Legislature(2003 - 2004)
03/25/2004 01:50 PM House FIN
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HOUSE JOINT RESOLUTION NO. 26
Proposing amendments to the Constitution of the State
of Alaska relating to and limiting appropriations from
and inflation proofing the Alaska permanent fund by
establishing a percent of market value spending limit.
Co-Chair Williams introduced Amendment #3, #23-LS1006\V,
Cook, 3/22/04. (Copy on File). He noted that the amendment
would completely change the bill. His intent was to take
testimony on Amendment #3 and take no action at this
meeting.
Representative Hawker MOVED to DIVIDE the question proposed
in Amendment #3, pointing out there are two distinct
considerations proposed in the amendment.
Co-Chair Williams reiterated that no official action would
be taken on Amendment #3 at this time.
ROBERT D. STORER, EXECUTIVE DIRECTOR, ALASKA PERMANENT FUND
CORPORATION, DEPARTMENT OF REVENUE, acknowledged that there
are two components to the amendment. He offered to address
the first component, which would in effect memorialize the
principal in the Alaska Constitution by identifying the
Earnings Reserve Account.
Mr. Storer provided a "history lesson" on how the Board came
to the conclusion that a Percent of Market Value (POMV)
without principal would be a better approach. There is no
question that the Board recognizes the merit and would not
be opposed to the proposed amendment, which puts principal
into the Constitution. Three years ago when identified, the
Board did opt to leave the principal in the Constitution.
He emphasized that the key is the 5% spending limit.
Principal puts a floor on what might be appropriated.
Following a lengthy discussion with the Permanent Fund Board
of Trustees, discussing the merits of continuing principal
versus the 5% limitation, the Board concluded that having
the percentage of market value payout with 5%, the principal
would be their preferred approach. The Board believes that
the 5% does memorialize inflation proofing in the
Constitution and would not need a floor. It recognizes that
on some occasions, there will be up and down markets, but
over the long term, the purchasing power of the fund would
be maintained. He noted that there is companion language,
which gives the Legislature direction of when they would be
moving below the 5% real rate of return.
Mr. Storer continued, if that language was maintained, there
is a limited chance that there could be a small or no pay
out at all, in a bear market. That could potentially limit
how much is available for payout. At this time, there is a
cushion in the fund. The principal is about $23 billion
dollars and the Permanent Fund is approximately $27 billion
dollars. As the market progress and the appreciation fund
grows significantly greater than this concept of principal,
then that would become less of an issue because the cushion
would become greater over time. He observed that including
the principal, will give decision makers a little more
latitude in terms of the pay out, no more than 5% in the
down markets. Also, by paying out the 5% in down & high
markets, will treat all generations equally.
Mr. Storer concluded, it is important to note, but not as it
applies to the proposed statute, there are proposals that
would memorialize the dividend in the Constitution at a
fixed rate. If the Legislature is contemplating putting
principal back into the Permanent Fund that would create a
limit on how much could be paid out. If there is a proposal
for a fixed payout, there would then be competing formulas.
He commented that could be worked with, however, it should
be evaluated with other proposals.
BOB BARTHOLOMEW, CHIEF OPERATING OFFICER, ALASKA PERMANENT
FUND CORPORATION, DEPARTMENT OF REVENUE, added, that he did
not have anything additional to add to the concept of
leaving in the principal and the protection of the
principal. He observed that another change that the
amendment proposes is to Section 2, where it actually
provides for the dividend and public education as two of the
uses for the money from the Permanent Fund. That was not in
the previous version.
Co-Chair Harris clarified that Section 1 basically
establishes an Earnings Reserve Account in the corpus and
under the umbrella of the Constitution. It also establishes
the fact that the only pot of money that can be used under
constitutional protection is the Earnings Reserve Account.
The second section then would establish in Constitution:
· The 5%,
· A dividend, and
· Allows the use of that 5% for public education and
the administration process.
Co-Chair Harris added that if the public was asking for some
sort of protection for a dividend, the amendment would
provide that and protects it from going into the principal
of the fund. He knew that was the public's highest
priorities.
Mr. Storer agreed that there is interest in those subjects.
He pointed out that it would also memorialize the concept of
the dividend. The public definitely understands the concept
of principal protection, which he thought was a good thing.
He urged members to keep in mind the concept of the worse
case scenario and that the amendment memorializes the
concept of the dividend but does not say that a dividend
would not be paid, but if the market value was eroded, the
floor would disappear. He emphasized that the language
creates both a discipline and a floor. There is a limited
chance that there could be a small or no dividend.
Mr. Bartholomew added that under the Board of Trustees
proposal, they merged principal and Earnings Reserve into
one account. From the administrative perspective, part of
the benefit from that action would be only the records from
the generally accepted accounting principals would tell the
Legislature the size of the fund and the market value times
5%. Into the future, the Permanent Fund Corporation would
continue to report as they are at this time. There are two
sets of accounting records used, the generally accepted
accounting principal and the accounting for the realized
income. He assumed that was a difficult piece to
understand. The existing process will remain in place. The
protection of principal is out-weighing some of the other
benefits.
Co-Chair Williams agreed that it is difficult to understand
these concepts. He asked if the proposed legislation would
put that language into the Constitution. Mr. Bartholomew
acknowledged that it would and that the principal is
included in the Constitution at this time. Co-Chair
Williams questioned why the Legislature would want to place
that language into the Constitution.
JOE BALASH, STAFF, SENATOR GENE THERRIAULT, presented a
history on the proposal, which dates back to 2001. At that
time, Senator Therriault was Chairman of the Legislative
Budget and Audit (LBA) Committee, which has oversight of the
Permanent Fund, and was responsible for introducing the
first proposal by the Trustees to switch to the percent of
market value (POMV) methodology. Then Senate President
Halford rewarded Senator Therriault for that introduction by
referring it to his Committee in Senate State Affairs.
During the next fourteen months, public hearings were held
statewide. During subsequent and current legislatures have
spent much of the interim taking public testimony on current
POMV language. The concept of principal keeps coming around
to "haunt" the notion of POMV and why it is not the public's
first choice as a way to preserve the fund. In order to
preserve the notion of principal, the rest of the fund must
be accounted for in some manner. By doing so, the decision
was to create an Earnings Reserve Account similar to what is
around today. He added that realized versus unrealized
income has not been distinguished in the bill.
Co-Chair Williams recommended that Senator Therriault be
th
present at the next scheduled meeting for Monday, March 29
at 9 a.m. Mr. Balash indicated that he could arrange that.
Representative Hawker asked if the amendment was attempting
to create two buckets of money within the Permanent Fund.
Mr. Bartholomew responded that there have been many legal
discussions over how many buckets of money there are.
Currently, the Permanent Fund is accounted for in three
separate pools. The principal pool, the unrealized
earnings, and the realized earnings. Language on Line 13,
of the proposed amendment addresses depositing earnings into
the reserve. He understood that language would require them
to continue as presently done and account for the Permanent
Fund in the three buckets. The spending is driven by what
is available in the realized earnings account.
Representative Hawker inquired why new language was needed
to accomplish something already being done. Mr. Bartholomew
stated that the constitutional amendment does achieve the 5%
spending limit, which is the most significant action being
taken by using the 5% spending limit, which protects
purchasing power into the future. However, the manner in
which it is accounted for will change.
Representative Hawker voiced his confusion regarding placing
the 5% limit into constitutional language. Mr. Bartholomew
reiterated that it was in original bill. He explained that
on Line 10, leaves the word "principal" in the Constitution
and requires that the principal not be spent. Mr. Storer
added that it was true that the 5% limit existed before. It
is consistent with the Permanent Fund's objective, putting a
limit on how much could be appropriated at any given time.
The amendment creates a floor, and if the value of the fund
falls below that floor, no money could be used below the
principal floor. Over time, as the profits of the fund grow
and the difference between the value of the fund and the
principal become wider and wider, then the point of
principal becomes less important because the cushion becomes
greater.
Representative Hawker understood that the 5% does not change
and would only apply to a portion of the money in the fund.
Mr. Storer replied that the 5% limit would apply to the
entire fund. The definition of how much could be used,
would be 5% of the 5-year moving average of the entire fund.
The next step would be how much would be available above the
floor, which is the second message clarifying if there are
sufficient funds in order to reach the 5% requirement in
excess of that floor. If not, then they cannot take more
than the floor.
Representative Hawker thought that the policy call would be
the 5% of the entire value of the fund but only making a
portion available to draw the 5%. He believed that language
was inconsistent. Mr. Bartholomew agreed. Representative
Hawker questioned limiting the source of that fund. Mr.
Storer advised there are ways to provide insight when the
fund does not earn the 5%. He pointed out that the
Permanent Fund has been working with a number of elected
officials, who could evaluate whether or not to use the
entire 5% or instead make less of a policy decision.
Representative Hawker thought if there was inadequate money
in the bucket, then nothing could be drawn. He questioned
if that would be the same effect as using the "sidebar".
Mr. Bartholomew explained that if the sidebars or guardrails
were placed into statute, there would always be the option
of the Legislature to not follow them. If the extra
protection were placed into the Constitution, there would
never be the option of not following it.
Representative Hawker suggested that was an "all or none"
attitude. Mr. Bartholomew attempted to clarify, noting that
had been the debate the Board went through when making their
decision. As the Constitution is written today, there are
market scenarios, where there can be short-term declines in
the financial markets, which reduce the value of the
earnings reserve. If that scenario was to repeat itself,
when there is a principal limitation, which is hard and
fast, there is a line or value of the Permanent Fund that
can not be spent below, and is how it currently is and would
continue with the amendment. He reiterated that there is a
hard and fast line, which the Legislature cannot spend
below. When the Trustees evaluated whether to remove
principal or not, they recommended that the benefits must be
evaluated from having a predictable, sustainable pay out
from the Permanent Fund versus the risk taken by removing
the principal protection and saying that there are near turn
down markets, spending down into the Permanent Fund with the
intention that it would be paid back in the future good
years. That was the discussion. From the sponsor of the
amendment and what the public wants, the Board is
comfortable using the word principal. The experience of the
Permanent Fund is that with time to educate and work with
the public, the public then tends to support the concept of
a sustainable and predictable payout.
Representative Hawker understood that the amendment was a
trade off and would provide some inherent predictability and
stability to the previous version of the bill for
preservation of the notion of principal. He commented that
the word "notion" troubled him and that he did not think
that the State really wanted to trade predictability and
sustainability for such a vague thought.
Co-Chair Harris stressed that the reality is that the
amendment would protect a value of the principal set at a
certain period of time when it is voted on. That value
could never be taken away. Any earnings of the Permanent
Fund above and beyond that time would be deposited into the
second account called the Earnings Reserve Account. Today,
that account is not protected at all. Under the amendment,
it would be entirely protected under the Constitution. The
Earnings Reserve Account is the only pot of money that the
5% could be taken from. If there were a down market for a
considerable period of time, it would not prohibit taking 5%
of the fund. However, if the Earnings Reserve Account was
depleted, then no more could be drawn from the Permanent
Fund, as it would be constitutionally protected as the
principal. He emphasized that there is no "notion" involved
at all in the proposed language and emphasized that there is
absolute value protected. He asked Mr. Storer if that was a
correct interpretation. Mr. Storer responded that the only
distinction would be when that point is hit, and then the
citizens of Alaska would have to vote.
Co-Chair Harris pointed out that they would only have to
vote on the constitutional question, which would require
two-thirds of both Bodies's in order to place the question
before the voters.
Co-Chair Harris noted that two concerns were being
addressed. One is the constitutional protection of the
corpus or principal value at a certain point. The Permanent
Fund will have to determine whatever that number is at that
point in time. Any amount above and beyond that is Earnings
Reserve Account money. Mr. Bartholomew indicated that the
question needing to be answered is how to address the
State's on-going receipt of oil deposits. The Permanent
Fund understands that the principal would have to grow from
the on-going oil deposits; however, all the earnings of the
fund would be what is placed into the Earnings Reserve
Account.
Co-Chair Harris pointed out that that the Constitution
already clarifies that 25% goes into the principal of the
fund. That value is what is created by the investments and
would become part of the Earnings Reserve Account. That is
the pot of money that is constitutionally protected by the
5%. Mr. Storer stated that there is approximately $4.7
billion dollars of realized and unrealized money in the
account at this time.
Co-Chair Harris added that the Legislature still must
determine how much of that 5% comes out of the Earnings
Reserve Account that could be used for dividends, general
operations of the departments and education. Mr. Storer
agreed. Co-Chair Harris added that the Legislature could
adopt 100% for dividends and could be changed at any period
in time by the Legislature if they wanted to face public
scrutiny. He noted that the public is concerned about the
erosion of the principal. They need assurance that the
principal is not going away. The only way that they will
get that assurance is if it is constitutionally protected.
Under the proposed amendment, the Legislature would have no
power, only the public would have that authority. Mr.
Storer agreed.
Vice Chair Meyer asked the highest and lowest amount earned
by the fund over the past twenty-five years. Mr. Storer
stated that in March 2000, the principal was between $19 &
$20 billion dollars and now the principal is $23 billion
dollars. Mr. Bartholomew responded that there is a return
that the fund has earned under the generally accepted
accounting principals. It is important to consider what the
fund has earned under the realized earnings approach.
Vice Chair Meyer thought that 8% had been the average over
that period. Mr. Storer commented that the fund has been
through a substantial bull market for about fifteen years.
The real rate of return for nineteen years is 6.9%, and is
not sustainable. In the last ten years, there has been both
bull markets and a severe down market. Over that period of
time, the fund earned a return of 7.8% with inflation at
2.5%, which makes a 5.3% real rate of return.
Vice Chair Meyer understood Co-Chair Harris' concerns of
eroding into the principal, however, pointed out that it had
gone up to 5%. With inclusion of the proposed safeguards,
it would not go up to the full 5%. Given the POMV concept,
it is anticipated that during the next 50 to 100 years, the
average earnings would be 8%. Mr. Storer interjected that a
5% real rate of return could be anticipated. That is how
the 5% has been determined on what should be appropriated.
Vice Chair Meyer asked if the Permanent Fund supports the
amendment. Mr. Storer responded that historically, the
Permanent Fund supported the constitutional amendment with
principal remaining in. After a long study, it was
determined that there could be a better way to approach it.
The Board has concluded that the percentage of market value
pay out, as it now stands, is the recommended way, and will
allow the Legislature to determine whether or not it is in
the best interest to sustain the full 5% pay out or less
depending on the market. At no time, has the Permanent Fund
claimed that leaving the principal in would be inherently
bad. That approach is considered to be second best and is
viable.
Representative Hawker commented on the statement regarding
the principal in as being the second best approach. He
asked if that was a decision made from a financial policy
point of view or a political perspective. Mr. Storer
responded that he hoped it was a decision made from his
financial hat perspective so as to insure the long-term
viability. Discipline must be created to provide a cushion
for both the good and bad times, which has been consistent
for the Permanent Fund. They do recognize the importance of
the principal to the citizens of Alaska.
Representative Hawker heard that the bill as originally
presented was the first best approach, however, the
Legislature wears a more political hat first. The political
debate is one of preserving the notion of the principal. He
recommended exploring how to manage it, while continuing to
accomplish distribution of the wealth to all Alaskans. He
asked if the Permanent Fund considered using the old three-
column trust account system.
TAPE HFC 04 - 67, Side B
Representative Hawker continued, that system consists of
three columns, principal, earnings and expenses. The
realized earnings would be shifted between the three
columns. He acknowledged that the methods of accounting
have evolved and changed. He pointed out that the fund has
gone from the notion of principal to an accounting standard
that measures funds by value instead of principal. Mr.
Bartholomew explained that in 1997, the accounting standards
that oversee all generally accepted accounting principals
require the Permanent Fund to mark all of its assets to
current daily price to guarantee knowing if value was being
gained or lost. At the end of each month, a report is made
available to the Legislature from the Permanent Fund.
Representative Hawker knew that accounting changes have
evolved during the 1990's. In 1997, pronouncements mandated
to take a new approach to the fund. He asked if that was
the basis of the first best value based approach. He
thought that the second best approach appears to be more
outdated and does not reflect these flucuations. Mr.
Bartholomew agreed. He added that under the concept of
principal, the Permanent Fund will maintain two sets of
accounting records. That is what is done today. That
methodology would have gone away under a pure market
approach. Representative Hawker commented that would put
the burden back on the Legislature.
Co-Chair Williams stated that HJR 26 would be HELD in
Committee.
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