02/26/2019 03:30 PM Senate STATE AFFAIRS

                                                                                                                                
        SB  23-APPROP:SUPP. PAYMENTS OF PRIOR YEARS' PFD                                                                    
                 SB  24-PFD SUPPLEMENTAL PAYMENTS                                                                           
                                                                                                                                
4:42:30 PM                                                                                                                    
CHAIR  SHOWER announced  the consideration  of SB  23 and  SB 24,                                                               
both sponsored  by the Senate  Rules Committee at the  request of                                                               
the governor. He  noted that the committee members  should have a                                                               
report  [February   16,  2019,  letter  to   the  committee  from                                                               
Commissioner Tangeman] that has  some information relating to the                                                               
permanent  fund  and the  dividend.  He  said the  committee  was                                                               
looking for a refresher on these  bills before looking at the new                                                               
information. He  wanted the committee  members familiar  with the                                                               
bills again  because he  wanted amendments  to be  submitted over                                                               
the next  week so they  could get  public testimony and  move the                                                               
bills out of committee.                                                                                                         
                                                                                                                                
4:44:01 PM                                                                                                                    
BRUCE  TANGEMAN,  Commissioner,   Department  of  Revenue  (DOR),                                                               
Anchorage, Alaska, introduced himself.                                                                                          
                                                                                                                                
BILL MILKS, Assistant Attorney General,  Department of Law (DOL),                                                               
Juneau, Alaska, introduced  himself and said he  was available to                                                               
answer questions                                                                                                                
                                                                                                                                
ED KING, Chief Economist, Office  of Management and Budget (OMB),                                                               
Juneau,  Alaska,   introduced  himself  and  offered   to  answer                                                               
questions.                                                                                                                      
                                                                                                                                
4:44:26 PM                                                                                                                    
COMMISSIONER TANGEMAN said SB 23 and  SB 24 are being referred to                                                               
as  the Backpay  PFD  bills. The  purpose is  to  make whole  the                                                               
dividend  amounts from  Fiscal  Year  (FY) 16,  17,  and 18.  The                                                               
governor's bill proposes  to pay out those amounts  over the next                                                               
three years. The  governor views it as a three-year  issue with a                                                               
three-year  solution. Instead  of  drawing the  full amount  down                                                               
from  the earnings  reserve to  pay  back the  amount, which  DOR                                                               
estimates to be $1.9 to $2  billion total, the proposal is to pay                                                               
the full amount out over the next three years.                                                                                  
                                                                                                                                
COMMISSIONER  TANGEMAN  said the  simple  mechanics  are that  if                                                               
someone  received  a dividend  in  FY16  and qualifies  in  FY19,                                                               
$1,061  would be  added  to that  person's  dividend. If  someone                                                               
received a dividend  in FY17 and qualifies in  FY21, $1,289 would                                                               
be  added  to  that  person's dividend.  If  someone  received  a                                                               
dividend in FY18 and qualifies in  FY22, $1,328 would be added to                                                               
that  person's   dividend.  The   justification  is   that  while                                                               
dividends were  not paid out in  full over the past  three years,                                                               
the  balance  of  those  dividend amounts  sat  in  the  earnings                                                               
reserve. That  account saw a ten  percent return one year  and 12                                                               
percent  another, so  some healthy  revenue was  earned from  the                                                               
money that did  sit there. Governor Dunleavy  believes that money                                                               
is owed to  the citizens of Alaska who qualified  for a dividend.                                                               
Allowing it  to also  sit in  the earnings  reserve for  the next                                                               
three years is  an opportunity to earn more revenue  to defer the                                                               
total cost of about $2 billion.                                                                                                 
                                                                                                                                
COMMISSIONER TANGEMAN  said there  were several questions  at the                                                               
last presentation  that he could  walk through. He asked  how the                                                               
committee wanted to proceed.                                                                                                    
                                                                                                                                
CHAIR  SHOWER  asked  for  the   30,000  feet  view  of  the  new                                                               
information. The purpose  was to get the members up  to speed and                                                               
review the latest numbers and any changes.                                                                                      
                                                                                                                                
COMMISSIONER TANGEMAN deferred to Mr. King.                                                                                     
                                                                                                                                
4:47:19 PM                                                                                                                    
ED KING, Chief Economist, Office  of Management and Budget (OMB),                                                               
said one  of the  first questions  was how  the mechanics  in the                                                               
changes  of  the   fund  would  play  out.  He   put  together  a                                                               
transactional report  [on page  1] showing  the transfers  out of                                                               
the earnings reserve and the  transfers into the earnings reserve                                                               
as earnings are realized. The  left-hand column is the status quo                                                               
without SB 23 passing. The  right-hand column shows the financial                                                               
impacts of  SB 23. He was  trying to illustrate that  although $2                                                               
billion will  be drawn  out of  the account,  in addition  to the                                                               
Percent of Market  Value (POMV), income also goes  into the fund.                                                               
He was addressing  the issue of whether there is  enough money in                                                               
the  account  to fund  both  general  fund obligations  and  this                                                               
proposed payback.                                                                                                               
                                                                                                                                
CHAIR SHOWER  said he wanted  to make this crystal  clear because                                                               
the committee went  around and around with this the  last time it                                                               
was  brought up.  This  would be  akin to  having  $20,000 in  an                                                               
account. Adding $4,100 brings it  up to $24,100. Taking the money                                                               
out for  the dividend brings the  account back to a  little under                                                               
$20,000. There was  a lot of confusion because they  are not just                                                               
taking several  billion out [of the  fund]. They would not  be at                                                               
$16 billion or, in his example,  with $16,000 in the account. The                                                               
account is close to where it  started because income is added and                                                               
subtracted.  It is  close to  a  wash. He  asked if  that was  an                                                               
accurate description.                                                                                                           
                                                                                                                                
MR. KING answered yes.                                                                                                          
                                                                                                                                
CHAIR SHOWER  said he wanted to  keep from going as  far down the                                                               
spin as last time.                                                                                                              
                                                                                                                                
MR. KING  said the question  continues on  page 2 with  regard to                                                               
how the account balances would change  over time. He's shown in a                                                               
stacked  bar chart  the three  different parts  of the  fund, the                                                               
principal  account,  the earnings  reserve  account  (which is  a                                                               
holding account  for the earnings),  and the  unrealized account.                                                               
That is  appreciation on assets  that are  held by the  fund, but                                                               
not sold  yet. The money  can't be spent;  it's like equity  in a                                                               
house.  That  equity doesn't  sit  in  a checking  account  until                                                               
someone sells  the house. It shows  that in either case,  with or                                                               
without  this bill,  the fund  is  projected to  grow and  remain                                                               
healthy. It  should not be  confused with  the fact, as  shown on                                                               
the next page,  that the ERA balance is projected  to decline. It                                                               
should not be  confused with the idea that the  entire fund is in                                                               
jeopardy.                                                                                                                       
                                                                                                                                
4:50:31 PM                                                                                                                    
SENATOR REINBOLD  said it is hard  for her to imagine  that there                                                               
is going to be growth. A  lot of these are risky investments. She                                                               
doesn't want a  Pollyanna view, but this chart is  "you are going                                                               
to have your cake and eat it too" thinking.                                                                                     
                                                                                                                                
COMMISSIONER TANGEMAN  said that  is a  good, healthy  concern to                                                               
have. Both  the dividend  calculation and  POMV calculation  is a                                                               
five-year  average.  DOR  used  a  five-year  average  to  absorb                                                               
corrections  in  the market.  While  they  are not  projecting  a                                                               
correction in the  market, the assumptions by  the Permanent Fund                                                               
account for things like that. It  is part of the Alaska Permanent                                                               
Fund Corporation's estimated 6.555  percent return. There will be                                                               
market  corrections.  That is  why  they  are using  a  five-year                                                               
average for both the POMV and permanent fund dividend.                                                                          
                                                                                                                                
4:51:46 PM                                                                                                                    
CHAIR SHOWER said  that on page 3, the red  bar, which represents                                                               
SB  23 passing,  shows the  ERA balance  declining over  time. He                                                               
asked why  they showed the blue  bar, which represents SB  23 not                                                               
passing, also  going down.  He thought they  should be  seeing an                                                               
increase if SB 23 does not pass.                                                                                                
                                                                                                                                
4:52:08 PM                                                                                                                    
MR. KING said he put the other charts  on page 2 to show there is                                                               
a difference  between the  entire fund balance  vs. just  the ERA                                                               
balance. The  way that the  mechanisms currently work,  with POMV                                                               
and inflation proofing and the  Permanent Fund projections, there                                                               
isn't enough  earnings to satisfy  all the requirements.  The ERA                                                               
balance  is  declining, even  with  the  status quo  because  the                                                               
principal account  is growing. The  money is not  evaporating. It                                                               
is migrating  to the other  account. The  reason why the  red bar                                                               
declines more  quickly is because  when there is a  smaller asset                                                               
base, there are smaller earnings;  the inflation proofing balance                                                               
does not  change because the  principal account is  the principal                                                               
account,  regardless,  and  the  inflation  proofing  requirement                                                               
doesn't change, but  the POMV number does. The  entire balance of                                                               
the account changes with those dynamics.                                                                                        
                                                                                                                                
CHAIR  SHOWER asked,  when talking  about the  difference between                                                               
the ERA to  the principal balance, how that is  reinvested or how                                                               
that ends  up back  in. He  asked him to  describe for  the folks                                                               
back home why  he sees that blue bar increasing.  He said you did                                                               
a good  job explaining  the Earnings  Reserve Account  itself and                                                               
he'd like the same thing for  the process with the permanent fund                                                               
principal, the corpus itself.                                                                                                   
                                                                                                                                
MR.  KING responded  that the  principal account  of the  fund is                                                               
protected  by  the  constitution.  It  receives  deposits  of  25                                                               
percent  or more  of all  royalties the  state collects.  All the                                                               
earnings on  that principal account  flow into a  holding account                                                               
called  the earnings  reserve. When  the  legislature decides  it                                                               
wants  to protect  some of  those earnings,  they move  the money                                                               
into the  principal account in  order to protect that  money from                                                               
future appropriations.  The statute  requires a transfer  of that                                                               
kind  to account  for inflation  proofing. The  principal account                                                               
increases   because   of   royalties  and   inflation   proofing.                                                               
Historically,  when   the  Earnings   Reserve  Account   has  had                                                               
additional funds  in it, the  legislatures of the past  have done                                                               
special appropriations to move that money.                                                                                      
                                                                                                                                
4:54:42 PM                                                                                                                    
SENATOR  MICCICHE said  he heard  what Mr.  King is  saying about                                                               
assuming a 6.55 percent total  return and a 6.4 percent statutory                                                               
return. He asked  if he injected a 2008 into  his modeling, which                                                               
would take some time to  recover from, especially in the earnings                                                               
reserve,  where   they  had  that   down  very  close   to  zero,                                                               
uncomfortably  close to  zero. He  said  he doesn't  see that  in                                                               
here.                                                                                                                           
                                                                                                                                
MR. KING replied that it is  not in here because it is portraying                                                               
the  average return  used by  the Permanent  Fund Corporation  to                                                               
demonstrate the fund. As DOR  does their Monte Carlo simulations,                                                               
they   look   at   different  iterations   that   include   these                                                               
corrections. A 2008-type correction  happens once every ten years                                                               
or so. Then  there are years of 20 percent  growth. When there is                                                               
volatility  of  negative 18  percent  in  one  year and  plus  22                                                               
percent in  another year, the  fund is saying in  its projection,                                                               
that over time  it results in a 6.5 percent  return. He said he'd                                                               
show  those iterations  in Finance  to show  how that  volatility                                                               
plays  out. In  some situations,  the permanent  fund only  grows                                                               
with inflation  and in other  situations, the fund grows  to over                                                               
$100 billion.  They don't  know which world  they will  be living                                                               
in, so they have to make a guess and play to those average.                                                                     
                                                                                                                                
SENATOR MICCICHE said he understands  and looks forward to seeing                                                               
those. He  has an investment account  and over 40 years  has seen                                                               
the worst of the worst and  the best of the best. Every committee                                                               
that deals  with SB  23 and  SB 24  becomes a  finance committee.                                                               
Normally  the   committee  is  policy  related,   but  it's  very                                                               
difficult in  this case. He  asked Mr.  King if he  could provide                                                               
these charts with more granularity.                                                                                             
                                                                                                                                
CHAIR SHOWER  asked him  to break  the charts  down for  the next                                                               
meeting.                                                                                                                        
                                                                                                                                
4:57:33 PM                                                                                                                    
SENATOR  REINBOLD echoed  Senator Micciche's  comments about  the                                                               
need for more  granular data. She said Mr. King  said this is the                                                               
average return the corporation is using  and she wants to know if                                                               
statistically,  it  is  based  on  what  happened  in  the  past,                                                               
including  2008. He  said they  will have  to guess  and play  to                                                               
averages  and she  wants  to know  what formula  he  is using  to                                                               
guess.                                                                                                                          
                                                                                                                                
MR.  KING replied  that  the  corporation uses  what  it calls  a                                                               
geometric  mean.  It  is  the average  of  all  future  projected                                                               
returns. The  fund uses a  consultant to generate  those returns.                                                               
The history  of the fund,  including the 2008 correction  and the                                                               
bad years in  the early 2000s, is overwhelmed by  the really good                                                               
year. Last year's  return was 10.74 percent. Some  years have had                                                               
a return  of 22 percent. The  average return of the  40-year fund                                                               
history is over  9 percent. The fund is looking  forward to a 6.5                                                               
percent return.  The corporation  is providing  a number  that is                                                               
more conservative  than the  historic performance  would suggest,                                                               
but it probably has good reasons for doing that.                                                                                
                                                                                                                                
MR. KING said  that because of the way that  interest works, a 10                                                               
percent return and  a 10 percent loss are  not equivalent because                                                               
of  the  way  compounding  works. The  arithmetic  mean  is  also                                                               
important.  The corporation's  6.5 percent  geometric mean  works                                                               
out  to about  a  7.65  percent arithmetic  mean.  When they  are                                                               
running  simulations, they  are  ending up  with situations  with                                                               
better returns that more closely  relate to historic performance,                                                               
with  some occasional  corrections.  The  standard deviation  the                                                               
corporation is using  is quite wide. They are trying  to pin down                                                               
whether that  distribution makes the  most sense for  running the                                                               
scenarios.                                                                                                                      
                                                                                                                                
CHAIR SHOWER asked that since they  were running out of time, was                                                               
there anything else to highlight.                                                                                               
                                                                                                                                
5:00:38 PM                                                                                                                    
MR.  KING  replied that  they  appreciate  that there  are  risks                                                               
associated  with  the  fund  balance,   whether  they  take  this                                                               
additional  draw or  not.  It is  an  important conversation.  He                                                               
would like to  highlight that the governor's opinion  is that the                                                               
money that he is talking about  repaying to the people should not                                                               
be in the fund at all.  That is an important conversation to have                                                               
at a later date.                                                                                                                
                                                                                                                                
MR. KING  pointed out that  the bill  needs a correction  for the                                                               
FY22  number.  Where it  reads  1,328,  it  should be  1,388.  He                                                               
thanked Legislative Finance for identifying that.                                                                               
                                                                                                                                
SENATOR MICCICHE  said he is looking  at the reality at  how they                                                               
are paying  bills today and  how he  is expecting that  they will                                                               
pay the bills at the end of the  session. He asked if it would be                                                               
helpful if he plugged in some  assumptions, so they don't have to                                                               
model on  a wide  band. If  they would like  to meet,  he thought                                                               
they could  model a few specific  numbers and see how  that looks                                                               
over time. They  cannot assume what the legislature  could do. He                                                               
is  worried about  that because  it  would create  stress on  the                                                               
earning reserve  and potentially the  corpus itself. If  they got                                                               
together, he might  be able to help DOR streamline  their work on                                                               
modeling stress testing.                                                                                                        
                                                                                                                                
SENATOR  REINBOLD  said she  wanted  to  reiterate the  need  for                                                               
better granular data. These charts  are not working for her. They                                                               
need to be historically accurate  and include the POMV, including                                                               
the unstructured draw with SB 23  and how they are modeling those                                                               
projections.  This   is  a  sensitive   issue.  The   people  are                                                               
listening.  The populist  view  is pay  them  all back,  everyone                                                               
wants their money. They cannot get  it wrong. However, it must be                                                               
a  permanent  fund  for  future generations.  She  asked  DOR  to                                                               
provide the  committee with  good data  because this,  along with                                                               
the crime legislation, is being watched closely.                                                                                
                                                                                                                                
5:03:40 PM                                                                                                                    
CHAIR SHOWER held SB 23 and SB 24 in committee.