Legislature(2003 - 2004)

04/22/2003 07:00 AM W&M

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
HJR 26-CONST. AM: PF APPROPS/INFLATION-PROOFING                                                                               
                                                                                                                                
Number 3041                                                                                                                     
                                                                                                                                
CO-CHAIR HAWKER announced that the  final order of business would                                                               
be 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 HAWKER explained that HJR  26 was submitted by the House                                                               
Rules  Standing  Committee  at the  request  of  the  Legislative                                                               
Budget and  Audit Committee  by request  of the  Alaska Permanent                                                               
Fund [Corporation].                                                                                                             
                                                                                                                                
Number 3147                                                                                                                     
                                                                                                                                
CLARK GRUENING,  Vice Chair, Board of  Trustees, Alaska Permanent                                                               
Fund Corporation,  testified in  support of  HJR 26  and answered                                                               
questions from the  members.  He told members that  HJR 26, which                                                               
is a  proposed constitutional  amendment, is  a different  way to                                                               
inflation proof, protect, and enhance  the Alaska permanent fund.                                                               
Mr. Gruening  explained that  for 23  of the  fund's 27  years of                                                               
existence, the permanent  fund has been governed  by a six-member                                                               
board of  trustees.   Protecting the  fund against  inflation has                                                               
been the  highest public  policy goal of  the trustees  since the                                                               
first  board was  appointed in  1980,  he commented.   The  first                                                               
board  testified  to  the  legislature  at  that  time  that  the                                                               
greatest threat to  the permanent fund and to  its permanence was                                                               
inflation.    In  response to  that  testimony,  the  legislature                                                               
adopted a statutory inflation-proofing  methodology in 1982 which                                                               
is in use today.                                                                                                                
                                                                                                                                
MR. GRUENING  said in more  recent years, the board  has examined                                                               
the  use, by  large endowments  and  public funds,  of a  formula                                                               
approach to determine  the method and size of  payouts from these                                                               
funds.   This  approach is  generally referred  to as  percent of                                                               
market  value payouts  or  POMV.   The  purpose  of placing  this                                                               
formula in  the state  constitution is  to protect  the long-term                                                               
real value of the fund  and to provide consistent and predictable                                                               
distributions for the  long term.  After  considerable review and                                                               
discussion the  board recommended in  February 2001, to  the last                                                               
legislature, a  constitutional change in  the form of SJR  13 and                                                               
15.   He explained that  both measures received hearings  but did                                                               
not come to the floor for a vote.   As in the prior proposal, the                                                               
language  in HJR  26 provides  a spending  limit on  what can  be                                                               
currently spent  or in legislative  parlance, appropriated.   The                                                               
existing constitutional language  establishing the permanent fund                                                               
only prohibits the  appropriation of principal.   In other words,                                                               
anything  but  the principal  is  income  and  can be  spent,  he                                                               
stated.   Since the first  board of  trustees, 23 years  ago, the                                                               
permanent  fund  has calculated  the  principal  as a  notational                                                               
number.    It  simply  equals the  sum  of  the  constitutionally                                                               
mandated  25  percent of  mineral  revenues  and non-mandated  or                                                               
voluntary deposits the legislature has  chosen to make.  He noted                                                               
that  the legislature  has made  appropriations to  two-thirds of                                                               
what is now calculated as principal.                                                                                            
                                                                                                                                
MR. GRUENING explained that the  principal does not vary with the                                                               
market.     Under  the  present  statutory   provision  inflation                                                               
proofing  is only  on the  principal, unlike  HJR 26  which would                                                               
provide inflation  proofing of the  entire fund.  He  stated that                                                               
one  of the  most important  reasons to  support the  proposal is                                                               
that  it  would maximize  distributions  over  the long  term  by                                                               
establishing a percent of market  value limit, and also eliminate                                                               
the  distinction between  principal  and income.   This  proposal                                                               
would  avoid  the  situation  where   market  volatility  on  the                                                               
downside prevents  any distribution  from the permanent  fund for                                                               
any  purpose, whether  it is  dividends  or anything  else.   Mr.                                                               
Gruening told the members that  this is significant because since                                                               
1982, as the members are  well aware, Alaska's fiscal picture has                                                               
changed dramatically.  The Alaska  permanent fund can be expected                                                               
to produce  more future  revenue than  any other  Alaska resource                                                               
including  oil,   natural  gas,  fishing,  tourism,   mining,  or                                                               
anything else,  he said.   Whatever future decisions are  made by                                                               
the  legislature or  the voters  regarding the  use of  permanent                                                               
fund earnings,  the 5 percent  payout of market value  limit will                                                               
assure complete and  protected inflation-proofing while providing                                                               
predictable and sustainable distributions over the long term.                                                                   
                                                                                                                                
Number 3640                                                                                                                     
                                                                                                                                
MR. GRUENING used  the analogy of managing  fisheries stocks when                                                               
the only sensible choice is to  avoid taking too much of the fish                                                               
stock so  that over the long  term the harvest is  maximized.  Of                                                               
course, he said,  over harvesting can reap  short-term rewards of                                                               
more fish and more money, but  the inevitable result, at best, is                                                               
fewer fish,  less money,  and at  worst, permanent  impairment or                                                               
destruction of  the fisheries stock.   He  said the same  is true                                                               
for  managing distributions  from a  large investment  fund, like                                                               
the Alaska  permanent fund.   If Alaska is  going to have  a fund                                                               
that is truly  permanent, it is important to take  those steps to                                                               
ensure permanence.   This means investing  for future generations                                                               
as well as  current generations.  This will  require a commitment                                                               
to basic principles  of long-term investment.   He explained that                                                               
the critical flip  side of a sound  long-term investment strategy                                                               
is  a sound,  sustainable, and  predictable distribution  plan; a                                                               
plan that  will sustain and  provide benefits to  each generation                                                               
of Alaskans.                                                                                                                    
                                                                                                                                
MR. GRUENING commented  that he believes everyone  wants to avoid                                                               
defaulting  to  the  position  where  the  Constitutional  Budget                                                               
Reserve (CBR) is today.  Within  the next three to four years the                                                               
CBR is destined for extinction,  he predicted.  As the investment                                                               
horizon of  the CBR  steadily shortens, it  will be  necessary to                                                               
keep  the investments  in very  short term,  and less  profitable                                                               
investments.    As the  day  the  CBR's  demise grows  near,  the                                                               
trustees  and staff  will have  to also  consider a  shorter-term                                                               
investment  horizon  for  a  significant  portion  of  the  fund.                                                               
However, one thing  is clear and that is that  the permanent fund                                                               
can continue  to import  significant sums  of money  into Alaska,                                                               
year after year  after year.  If properly  invested and protected                                                               
the   permanent  fund   will   successfully  convert   nonrenewal                                                               
petroleum  wealth into  Alaska for  a  permanent and  substantial                                                               
stream of  revenue for generations  after the last barrel  of oil                                                               
has been pumped.  Mr.  Gruening said that legislative passage and                                                               
voter approval  of HJR 26 would  protect the ability of  the fund                                                               
to be managed for the long  term and would continue to pour money                                                               
into the Alaskan economy over the long term.                                                                                    
                                                                                                                                
Number 3941                                                                                                                     
                                                                                                                                
MR.  GRUENING concluded  his testimony  by telling  the committee                                                               
that the  proposed constitutional change  in HJR 26 is  much more                                                               
compatible  with  the   funds  diversified  long-term  investment                                                               
strategy with  a 5 percent  real rate of  return over time.   The                                                               
present constitutional  language was  designed over 25  years ago                                                               
for a fund that was 100  percent invested in bonds.  Mr. Gruening                                                               
said  he believes  that succeeding  generations of  Alaskans will                                                               
view this amendment  with the same degree of  appreciation as the                                                               
original one  approved 27 years  ago.  The trustees  believe that                                                               
this  proposal  for  complete  and  protected  inflation-proofing                                                               
makes  ultimate good  sense  for the  Alaska  permanent fund  and                                                               
Alaska's future.                                                                                                                
                                                                                                                                
Number 4025                                                                                                                     
                                                                                                                                
ROBERT   STORER,  Executive   Director,  Alaska   Permanent  Fund                                                               
Corporation,  testified  in  support   of  HJR  26  and  answered                                                               
question by the members.  He  told the members there are five key                                                               
issues that he  believes are very important  in this legislation.                                                               
The first  issue of HJR 26  is a new method  of memorializing and                                                               
inflation-proofing the  fund in the  constitution.   He explained                                                               
that at  the moment  inflation-proofing is in  statute and  it is                                                               
done after the dividend [distribution].   It is important to note                                                               
that  in  the past  the  legislature  has  always had  the  money                                                               
available  to inflation  proof  the  fund.   Mr.  Storer said  he                                                               
believes  it is  important  to ensure  that  all generations  are                                                               
treated equally  and that the  purchasing power of  the permanent                                                               
fund is maintained over time.                                                                                                   
                                                                                                                                
MR. STORER explained that HJR  26 includes a spending limit which                                                               
means that  no more than 5  percent of the moving  average of the                                                               
fund  [can be  appropriated].   There has  been discussion  about                                                               
spending  limits  and  making more  money  available  during  the                                                               
"bear"  markets.    However,  he  said he  believes  it  is  very                                                               
important to  create discipline  during the  bull markets.   What                                                               
has  occurred is  that endowments  and foundations  have incurred                                                               
spending  patterns that  they could  not meet  because they  were                                                               
extrapolating a  bull market and  higher payouts.   He emphasized                                                               
that this resolution would create  a spending limit on the upside                                                               
so  that it  ensures there  will be  continuity over  time during                                                               
both bear  and bull markets.   This change would  provide greater                                                               
stability  during   volatile  markets;  since  all   markets  are                                                               
volatile  all the  time, it  is a  question of  magnitude.   This                                                               
payout  methodology creates  greater stability  than the  current                                                               
methodology that is in statutes.                                                                                                
                                                                                                                                
Number 4318                                                                                                                     
                                                                                                                                
MR.  STORER  said, for  example,  if  the  members were  to  look                                                               
forward  [from now]  to FY  06,  the rate  of change  on what  is                                                               
available for  distribution, would  be an  increase in  the first                                                               
year [2004] of 35 percent,  the following year [2005] 16 percent,                                                               
and  the next  year [2006]  18 percent.   The  POMV would  be 2.5                                                               
percent  growth   to  4  percent  greater   predictability.    He                                                               
explained  that if  the members  looked at  the bull  market that                                                               
ended in March  of 2000, the dividend payout was  [based on] what                                                               
was   available   for   the    dividends   which   were   growing                                                               
substantially;  however, now  what  is available  is dropping  in                                                               
equal magnitude.   He pointed  out that the [dividend]  went from                                                               
$1,963  to $1,541.    If markets  hold, there  will  be a  $1,000                                                               
distribution  this  year.    The  change  would  provide  greater                                                               
stability and predictability.                                                                                                   
                                                                                                                                
Number 4435                                                                                                                     
                                                                                                                                
MR. STORER reaffirmed Mr. Gruening's  comments that the 5 percent                                                               
payout is consistent with long-term  objectives.  He said that in                                                               
examining  the history  and projected  future assets,  allocation                                                               
and statutory  limitations will allow  the Alaska  permanent fund                                                               
to achieve  a 5 percent real  rate of return, which  is 5 percent                                                               
in excess  of inflation over  time.  As  was noted, 26  years ago                                                               
the Alaska permanent  fund was established and it was  a world of                                                               
fixed  income  securities,  lower  volatility,  and  higher  cash                                                               
payouts,  and that  is  what  the current  methodology  is.   Mr.                                                               
Storer said  that the statutes  served the fund well  during that                                                               
period,  but investment  management has  changed and  he believes                                                               
that these changes [proposed in HJR  26] would move the fund to a                                                               
more consistent approach.                                                                                                       
                                                                                                                                
MR. STORER said his final point  is that the changes will provide                                                               
predictability  of  annual appropriations  under  the  POMV.   He                                                               
pointed out  that under the status  quo it is not  known if there                                                               
will  be funds  available for  appropriation in  any given  year.                                                               
Mr.  Storer commented  that  the  fund uses  a  5 percent  moving                                                               
average of  realized income.   At the end  of May, the  fund will                                                               
have four years and 11 months  left, and beyond that he would not                                                               
be able  to say because of  the magnitude of volatility  that has                                                               
been experienced.  He cautioned that  there still is a 10 percent                                                               
chance that there will be no  dividend.  It really depends on how                                                               
the  markets behave  over time.    Mr. Storer  offered to  answer                                                               
questions from the members.                                                                                                     
                                                                                                                                
Number 4642                                                                                                                     
                                                                                                                                
ROBERT  BARTHOLOMEW, Chief  Operating  Officer, Alaska  Permanent                                                               
Fund Corporation,  testified in  support of  HJR 26  and answered                                                               
questions from the committee.                                                                                                   
                                                                                                                                
TAPE 03-10, SIDE B                                                                                                            
                                                                                                                                
MR. BARTHOLOMEW told the members he  would like to go through the                                                               
financial schedules  and then review the  resolution to highlight                                                               
suggested  changes  to the  constitution.    The first  schedule,                                                               
titled  "HJR 26  Financial projection  [comparison of  the Alaska                                                               
permanent fund],"  is on  page 4  of the handout.   He  asked the                                                               
members to  look at  FY 03  column and go  down to  the "Dividend                                                               
(lump  sum) -  Status Quo,"  which  is the  distribution or  what                                                               
would  be paid  out for  the  dividend in  FY 03,  which is  $686                                                               
million.  He explained that  [the corporation] will not know with                                                               
even one day left  of the fiscal year if there  will be any money                                                               
for the  payout of the permanent  fund dividend.  If  the markets                                                               
go  well,  there  will  be  a payout  of  $686  million  for  the                                                               
dividend; if there is  a bad market for a week at  the end of the                                                               
fiscal year,  given the way the  rules work, the payout  could be                                                               
zero.                                                                                                                           
                                                                                                                                
MR. BARTHOLOMEW noted that whether there  is an effort to build a                                                               
budget  or  an  economy  that  has  dividends,  or  whatever  the                                                               
legislature chooses to do with  the distribution of the permanent                                                               
fund,  there is  a  significant risk.    With the  constitutional                                                               
amendment, he  said, there is an  assured payout every year.   He                                                               
said that  it is important to  note that under the  "status quo,"                                                               
all numbers that  are shown being paid out of  the permanent fund                                                               
each year are the dividends,  then funds are transferred from the                                                               
earnings  reserve  [account]  to   the  principal  for  inflation                                                               
proofing.     It  is  assumed   that  there  will  be   no  other                                                               
distribution because that is the  way the permanent fund has been                                                               
used for  the past 10-15  years.  Mr. Bartholomew  commented that                                                               
whether  that  is  the  way  it  would  work  in  the  future  is                                                               
speculative.                                                                                                                    
                                                                                                                                
Number 4301                                                                                                                     
                                                                                                                                
MR. BARTHOLOMEW  asked the members to  look at the lower  part of                                                               
the schedule  on the POMV where  it shows the market  value after                                                               
payout.  This schedule assumes that  the whole 5 percent would be                                                               
distributed from  the permanent fund,  and the market  value over                                                               
time will  be much  smaller, he  said.  If  under POMV,  only the                                                               
dividend was paid  out which has happened over  time, the numbers                                                               
would be exactly  the same.  This schedule  shows the differences                                                               
if the  permanent fund were  to be  used for another  purpose, it                                                               
will change what is available.                                                                                                  
                                                                                                                                
MR.  BARTHOLOMEW pointed  out that  under Status  Quo, lines  2-4                                                               
give a picture of the earnings  reserve [account] as it is set up                                                               
today.  He asked  the members to note that if  they look out over                                                               
time the  earnings reserve [account]  grows if there is  only the                                                               
payout of the  dividend, which happened in FY 02.   The permanent                                                               
fund  earnings  reserve  [account]  had $6.5  billion,  which  is                                                               
available  for appropriation  by the  legislature.   The trustees                                                               
cannot manage for  a large distribution if they do  not know what                                                               
the legislature  will do with  it.   With the 5  percent spending                                                               
limit the trustees  know that the most that will  come out in any                                                               
one  year  is 5  percent.    The  [fund  managers] will  be  more                                                               
comfortable with  that asset allocation of  long-term investments                                                               
because there  would not be a  risk of large sums  of money, that                                                               
may be sitting in long-term  investments, such as stocks that are                                                               
in a down market.   If the plan is to take a  lot of money out of                                                               
the permanent fund,  it is important not to be  invested in long-                                                               
term  investments.   Mr. Bartholomew  summarized his  comments by                                                               
saying that the schedule is designed  to give the members an idea                                                               
of  what  the numbers  look  like  and  what the  permanent  fund                                                               
produces in income each year and what will be available.                                                                        
                                                                                                                                
Number 4118                                                                                                                     
                                                                                                                                
MR.   BARTHOLOMEW   directed   attention  to   page   5,   titled                                                               
"Calculation  of  annual  effective  rates of  5%  POMV  spending                                                               
limit."   This schedule points  out that  a 5 percent  payout, as                                                               
stated by the  executive director, is an  aggressive payout rate.                                                               
It  is  at  the  high  end  of  what  statutory  limitations  for                                                               
investments would allow  the permanent fund to  return over time.                                                               
He noted  that the [trustees]  are comfortable using a  5 percent                                                               
payout.   There are two issues  in this schedule that  reduce the                                                               
effective  rate or  what is  really  being paid  out.   Normally,                                                               
capital markets grow  every year.  For example,  today the Alaska                                                               
permanent fund  has $23 billion.   If it grows for  the next five                                                               
years, then  there will be an  average that may vary  from $23 to                                                               
$26  billion.   The average  of those  five years  will be  $24.5                                                               
billion.  The fund will take  5 percent of that five year average                                                               
and that is what is available [for payouts].                                                                                    
                                                                                                                                
Number 3939                                                                                                                     
                                                                                                                                
MR. BARTHOLOMEW  went on to  say that for  example, in FY  08 the                                                               
fund is  [projected to  be] $26 billion,  what is  actually being                                                               
paid out of the total market value  of the fund that year is less                                                               
than  5 percent.   The  first  blue line  across the  spreadsheet                                                               
shows that  the actual  effective rate is  closer to  4.7 percent                                                               
which is  a built  in cushion  to ensure that  the fund  does not                                                               
overspend the  sustainable yield  from the  permanent fund.   The                                                               
second half of that schedule points  out the rate of payout after                                                               
deducting the  costs for the  Alaska permanent fund.   Currently,                                                               
when  calculating income  or what  is available  for distribution                                                               
that  is determined  after  paying the  operating  budget of  the                                                               
Alaska  Permanent Fund  Corporation.   Right  now the  [operating                                                               
budget]  is  roughly $35-$40  million  per  year.   The  way  the                                                               
constitutional amendment  [HJR 26] is written  the permanent fund                                                               
[Corporation's]  operating  budget  would  come  out  of  that  5                                                               
percent limit, he told members.   So this further reduces what is                                                               
being  paid  out  after  covering  the  costs  of  investing  and                                                               
managing the funds.   So again, this would mean  there would be a                                                               
4.5  percent   effective  payout  rate.     This  [constitutional                                                               
amendment] would  ensure that there  is a bigger cushion  and the                                                               
risk of overspending is diminished.                                                                                             
                                                                                                                                
CO-CHAIR  HAWKER told  Mr. Bartholomew  that  he appreciates  the                                                               
succinctness and clarity of the first schedule.                                                                                 
                                                                                                                                
CO-CHAIR  HAWKER  commented that  he  received  30 e-mails  today                                                               
expressing the view  that the only purpose of  the permanent fund                                                               
is to  pay dividends to  individual Alaskans.   He asked  how the                                                               
permanent fund Board responds to those folks.                                                                                   
                                                                                                                                
Number 3656                                                                                                                     
                                                                                                                                
MR. GRUENING  responded that this  board, like prior  boards, has                                                               
avoided  getting involved  in recommending  what the  legislature                                                               
should do  with income from the  fund.  However, as  a legislator                                                               
who helped  craft the original  language, and who was  there when                                                               
it was  approved by the  legislature and  the voters, he  said, a                                                               
majority of the members did not  see this fund as strictly a fund                                                               
to pay  dividends.   At that time,  then-Governor Hammond  had an                                                               
idea of what  to do with dividends, but it  was really envisioned                                                               
as  a   way  to   conserve  this   one-time  wealth   for  future                                                               
generations.  How  those benefits would flow  were not determined                                                               
by us, but many could foresee  that when the oil wealth was gone,                                                               
this could help replace some of  that [revenue] and serve to help                                                               
support services to  which the public had become  accustomed.  He                                                               
emphasized that  his comments  are made  not as  a trustee  or on                                                               
behalf of the  permanent fund Board, but as a  legislator who was                                                               
there in  the beginning.   Mr. Gruening  added that the  fund was                                                               
all things  to all  people.  A  lot of people  saw it  doing many                                                               
things.  The two major thoughts  were to conserve wealth and help                                                               
provide for some of the load when oil revenue was not there.                                                                    
                                                                                                                                
Number 3450                                                                                                                     
                                                                                                                                
CO-CHAIR HAWKER stated for the  record that his intention was not                                                               
to ask Mr.  Gruening to take a  position for the board.   He said                                                               
he  appreciates hearing  Mr. Gruening's  institutional experience                                                               
and  understands that  his  comments are  based  on his  personal                                                               
experience and  not as a trustee  of the board.   Co-Chair Hawker                                                               
noted that the board has not  taken a position on the disposition                                                               
of  the  funds.    He  asked Mr.  Gruening  if  he  believed  the                                                               
disposition of  the funds  is the  providence of  the legislature                                                               
rather than the  providence of the permanent fund Board  if it is                                                               
not established in any constitutional dictate.                                                                                  
                                                                                                                                
MR. GRUENING responded that is correct.                                                                                         
                                                                                                                                
Number 3416                                                                                                                     
                                                                                                                                
MR. BARTHOLOMEW  pointed out  that the statutes  that are  on the                                                               
books today have  been there since 1982.  These  statutes set out                                                               
the formula which directs that  the annual appropriation from the                                                               
permanent  fund  be based  on  the  realized income,  which  then                                                               
directs  50  percent  of  that  income to  be  allocated  to  the                                                               
dividends.   The  second step  that is  required is  to inflation                                                               
proof  the fund  out of  what  is available  [after the  dividend                                                               
distribution].   He told the members  that for the last  20 years                                                               
the  permanent  fund  has  only   allocated  50  percent  of  the                                                               
available  annual  distribution  to  the  dividend  program  even                                                               
though there have  been residual funds after  paying the dividend                                                               
and  inflation-proofing the  fund.    Mr. Bartholomew  reiterated                                                               
that there has been money available for other uses.                                                                             
                                                                                                                                
MR. BARTHOLOMEW  explained that the  history that the  fund could                                                               
be available for other uses goes  back to when the fund was small                                                               
and people  were not use  to the  dividend.  Those  statutes have                                                               
not changed.   The  expression of the  legislature 20  years ago,                                                               
however,  was  to  not  make  the  whole  amount  available  [for                                                               
distribution].                                                                                                                  
                                                                                                                                
Number 3251                                                                                                                     
                                                                                                                                
CO-CHAIR  HAWKER  said  he  would   like  to  follow  up  on  the                                                               
spreadsheet [titled  HJR 26 - Financial  projection comparison of                                                               
the Alaska  permanent fund on page  4].  He commented  that there                                                               
is a trend.  In looking all the  way out to the projected FY 2013                                                               
numbers,  which  is  a  10-year  consequence  of  what  is  being                                                               
considered,  the  schedule  is   predicated  on  a  total  return                                                               
estimate of 7.6  percent to the future.  He  acknowledged that it                                                               
is a premise that is subject  to debate; however he said he would                                                               
use these  figures for  the purposes of  discussion.   Lines 2-4,                                                               
which  are  the earnings  reserve  accumulations  in this  model,                                                               
shows an accumulation of $6.9  billion in the earnings reserve on                                                               
a  market   value  basis.     Co-Chair  Hawker  noted   that  Mr.                                                               
Bartholomew said  that the  fund currently  pays out  one-half of                                                               
the  earnings of  the fund  in dividends  and the  other half  is                                                               
being internalized  into the fund.   He  asked if the  other one-                                                               
half that  is being internalized corresponds  to the accumulation                                                               
of the earnings reserve.                                                                                                        
                                                                                                                                
Number 3128                                                                                                                     
                                                                                                                                
MR.  BARTHOLOMEW   replied  that  it  does   [correspond  to  the                                                               
accumulation of the earnings reserve].   What this model projects                                                               
is what the fund will earn.   It is the [projected] median return                                                               
that the fund's consultants have  said the capital markets should                                                               
produce over the long term.   He pointed out that the 7.6 percent                                                               
is the  total return;  the current  assumption for  inflation for                                                               
the next  five years is  2.6 percent; and the  difference between                                                               
those  two [figures]  is 5  percent.   If the  fund is  earning 5                                                               
percent and  only paying out  the dividends, around 2  percent of                                                               
the  fund would  be  needed for  the dividend  for  the next  few                                                               
years.   Mr. Bartholomew explained  that what is  accumulating in                                                               
the earnings  reserve is the  excess earnings that have  not been                                                               
spent, and are  believed to be available on  a sustainable basis.                                                               
What has happened in the past  10-15 years is that there has been                                                               
more saved for future generations  than has been spent on current                                                               
years.  He  told the members that the 5  percent [spending limit]                                                               
is research  and analysis' best  estimate regarding the  best way                                                               
to balance the  fund between current and future [needs].   As the                                                               
earnings reserve  grows it  means more money  is being  saved for                                                               
the future and  less money is being spent from  what is available                                                               
currently.                                                                                                                      
                                                                                                                                
Number 2955                                                                                                                     
                                                                                                                                
CO-CHAIR HAWKER clarified  that the $6.9 billion in  FY 13 [Total                                                               
earnings reserve  - end of  year (after payouts)]  represents the                                                               
continued  discipline of  savings  and spending  only for  either                                                               
dividends  or inflation-proofing,  not  spending  for any  public                                                               
purpose that portion  of projected earnings that is  not used for                                                               
either dividends or inflation proofing.                                                                                         
                                                                                                                                
MR. BARTHOLOMEW responded that is correct.                                                                                      
                                                                                                                                
CO-CHAIR HAWKER  noted that FY  13 [line  1 under the  heading of                                                               
POMV -  5% (beginning in  FY 05)] the  Total Market Value  End of                                                               
Year (after  payouts) is  $31.7 [billion],  and the  Total Market                                                               
Value in  FY 13  under the  current Status  Quo heading  is $38.8                                                               
[billion].  He asked if the  difference of $7 [billion more under                                                               
the Status  Quo option]  is a result  of the  accumulated savings                                                               
discipline  of   not  having  used   those  earnings   that  were                                                               
reinternatized into the fund.                                                                                                   
                                                                                                                                
MR. BARTHOLOMEW responded that it is exactly right.                                                                             
                                                                                                                                
CO-CHAIR HAWKER  reemphasized Mr. Bartholomew's point  that it is                                                               
the  legislature's prerogative  to  use the  full  5 percent  for                                                               
public purposes in whatever manner is appropriate.                                                                              
                                                                                                                                
MR.  BARTHOLOMEW replied  that  they chose  a  scenario to  model                                                               
which would  show the  full effect  of the 5  percent.   He noted                                                               
that he believed that was the  most that could be taken [from the                                                               
fund].                                                                                                                          
                                                                                                                                
Number 2743                                                                                                                     
                                                                                                                                
CO-CHAIR HAWKER asked if using  the 5 percent POMV payout option,                                                               
with the  continued current statutory concept  regarding how much                                                               
is paid  in individual dividends,  which is 50 percent  of payout                                                               
right off the top, would mean  the payout will be one-half of the                                                               
$1.235 billion  in FY 05,  which is the POMV payout available for                                                               
appropriation in lump sum.                                                                                                      
                                                                                                                                
MR. BARTHOLOMEW responded that there  is a difference between the                                                               
two methods.  If using the  second method, which is the payout of                                                               
the POMV  method, and there  would be  a continuation of  the 20-                                                               
year history  of making  one-half of  what is  annually available                                                               
allocated  to  the dividend,  then  that  line which  says  [POMV                                                               
Payout] available  for appropriation in  lump sum would  be split                                                               
50-50 and that is how much money would be allocated.                                                                            
                                                                                                                                
Number 2617                                                                                                                     
                                                                                                                                
CO-CHAIR HAWKER  compared the  status quo  or the  current payout                                                               
structure   with  the   POMV  methodology.      Under  the   POMV                                                               
methodology, he  said, approximately one-half of  $1.2 billion is                                                               
roughly $600  million, which would  be $200 million  greater than                                                               
the  current projected  dividend  under the  status  quo of  $400                                                               
million.  He  noted that these results are in  the trailing years                                                               
of a declining  market, with 5-year averaging  the dividends will                                                               
continue to drop  precipitously.  Co-Chair Hawker  compared FY 06                                                               
and FY 07,  noting that FY 07  is at a breakeven point.   What is                                                               
prudent in managing future revenue  streams in a period of rising                                                               
markets, he asked.                                                                                                              
                                                                                                                                
Number 2427                                                                                                                     
                                                                                                                                
MR.  BARTHOLOMEW explained  that what  has happened  is that  the                                                               
dividend got up  to almost $2,000.  If the  formula remains as it                                                               
is today that  will drop down to  $700 or $800 in a  year or two.                                                               
That is a huge fluctuation that  hits the economy or wherever the                                                               
legislature chooses  to use  the earnings.   He told  the members                                                               
that  [the  corporation]  would recommend  changing  that  payout                                                               
method so the dividend does not go  so high in the good years and                                                               
not drop down drastically in the down years.                                                                                    
                                                                                                                                
CO-CHAIR HAWKER commented that is  the fundamental premise of the                                                               
POMV method which enforces savings  in periods of rising and good                                                               
markets and keeps the legislature's  hands off of those earnings,                                                               
but makes  an element  of those  earnings available  in declining                                                               
years.                                                                                                                          
                                                                                                                                
Number 2326                                                                                                                     
                                                                                                                                
REPRESENTATIVE WILSON observed that  what has been currently done                                                               
in paying  out 50 percent  in dividends  and saving the  other 50                                                               
percent  for future  generations,  has resulted  in  the loss  of                                                               
those funds.                                                                                                                    
                                                                                                                                
Number 2244                                                                                                                     
                                                                                                                                
MR. BARTHOLOMEW  responded that  what has  happened is  that part                                                               
[of the  funds] have been  paid out  in dividends, and  part have                                                               
been transferred from  the earnings reserve to  the principal for                                                               
inflation-proofing the  fund.   Part was lost  in the  decline in                                                               
the stock markets.   He said that  it is true to  say that [some]                                                               
of  the funds  have  been lost,  but that  is  also reflected  in                                                               
capital markets.   The  funds were  there in 2000  and if  a guru                                                               
could  predict the  markets, the  funds could  have been  removed                                                               
from the  permanent fund, but the  investment professionals would                                                               
caution  against  thinking cherry  picking  at  the top  [of  the                                                               
market] can be done and then  re-enter the market when it is low.                                                               
The  markets go  up  and  down, and  therefore  he recommended  a                                                               
distribution method  that stays  in the middle  and does  not run                                                               
up.                                                                                                                             
                                                                                                                                
MR.  STORER commented  that  one-third of  the  principal of  the                                                               
permanent fund  is special appropriations.   So prior legislators                                                               
have  invoked  a discipline,  by  virtue  of taking  that  larger                                                               
earnings reserve  and moving  it into the  principal, so  all the                                                               
funds have not been dissipated away.                                                                                            
                                                                                                                                
Number 2109                                                                                                                     
                                                                                                                                
REPRESENTATIVE WILSON  said that when comparing  the two options,                                                               
it appears  to her that the  POMV at the 5  percent option, which                                                               
the  permanent  fund  Board  is  suggesting,  really  gives  more                                                               
security  and predictability  for the  future of  the fund.   She                                                               
noted that it also allows  the legislature to appropriate some of                                                               
the  other  50  percent  and  still ensure  that  the  fund  will                                                               
continue to grow.                                                                                                               
                                                                                                                                
MR. STORER agreed with Representative  Wilson.  He commented that                                                               
this  option  would  create discipline  and  predictability  that                                                               
allows informed decisions to be made.                                                                                           
                                                                                                                                
Number 2012                                                                                                                     
                                                                                                                                
REPRESENTATIVE   HEINZE  asked   Mr.   Gruening   to  address   a                                                               
hypothetical question.  Assuming there  is a year where the funds                                                               
in the  capital markets are low  and the inflation rate  is high,                                                               
under this  [constitutional] amendment does the  legislature have                                                               
the  flexibility  to  add  more into  [the  fund]  for  inflation                                                               
proofing.                                                                                                                       
                                                                                                                                
Number 1929                                                                                                                     
                                                                                                                                
MR.  GRUENING  commented that  he  will  address the  legislative                                                               
portion of  the question  and Mr. Storer  will answer  the market                                                               
situation Representative  Heinze envisions.  He  told the members                                                               
that the  legislature always has  the power of  appropriation and                                                               
could decide to  appropriate more money to the fund.   Nothing in                                                               
HJR 26 would prevent that.                                                                                                      
                                                                                                                                
MR. STORER reiterated  that the [resolution] would  implement a 5                                                               
percent spending limit.   The legislature is not  required to use                                                               
all  5  percent,   and  can  use  less   if  deemed  appropriate.                                                               
Historically,  inflation has  been about  3.1 percent  so it  not                                                               
only  invokes  a   discipline  on  the  payout,   but  invokes  a                                                               
discipline on what [is required  for] inflation [-proofing].  The                                                               
current inflation rate is about  2 percent.  The permanent fund's                                                               
consultants  think inflation  over the  next five  years will  be                                                               
about 2.6  percent.  He  commented that they recognize  that some                                                               
years  inflation will  be higher  than the  3 [percent]  and some                                                               
years lower.   He emphasized that  they expect to earn  5 percent                                                               
real income in excess of inflation.                                                                                             
                                                                                                                                
Number 1800                                                                                                                     
                                                                                                                                
REPRESENTATIVE  HEINZE   asked  if  there  is   another  national                                                               
endowment that calculates its payouts  the way the permanent fund                                                               
does.                                                                                                                           
                                                                                                                                
MR. STORER  responded that  the permanent fund  did a  study, and                                                               
what is  being proposed  is currently  used for  approximately 70                                                               
percent  of  the endowments  and  foundations.   [Endowments  and                                                               
foundations] use the methodology of  payout of the moving average                                                               
of their funds.  He told  the members that what is being proposed                                                               
is consistent  with the  way most  endowment funds  move forward.                                                               
Mr. Storer  commented that he  is not aware  of any example  of a                                                               
fund that uses the 5 percent moving average of realized income.                                                                 
                                                                                                                                
Number 1704                                                                                                                     
                                                                                                                                
CO-CHAIR HAWKER  said that  over the years  there have  been many                                                               
references  in reports  and documents  by the  permanent fund  on                                                               
research done with respect to  other large endowments and managed                                                               
funds.  He  asked if there is  a report or summary  study on that                                                               
work which would be available to the public.                                                                                    
                                                                                                                                
MR.  STORER replied  that  some  of that  information  is in  the                                                               
trustees'  paper,  but  there  are also  two  surveys,  one  from                                                               
Greenwich Associates  and one  from NACUBO  [National Association                                                               
of  College  and University  Business  Officers].   He  told  the                                                               
members  that  they  would  be  glad to  provide  copies  of  the                                                               
studies.                                                                                                                        
                                                                                                                                
CO-CHAIR  HAWKER  replied  that  he  would  appreciate  receiving                                                               
copies of  these studies.   He turned to the  trustees' document,                                                               
volume 7,  which is  about a  year old  now, and  addresses prior                                                               
proposals  and  legislation.    He  asked  if  the  premises  and                                                               
presentation in that document are  still fairly applicable to the                                                               
current situation.                                                                                                              
                                                                                                                                
MR.  STORER  said   that  he  still  believes   the  document  is                                                               
applicable with  the exception of one  thought.  At the  time the                                                               
document was  created the earnings  reserve was so large  that no                                                               
one thought  that it was  necessary to change the  distinction of                                                               
principle.   However, now the  corporation believes it is  not in                                                               
the best  interest of  the long-term management  of the  fund for                                                               
predictability, et cetera.                                                                                                      
                                                                                                                                
Number 1516                                                                                                                     
                                                                                                                                
REPRESENTATIVE SAMUELS asked  Mr. Storer if he said  that none of                                                               
the other large endowments use a rolling average.                                                                               
                                                                                                                                
MR. STORER  responded that about  70 percent of  large endowments                                                               
and foundations use  a rolling average.  Some use  five years and                                                               
others use  seven years.   However, [these rolling  averages] are                                                               
not of realized gains.                                                                                                          
                                                                                                                                
REPRESENTATIVE SAMUELS asked  if our current formula,  which is a                                                               
five-year average  of cash flow  income, is used by  any existing                                                               
funds or endowments.                                                                                                            
                                                                                                                                
MR. BARTHOLOMEW said no.                                                                                                        
                                                                                                                                
Number 1441                                                                                                                     
                                                                                                                                
REPRESENTATIVE SAMUELS  asked how the 5  percent [spending limit]                                                               
compared with  other endowments:   large, middle of the  road, or                                                               
conservative.                                                                                                                   
                                                                                                                                
MR.  STORER  responded  that  the [5  percent]  figure  would  be                                                               
considered the  middle of road.   He said they found  4.5 percent                                                               
to 5.5 percent  for the more aggressive funds  which are invested                                                               
in more volatile assets, publicly  traded stocks, private equity,                                                               
market  venture  capital  will  tend to  have  a  higher  payout.                                                               
Furthermore,  this is  consistent with  our long-term  objectives                                                               
regarding how the fund is managed.                                                                                              
                                                                                                                                
Number 1347                                                                                                                     
                                                                                                                                
CO-CHAIR HAWKER  recalled Mr.  Storer's earlier  observation that                                                               
no one  does it quite like  the permanent fund.   Co-Chair Hawker                                                               
asked if  he was  referring to the  measurement only  on realized                                                               
market  gains  and  losses  rather   than  a  full  market  value                                                               
calculation which includes unrealized gains and losses.                                                                         
                                                                                                                                
MR. STORER responded that is correct.                                                                                           
                                                                                                                                
Number 1250                                                                                                                     
                                                                                                                                
MR. BARTHOLOMEW, upon the  committee's agreement, began reviewing                                                               
HJR  26.   He  truned attention  to  Section 1,  page  1, of  the                                                               
resolution  and specified  that the  bold print  is what  will be                                                               
inserted into  constitution.  This [language]  gives reference to                                                               
the spending limit  that is established in Section 2.   The first                                                               
addition is  just to add into  the text that how  the legislature                                                               
uses the money will  be addressed in Section 2.   On line 10, the                                                               
word  "principal"   is  removed   from  the  constitution.     He                                                               
reiterated  the   executive  director's  statement  that   it  is                                                               
believed that the  permanent fund will be protected  and that the                                                               
corpus  and principal  of the  permanent fund  will be  protected                                                               
through a  spending limit versus  the limitation of  principal in                                                               
the constitution.   Lines 12-13 remove language that  has been in                                                               
the  constitution since  1976, when  the  original amendment  was                                                               
passed.   [The original amendment]  stated that all  earnings and                                                               
all  earnings  and  income  from  the  permanent  fund  would  be                                                               
deposited  into the  general fund  unless  otherwise directed  by                                                               
law.   That  language is  deleted with  the intent  that all  the                                                               
income of  the permanent fund  will remain in the  permanent fund                                                               
subject to  Section 2.   In other words,  the income will  now be                                                               
part of the permanent fund.                                                                                                     
                                                                                                                                
Number 1056                                                                                                                     
                                                                                                                                
MR. BARTHOLOMEW responded to Co-Chair  Hawker's comment that this                                                               
section  does  take  the  income   away  from  the  appropriation                                                               
[process].   On  page 2,  Section 2,  the first  [two lines]  add                                                               
language to explain  that the objective of the  spending limit is                                                               
to make sure  only the real income is appropriated.   That is the                                                               
income  that is  earned  in  addition to  inflation.   The  [next                                                               
lines,  lines  4-6]  set  the   actual  spending  limit  and  the                                                               
protection  of  the permanent  fund  through  the limit  to  real                                                               
income of 5 percent of the 5-year average.                                                                                      
                                                                                                                                
MR. BARTHOLOMEW pointed  out that the legislature  is now working                                                               
on  the FY  04 budget  with a  month to  go with  the legislative                                                               
session, and  there is no  idea what  will be available  from the                                                               
permanent fund.   This language, says the permanent  fund will go                                                               
back  one extra  year, so  in  essence the  five-year average  is                                                               
going to be  for the fiscal year  that is already over.   So when                                                               
the legislature comes  to town in January, there will  not be any                                                               
speculation  with regard  to what  is available.   The  permanent                                                               
fund  will have  computed  all the  numbers,  done the  five-year                                                               
average, and  will say X number  of dollars will be  available if                                                               
necessary.                                                                                                                      
                                                                                                                                
Number 0913                                                                                                                     
                                                                                                                                
MR.  BARTHOLOMEW  explained  that  in Section  3  there  is  some                                                               
transitional language.  There was  some concern when the proposal                                                               
was brought forward for a  constitutional amendment two years ago                                                               
that the current  earnings reserve was not part  of the permanent                                                               
fund  and  there could  be  an  argument  to leave  the  earnings                                                               
reserve  in the  general  fund.   The  Senate  State Affairs  and                                                               
Senate  Judiciary  Committees,  and  the  Legislative  Legal  and                                                               
Research Services director felt  that by adding this transitional                                                               
language  it would  clarify that  the earnings  of the  permanent                                                               
fund that are accumulated at the  time the resolution is voted on                                                               
by the  people would  be part  of permanent  fund.   He commented                                                               
that the  Board of Trustees  supports the idea that  the earnings                                                               
reserve would be a part of  the permanent fund.  Section 4, talks                                                               
about the  fact that  this would go  to a vote  of the  people in                                                               
November 2004, he said.                                                                                                         
                                                                                                                                
Number 0805                                                                                                                     
                                                                                                                                
CO-CHAIR HAWKER  asked if  the model  includes any  provision for                                                               
new  principal  investment  from   on-going  oil  and  gas  state                                                               
resource revenues  or is  this a  status quo  model based  on the                                                               
existing investment.                                                                                                            
                                                                                                                                
MR.  STORER  replied  that  the  model  does  anticipates  future                                                               
contributions for mineral leasing.                                                                                              
                                                                                                                                
MR. BARTHOLOMEW explained that the  model is based on the current                                                               
Department  of Revenue  forecast.   It is  not based  on any  new                                                               
fields that  are not  in production  today.  It  is based  on the                                                               
known and expected production from the existing oil fields.                                                                     
                                                                                                                                
CO-CHAIR HAWKER clarified that it is  not based on any new fields                                                               
that could be brought  on line.  Is it also  based on the current                                                               
statute which  has the calendar  division between old  fields and                                                               
new fields for the 25-50 [split,  which refers to a change in the                                                               
amount  of  money the  State  of  Alaska  receives from  new  oil                                                               
leases].                                                                                                                        
                                                                                                                                
Number 0704                                                                                                                     
                                                                                                                                
REPRESENTATIVE WILSON  commented that she really  appreciates the                                                               
provision  in Section  2  (b), lines  4-5,  which eliminates  the                                                               
guess work and provides the legislature with solid numbers.                                                                     
                                                                                                                                
REPRESENTATIVE HEINZE asked what the rate of change means.                                                                      
                                                                                                                                
Number 0618                                                                                                                     
                                                                                                                                
MR. STORER  responded that when  he mentioned the rate  of change                                                               
he was talking  about distribution.  It is  the percentage change                                                               
from  one year  to  another.   For  example,  two  years ago  the                                                               
dividend was  $1,963; last year it  was $1,541, and that  rate of                                                               
change is about a 25 percent drop.                                                                                              
                                                                                                                                
CO-CHAIR HAWKER announced that is  the end of testimony today and                                                               
that there will be more hearings on HJR 26.                                                                                     
                                                                                                                                
[HJR 26 was held over.]                                                                                                         

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