Legislature(2017 - 2018)SENATE FINANCE 532

04/16/2018 01:30 PM FINANCE

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CS FOR HOUSE BILL NO. 213(FIN)(efd fld)                                                                                       
     "An Act relating to the investment, appropriation, and                                                                     
     administration of the public school trust fund."                                                                           
3:12:54 PM                                                                                                                    
REPRESENTATIVE  JUSTIN   PARISH,  SPONSOR,   introduced  the                                                                    
legislation.  He  explained that  the  bill  would help  the                                                                    
public  school  trust  fund  to   operate  at  the  industry                                                                    
standard. He  lamented that failure  to modernize  the trust                                                                    
had resulted in years of lost income.                                                                                           
3:13:45 PM                                                                                                                    
AT EASE                                                                                                                         
3:14:25 PM                                                                                                                    
3:14:44 PM                                                                                                                    
Representative  Parish  looked  at   a  graph  title,  "CSHB
213(FIN),  Public   School  Trust,  Actual  vs.   POMV  6/30                                                                    
Balances"  (copy  on file).  The  document  contained a  bar                                                                    
graph  that  provided the  numbers  in  thousands. the  POMV                                                                    
assumed a  70/30 equity/fixed  income asset  allocation from                                                                    
July 1,  1978 -  with a  4.75 percent  payout of  trailing 5                                                                    
year market  average. He relayed  that the bill  would allow                                                                    
the use  of equity growth as  a form of income,  which would                                                                    
have a higher yielded income.  He remarked that the fund was                                                                    
dedicated  to  education. He  thought  that  the bill  would                                                                    
allow for more consistency and predictability by using the                                                                      
POMV draw on the fund and preserving the inflation adjusted                                                                     
3:16:28 PM                                                                                                                    
Co-Chair MacKinnon solicited questions from the committee.                                                                      
She believed that the fund management plan in the bill was                                                                      
3:16:54 PM                                                                                                                    
ROBERT EDWARDSON, STAFF TO REPRESENTATIVE PARISH, discussed                                                                     
the Sectional Analysis (copy on file):                                                                                          
     Section 1. (page 1, line  4): Amends AS 37.10.071(d) to                                                                  
     reflect the repeal  of AS 37.14.110(c) in  section 5 of                                                                    
     the  bill.   Current  AS  37.14.110(c)   maintains  the                                                                    
     distinction  between  principal  and  income,  and  the                                                                    
     purpose of  this bill is  to convert the  public school                                                                    
     trust  fund to  an endowment  fund structure  that does                                                                    
     not   require  maintaining   the  distinction   between                                                                    
     principal and income.                                                                                                      
     Section 2. (page,  line 7): AS 37.14.160  is amended to                                                                  
     add 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  five years preceding                                                                    
     the previous fiscal year.                                                                                                  
3:18:52 PM                                                                                                                    
Mr. Edwardson continued to discuss the Sectional Analysis:                                                                      
     Section 3. (page  2, line 21-26): Adds  new section, AS                                                                  
     37.14.165  relating to  the use  of  the public  school                                                                    
     trust  fund  allowing  the legislature  to  appropriate                                                                    
     4.75   percent  of   the  amount   determined  by   the                                                                    
     commissioner  under   new  AS  37.14.160   (enacted  by                                                                    
     section 2 of the bill).  Appropriations must be for the                                                                    
     purpose of funding support for  state public schools or                                                                    
     for  reimbursing the  costs  of  administration of  the                                                                    
     Section  4. (page  2, line  27    page 3,  line 8):  AS                                                                  
     37.14.170  is amended  to focus  the investment  of the                                                                    
     trust   fund  on   increasing   returns  from   capital                                                                    
     appreciation as  opposed to increasing net  income from                                                                    
     the  generation of  cash dividends  and interest.  This                                                                    
     permits  the  commissioner  to  invest  for  long  term                                                                    
     capital appreciation by  adjusting the asset allocation                                                                    
     of  the  trust  fund  to  weight  it  more  heavily  to                                                                    
     equities  as opposed  to  cash-generating fixed  income                                                                    
     Section 5.  (page 3,  line 9):  AS 37.14.110(c)  and AS                                                                  
     37.14.140  are repealed.  AS 37.14.110(c)  is discussed                                                                    
     above at  section 1. Current AS  37.14.140 provides for                                                                    
     expenditure of net income only.  This is replaced by AS                                                                    
     37.14.165  (section  3  of  the  bill),  which  permits                                                                    
     expenditure  of  4.75  percent of  the  average  market                                                                    
     value of the fund.                                                                                                         
3:20:13 PM                                                                                                                    
Senator  Micciche asked  whether the  actual rate  of return                                                                    
had  been  assumed  in  the   data  set  on  the  previously                                                                    
discussed document.                                                                                                             
Representative   Parish  deferred   the   question  to   Mr.                                                                    
3:21:19 PM                                                                                                                    
MIKE BARNHILL,  DEPUTY COMMISSIONER, DEPARTMENT  OF REVENUE,                                                                    
said that  the key element  of the fund management  could be                                                                    
found  in   existing  state  law,  AS   37.14.110(c),  which                                                                    
required  retention of  the deposits  to  principal and  the                                                                    
capital gains  and losses.  He provided  a brief  history of                                                                    
the fund and  its comparison to the Permanent  Fund. He said                                                                    
that the education fund had  grown slowly because it had not                                                                    
been fully  exposed to  equity markets.  He shared  that the                                                                    
chart showed what  would have happened if the  fund had been                                                                    
invested from the beginning like  an endowment. He said that                                                                    
the department supported  the bill and believed  that it was                                                                    
time to  treat the fund  more like  an endowment so  that it                                                                    
could take  on a larger exposure  to equities and grow  at a                                                                    
faster rate over long periods of time.                                                                                          
3:24:04 PM                                                                                                                    
Co-Chair MacKinnon understood that  the fund was a dedicated                                                                    
fund,  which was  rare.  She asked  whether  there were  any                                                                    
problems  with  this approach  to  the  fund, based  on  its                                                                    
historical use.                                                                                                                 
Mr. Barnhill  believed that  there were  no legal  issues. e                                                                    
provided  He  shared  that  the  fund  was  a  pre-statehood                                                                    
dedicated fund formed  in 1915 by the  federal government as                                                                    
a land grant  fund for public education. He  relayed that in                                                                    
the mid-1970s, with the anticipation  of substantial oil and                                                                    
gas  revenues, the  legislature made  the decision  that the                                                                    
fund  would be  more robust  if  the land  were removed  and                                                                    
replaced  with a  dedication  of  one-half percent  receipts                                                                    
from the management of state lands.                                                                                             
3:26:51 PM                                                                                                                    
BRIAN  BJORQUIST, ATTORNEY  GENERALS OFFICE,  ANCHORAGE (via                                                                    
teleconference),  relayed   that  the  department   did  not                                                                    
believe that  there was  a dedicated  fund problem  with the                                                                    
3:28:07 PM                                                                                                                    
Co-Chair MacKinnon asked what would  happen if the fund lost                                                                    
money and had to pay out part of its principal.                                                                                 
Mr.  Bjorquist replied  that  the  dedicated fund  component                                                                    
meant that the trust and the  monies in it were dedicated to                                                                    
supporting public  schools, regardless  of the  amounts paid                                                                    
out  or what  happened with  increases or  decreases of  the                                                                    
fund. He added  that there was no requirement  that there be                                                                    
no  invasion  of  principal,  restrictions  applied  to  one                                                                    
section of land, only 30 percent  of the value of the trust.                                                                    
He said that  the bill would modernize  the trust management                                                                    
of the  fund. He did not  believe that there were  any legal                                                                    
problems  with the  bill and  that  it did  not violate  the                                                                    
dedicated fund clause.                                                                                                          
3:29:55 PM                                                                                                                    
Co-Chair MacKinnon referred to  a letter from the department                                                                    
from  February 6,  2018. She  asked  whether the  department                                                                    
maintained the position taken in the letter.                                                                                    
Mr. Bjorquist replied in the affirmative.                                                                                       
3:30:11 PM                                                                                                                    
Senator  von Imhof  asked  whether the  model  on the  graph                                                                    
assumed a  certain return or  used historical  returns based                                                                    
on a theoretical mix of assets.                                                                                                 
Mr.  Barnhill replied  that the  graph was  modeled on  a 70                                                                    
percent  equity, 30  percent fixed  income asset  allocation                                                                    
represented by  the Russel 3000  Index when it  began, prior                                                                    
to the  Russel 3000,  the S&P  500 Index  had been  used. He                                                                    
said the  Lehman Aggregate Index,  now called  the Bloomberg                                                                    
Barclays  Index, had  been  used for  the  30 percent  fixed                                                                    
income asset allocation.                                                                                                        
3:31:06 PM                                                                                                                    
Senator von  Imhof asked  who would manage  the fund  in its                                                                    
new format.                                                                                                                     
Mr. Barnhill  replied that the department  would continue to                                                                    
manage the fund.                                                                                                                
3:31:29 PM                                                                                                                    
Senator  von   Imhof  asked  whether  there   would  be  any                                                                    
cooperation  with  the  Alaska  Permanent  Fund  Corporation                                                                    
Mr. Barnhill responded that the  fund would be kept separate                                                                    
from APFC.                                                                                                                      
3:31:48 PM                                                                                                                    
Co-Chair MacKinnon  noted that the department  was outpacing                                                                    
APFC in some areas.                                                                                                             
Mr. Barnhill  stated that  the relative  performance between                                                                    
APFC and the Treasury Division vacillated over time.                                                                            
3:32:23 PM                                                                                                                    
Senator  von  Imhof  queried   the  future  proforma  return                                                                    
Mr.  Barnhill relayed  that under  current  practices a  6.6                                                                    
percent return was expected.                                                                                                    
3:33:46 PM                                                                                                                    
AT EASE                                                                                                                         
3:35:31 PM                                                                                                                    
3:35:34 PM                                                                                                                    
Co-Chair  MacKinnon   explained  that  a   chart  containing                                                                    
forward  looking assumptions  was being  distributed to  the                                                                    
committee. [This  document is  posted under  the "documents"                                                                    
tab for HFIN meeting 2/28/18]                                                                                                   
3:35:51 PM                                                                                                                    
Mr. Barnhill  related that the  chart had been  developed in                                                                    
the  other  body  in  an   effort  to  understand  what  the                                                                    
different  trailing  averages  looked   like  under  a  4.75                                                                    
percent POMV.  He noted  that the impact  on the  balance on                                                                    
the fund in  terms of its ability to keep  up with inflation                                                                    
using  the current  Callan  Capital  market assumptions.  He                                                                    
said that the  modeling was done on the  current balance, as                                                                    
opposed to  the principal balance or  the inflation adjusted                                                                    
balance. He  said that because  the Callan  assumptions were                                                                    
pessimistic over  the next 10  years at 6.5 percent,  if the                                                                    
objective was  to maintain the  inflation adjusted  value of                                                                    
the current  balance, that would  be difficult under  any of                                                                    
the methodologies.  He said that  at some point the  10 year                                                                    
plus bull  market would  come to  an end  and the  8 percent                                                                    
that was hoped for would not  be a reality. He lamented that                                                                    
it  would be  difficult to  maintain the  inflation adjusted                                                                    
value of  the current  balance under  a POMV  methodology, a                                                                    
variety of percentages, over the  next 10 years. He believed                                                                    
that things would improve over a  longer horizon of 20 to 30                                                                    
years. He stated  that as an endowment the  objective was to                                                                    
maintain  the  inflation  adjusted   value  of  deposits  to                                                                    
principal. He  said that  the total balance  of the  fund is                                                                    
north of $650  million. The notional value of  those is $310                                                                    
million  and  had been  tracked  since  1978. He  said  that                                                                    
taking  the deposits  to principal  and  adjusting them  for                                                                    
inflation  using  the  consumer  price  index,  the  current                                                                    
approximate inflation adjusted value  of the fund was closer                                                                    
to  $513 million.  He furthered  that if  the objective  for                                                                    
managing the endowment  was to maintain over  all periods of                                                                    
time the  inflation adjusted value of  the principal deposit                                                                    
it  did not  matter which  trailing average  was used.  At a                                                                    
4.75 percent distribution, under  the current Callan Capital                                                                    
market   assumptions,  inflation   adjusted  value   of  the                                                                    
deposits to  principal would be successful  over the 10-year                                                                    
horizon and into the future.                                                                                                    
3:40:14 PM                                                                                                                    
Co-Chair  MacKinnon said  that  she had  been measuring  the                                                                    
fund by  the Power Cost  Equalization Fund. She  stated that                                                                    
with that fund,  the state had lowered the  expected rate of                                                                    
return  and decreased  the risk.  She understood  that under                                                                    
the  bill the  asset allocation  would be  changed, possibly                                                                    
increasing the risk factor.                                                                                                     
Mr. Barnhill  felt that the  distribution point for  the PCE                                                                    
fund  had been  fairly  aggressive. He  said  that the  bill                                                                    
contained  a  modest  4.75 percent  distribution  point.  He                                                                    
added  that the  4.75 to  5 percent  distribution range  was                                                                    
standard  in  managing  endowments around  the  country.  He                                                                    
believed  that   the  department  would  be   successful  in                                                                    
managing  the  fund  going   forward  while  protecting  the                                                                    
inflation adjusted value.                                                                                                       
3:40:44 PM                                                                                                                    
Co-Chair MacKinnon asked whether  the 4.75 percent suggested                                                                    
in the legislation was the effective draw.                                                                                      
Mr. Barnhill said  that taking 4.75 percent  of the trailing                                                                    
5-year  average would  almost  always  produce a  percentage                                                                    
draw  of that  year balance  of less  than 4.75  percent. He                                                                    
reiterated that the objective was  to maintain the inflation                                                                    
adjusted value  over long periods  of time.  He  shared that                                                                    
the department  had requested in  the bill that  rather than                                                                    
have a static  4.75 percent, that the words,  "not more than                                                                    
4.75  percent" be  included in  the  language. He  explained                                                                    
that this would  correct annually if for  whatever reason it                                                                    
was prudent to spend less  than 4.75 percent in a particular                                                                    
3:41:26 PM                                                                                                                    
Co-Chair   MacKinnon   agreed   that  the   department   was                                                                    
attempting to maintain the value.  She felt that it had been                                                                    
hard  to determine  a calculation  on  this particular  fund                                                                    
over the  past few  years working  with the  department. She                                                                    
wondered why the legislature would  give the department more                                                                    
flexibility. She  wondered how the Office  of Management and                                                                    
Budget  Director   arrived  at  the  calculation   of  money                                                                    
available  for  education out  of  the  fund over  the  past                                                                    
decade. She said  that a solid mathematical  formula had not                                                                    
been determined.                                                                                                                
Mr.  Barnhill did  not think  that the  cash flow  should be                                                                    
volatile. He  said that  going to a  static 4.75  percent of                                                                    
market value should make the  cash flow more predictable and                                                                    
stable.  He offered  reasons for  why  the department  would                                                                    
suggest going below 4.75 percent.                                                                                               
3:46:56 PM                                                                                                                    
ALEXEI  PAINTER,  ANALYST,   LEGISLATIVE  FINANCE  DIVISION,                                                                    
discussed  the fiscal  notes. The  first note  was from  the                                                                    
Department of  Education and Early Development  (DEED), K-12                                                                    
Aid to School  Districts. He stated that the  true impact of                                                                    
the bill would be the increase  of the amount of trust funds                                                                    
used. He asserted  that the fiscal notes  could be confusing                                                                    
due  to  the  way  that  the Governor's  FY  19  budget  was                                                                    
written. The  fiscal note reflected  an increase  of general                                                                    
funds of $1  million, and a decrease of  Public School Trust                                                                    
Funds of $1 million, the actual  affect of which would be to                                                                    
make an additional  $17 million realizable. He  said that if                                                                    
the  bill passed,  the fund  change that  would be  built in                                                                    
would be  an increase of  $17 million  of trust funds  and a                                                                    
decrease of  the same amount  of undesignated  general fund.                                                                    
The  second  note was  for  DEED,  Mount Edgecumbe  Boarding                                                                    
School and  showed that  the school was  no affected  by the                                                                    
Co-Chair MacKinnon  asked if the  first note  reflected $1.2                                                                    
billion in total operating cost.                                                                                                
Mr. Painter  replied in the  affirmative. He  explained that                                                                    
the bill would  impact the source of the funding  for the K-                                                                    
12 formula and the easiest way  to show that was to show all                                                                    
of the funding  in the Governor's request and  then show the                                                                    
change  in  the  funding.  He clarified  that  not  all  the                                                                    
funding would be affected by the bill.                                                                                          
3:49:39 PM                                                                                                                    
Co-Chair MacKinnon  asked whether  the fiscal note  would be                                                                    
incorporated in to the budget.                                                                                                  
Mr. Painter  replied that the  fund source would  change and                                                                    
the  numbers  appropriation  of Public  School  Trust  Funds                                                                    
would increase,  thereby decreasing the  fund capitalization                                                                    
of unrestricted general  funds by the same  amount. It would                                                                    
not  change  the amount  that  would  go to  the  foundation                                                                    
formula. He reiterated that the note lacked clarity.                                                                            
3:50:24 PM                                                                                                                    
Co-Chair  MacKinnon thought  that  there was  a chance  that                                                                    
education was being double funded.                                                                                              
Mr. Painter said  that the $1.2 billion was  included in the                                                                    
Governor's request. The appropriation  requested in the left                                                                    
column of the note showed the  change in the fund source. He                                                                    
revealed that the fiscal note  could not be adopted into the                                                                    
budget because the budget adopted  by the body did not match                                                                    
the Governor's request on the fund source.                                                                                      
3:51:15 PM                                                                                                                    
Senator von  Imhof asked why  a fiscal note that  showed the                                                                    
difference going from the current  statutory income from the                                                                    
fund to a potential new POMV.                                                                                                   
Mr. Painter replied that the  Governor's budget had built in                                                                    
a fiscal note  similar to the one before  the committee into                                                                    
the base budget that did  not reflect current statute or the                                                                    
legislation before  the committee.  He shared that  the note                                                                    
reflected  a  version  of  a different  bill,  that  used  a                                                                    
different calculation; and unorthodox  move by the Governor,                                                                    
that created an unusual fiscal note.                                                                                            
3:52:07 PM                                                                                                                    
Co-Chair  MacKinnon offered  assurances that  an appropriate                                                                    
bill would  be crafted  by the  committee, and  would travel                                                                    
with  the   bill,  should  the   legislation  pass   out  of                                                                    
3:52:30 PM                                                                                                                    
Co-Chair MacKinnon OPENED public testimony.                                                                                     
Co-Chair MacKinnon CLOSED public testimony.                                                                                     
3:53:14 PM                                                                                                                    
Co-Chair MacKinnon announced that amendments were due by                                                                        
5pm   the   following    day.   She   discussed   additional                                                                    
CSHB 213(FIN)(efd fld) was HEARD and HELD in committee for                                                                      
further consideration.                                                                                                          

Document Name Date/Time Subjects
HB 176 AML Letter.pdf SFIN 4/16/2018 1:30:00 PM
HB 176
HB176 Sponsor Statement.pdf SFIN 4/16/2018 1:30:00 PM
HB 176
HB176 Flow Chart.pdf SFIN 4/16/2018 1:30:00 PM
HB 176
HB176 Letters of Support.pdf SFIN 4/16/2018 1:30:00 PM
HB 176
HB176 - Explanation of Changes.pdf SFIN 4/16/2018 1:30:00 PM
HB 176
HB 213 Letter to House Finance - Dept. of Revenue.pdf SFIN 4/16/2018 1:30:00 PM
HB 213
HB 213 Letter to House Finance - Dept. of Law.pdf SFIN 4/16/2018 1:30:00 PM
HB 213
HB 213--Supportive Letter.pdf SFIN 4/16/2018 1:30:00 PM
HB 213
HB 213 Support letter.pdf SFIN 4/16/2018 1:30:00 PM
HB 213
HB 213 Summary of Changes ver. R 2-8-18.pdf SFIN 4/16/2018 1:30:00 PM
HB 213
HB 213 Summary of Changes Ver U to N.A 4-12-2018.pdf SFIN 4/16/2018 1:30:00 PM
HB 213
HB 213 Sectional Analysis.pdf SFIN 4/16/2018 1:30:00 PM
HB 213
HB 213 Sectional Analysis Ver N.A 4-12-2018.pdf SFIN 4/16/2018 1:30:00 PM
HB 213
HB 213 Actual vs. POMV bar chart.pdf SFIN 4/16/2018 1:30:00 PM
HB 213