the 7  percent rate of                                                                    
return was  tied to what could  be drawn from the  fund. She                                                                    
noted  that as  the administration  was trying  to create  a                                                                    
more  conservative  approach  by limiting  the  amount  that                                                                    
could be withdrawn  from the fund. She felt  that this could                                                                    
create  unintended consequence  for the  legislature because                                                                    
it would limit the amount that could be withdrawn.                                                                              
Mr. Bader believed  that the statute allowed  the average of                                                                    
7 percent monthly  return over a three year  period. He said                                                                    
that there would  be times when a commissioner  could set an                                                                    
asset allocation that would target  an earnings rate of less                                                                    
than  7 percent.  He added  that there  could also  be times                                                                    
when the  commissioner might  try to have  a rate  of return                                                                    
that was greater than 7 percent.                                                                                                
Co-Chair MacKinnon  understood that with the  passage of the                                                                    
bill,  up to  7 percent  could still  be withdrawn  from the                                                                    
Ms. Leary added  that over the life of the  fund the rate of                                                                    
return that it had earned was 6 percent.                                                                                        
9:19:00 AM                                                                                                                    
Vice-Chair  Micciche asked  where  the language  was in  the                                                                    
bill that changed the amount that could be drawn.                                                                               
Co-Chair MacKinnon  clarified that the amount  that could be                                                                    
drawn would not be affected by the legislation.                                                                                 
9:19:40 AM                                                                                                                    
Co-Chair    MacKinnon    expressed    concern    that    the                                                                    
administration  was   proposing  no  percentage   rate.  She                                                                    
wondered why  the nominal return had  been considered rather                                                                    
than a reduction in the percentage rate.                                                                                        
Mr. Bader expected  that a recommendation would  be taken to                                                                    
the commissioner that  would be based upon  achieving a real                                                                    
rate  of   return,  one   earned  before   consideration  of                                                                    
inflation, which would be in the 4 to 5 percent rage.                                                                           
9:21:20 AM                                                                                                                    
Senator  Hoffman commented  that  a minimum  rate of  return                                                                    
should be set,  with flexibility for the  department to make                                                                    
the ultimate decision.                                                                                                          
9:22:08 AM                                                                                                                    
Vice-Chair  Micciche  believed  that  requiring  a  rate  of                                                                    
return   would  be   micromanaging  and   was  out   of  the                                                                    
legislatures per  view. He  said he  would rather  define an                                                                    
acceptable  level of  risk and  not an  acceptable level  of                                                                    
9:23:05 AM                                                                                                                    
Senator Bishop  asked whether  it would  be prudent  to have                                                                    
the ability to manage the fund  so it met the outcome at the                                                                    
end of the year with the corpus of the fund intact.                                                                             
Ms.  Leary stated  that the  question was  considered during                                                                    
the asset allocation process.                                                                                                   
9:24:11 AM                                                                                                                    
Co-Chair MacKinnon opened public testimony.                                                                                     
9:24:39 AM                                                                                                                    
Co-Chair MacKinnon closed public testimony.                                                                                     
SB  34  was   HEARD  and  HELD  in   committee  for  further                                                                    
9:24:57 AM                                                                                                                    

Document Name Date/Time Subjects
SB34 PCE presentation March 26 2015.pdf SFIN 3/26/2015 9:00:00 AM
SB 34
SB34 Sponsor Statement.pdf SFIN 3/26/2015 9:00:00 AM
SB 34
SJR 2 Letter of Support-Juneau Chamber of Commerce.pdf SFIN 3/26/2015 9:00:00 AM
SJR 2 Letter of Support-University of Alaska.pdf SFIN 3/26/2015 9:00:00 AM
SJR 2 Sectional Analysis.pdf SFIN 3/26/2015 9:00:00 AM
SJR 2 Sponsor Statement.pdf SFIN 3/26/2015 9:00:00 AM