Legislature(2015 - 2016)HOUSE FINANCE 519
04/05/2016 01:30 PM House FINANCE
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| Audio | Topic |
|---|---|
| Start | |
| HB224 || HB245 || HB303 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | HB 224 | TELECONFERENCED | |
| += | HB 245 | TELECONFERENCED | |
| += | HB 303 | TELECONFERENCED | |
| + | TELECONFERENCED |
HOUSE FINANCE COMMITTEE
April 5, 2016
1:32 p.m.
1:32:44 PM
CALL TO ORDER
Co-Chair Thompson called the House Finance Committee
meeting to order at 1:32 p.m.
MEMBERS PRESENT
Representative Mark Neuman, Co-Chair
Representative Steve Thompson, Co-Chair
Representative Dan Saddler, Vice-Chair
Representative Bryce Edgmon
Representative Les Gara
Representative Lynn Gattis
Representative David Guttenberg
Representative Scott Kawasaki
Representative Cathy Munoz
Representative Lance Pruitt
Representative Tammie Wilson
MEMBERS ABSENT
None
ALSO PRESENT
Randall Hoffbeck, Commissioner, Department of Revenue;
Martin Baily, Economist, McKinsey and Company; Senior
Fellow, Brookings Institution; Craig Richards, Attorney
General, Department of Law; Representative Mike Chenault;
Representative Charisse Millett; Representative Craig
Johnson.
SUMMARY
HB 224 PERM FUND: INCOME; DISTRIBUTION; PFD;
HB 224 was HEARD and HELD in committee for
further consideration.
HB 245 PERM. FUND:DEPOSITS;DIVIDEND;EARNINGS
HB 245 was HEARD and HELD in committee for
further consideration.
HB 303 PERM FUND: EARNINGS, DEPOSITS, ACCOUNTS
HB 303 was HEARD and HELD in committee for
further consideration.
Co-Chair Thompson discussed the meeting agenda. He relayed
that the committee would focus on HB 245.
HOUSE BILL NO. 224
"An Act relating to the governor's submission of a
projection of anticipated revenue and expenditures and
proposal for enactment of an individual broad-based
tax; relating to income of the Alaska permanent fund;
relating to the disposition of income of the Alaska
permanent fund; relating to the calculation of
permanent fund dividends; relating to the dividend
fund; and providing for an effective date."
HOUSE BILL NO. 245
"An Act relating to the Alaska permanent fund;
relating to appropriations to the dividend fund;
relating to income of the Alaska permanent fund;
relating to the earnings reserve account; relating to
the Alaska permanent fund dividend; making conforming
amendments; and providing for an effective date."
HOUSE BILL NO. 303
"An Act relating to the Alaska Permanent Fund
Corporation, the earnings of the Alaska permanent
fund, and the earnings reserve account; relating to
the mental health trust fund; relating to deposits
into the dividend fund; and providing for an effective
date."
1:33:50 PM
RANDALL HOFFBECK, COMMISSIONER, DEPARTMENT OF REVENUE,
remarked that as the department put together its permanent
fund bill it had landed on a robust and sustainable
package. He relayed that the department had submitted a
request for proposal to advise on the use of the Permanent
Fund earnings reserve. McKinsey and Company, Inc. had been
awarded with the bid. He introduced the presenter.
1:37:09 PM
MARTIN BAILY, ECONOMIST, MCKINSEY AND COMPANY; SENIOR
FELLOW, BROOKINGS INSTITUTION, provided a PowerPoint
presentation titled "Ensuring a Sound Fiscal Future" dated
April 5, 2016 (copy on file). He turned to slide 1:
The Alaska Department of Revenue has sought an
objective assessment of the financial model it built
to evaluate an annual draw from the Earnings Reserve
of the Permanent Fund, as outlined in the Alaska
Permanent Fund Protection Act. The fact-based
assessment of the financial model included in this
document was conducted by McKinsey and Company, Inc.
with support from expert Martin Baily.
Mr. Bailey discussed slide 2, "Context for this effort":
The APFPA proposal would re-route oil revenues to the
APFC to help stabilize State spending
The Alaska Permanent Fund Protection Act (APFPA)
calls for directing a steady annual amount to the
General Fund to mitigate the impact of oil price
volatility on year-to-year budgeting.
Specifically, the proposal recommends that:
50 percent of oil royalty revenues and 100
percent of production tax revenues flow to
the Alaska Permanent Fund Corporation (APFC)
for investment
A fixed annual draw of $3.3B (adjusted for
inflation beginning in 2020) from the APFC
to the General Fund to fund State
expenditures; the amount would be
methodically revisited every 4 years to
ensure continued Fund sustainability
Dividend payments be paid out of the
remaining 50 percent of oil royalties
The APFPA seeks to improve budget stability
Given a rising budget deficit and declining oil
production revenues, the APFPA seeks to:
Protect and grow the State's sovereign
wealth to maximize long-term returns,
acknowledging the rising importance of
investment income in funding its budget
Delink public spending from volatile
commodity prices and stabilize the budget by
establishing a disciplined, formulaic
approach to drawing from the State's wealth
State modeling proposes that a $3.3B draw should be
sustainable
The Department of Revenue (DOR) has undertaken an
extensive exercise to assess in a financial model
what amount of annual draw will be sustainable
(i.e., what draw amount can the State expect with
greater than 50 percent confidence to maintain
the starting asset's real value over time without
depleting the Earnings Reserve)
Given the Earnings Reserve's current size and the
$3B proposed transfer from the Constitutional
Budget Reserve, the State can plan with 100
percent confidence to draw $3.3B annually for at
least 4 years (at which point the draw amount
will be reviewed)
The cumulative confidence level of being able to
draw $3.3B annually falls to 95 percent over 10
years and to 69 percent through 2040. Revisiting
the draw on a 4-year cadence will lend additional
confidence (e.g., this safeguard has not been
factored in to modeling)
The State sought an independent review of this model's
rigor
The State sought an independent evaluation of (i)
the soundness of the model's methodology and (ii)
critical assumptions underlying the model (most
notably those related to expected oil revenues
and investment returns)
Mr. Baily addressed slide 3, "Overview of conclusions":
The DOR model is sound in its methodology
The model tests whether a $3.3B annual draw will be
sustainable
Carlo simulations, to estimate confidence levels for
(i) future oil prices and (ii) investment returns, as
well as deterministic analysis to establish a base
case scenario for oil production
proach taken is reasonable and the model's
logic is generally robust in testing the likely impact
of a $3.3B draw, based on a review of the model's
structure, logic, conceptual soundness, and process
for future updates
The assumptions that underlie the model are reasonable
Key assumptions on future crude oil selling
price, oil production, and investment returns (total
and statutory) were obtained from credible, objective
sources
These assumptions are all within the range of
reasonableness Assumptions on oil production and price
are reasonable and, taken together, somewhat more
conservative than most
Investment returns assumptions are reasonable,
though were considered optimistic for the near-term by
some members of the APFC investment staff and were
higher than those projected by APFC's strategic
partners (third-party asset managers)
Certain institutional investor best practices could
help improve this plan's long-term sustainability
The State of Alaska could further strengthen the
long-term viability of the APFC and the sustainability
of its contributions to the General Fund by leveraging
best practice learnings from other SWFs and investors,
e.g.: Clear savings-and-spending rules and capital
planning
Regular communication between investor and
sponsor
Formal and informal investment education
opportunities for government officials and board
members
Board governance processes with appropriate
composition, appointment expertise and roles
Well-designed strategy tied to Fund obligations
and long-term investing
1:42:21 PM
Mr. Baily spoke to slide 5, "The scope of this assessment":
Overview
The Department of Revenue is seeking an objective
assessment of its financial model which analyzes a
$3.3B fixed annual draw from the Earnings Reserve of
the Permanent Fund to finance General Fund spending
In scope:
Detailed review and vetting of the DOR financial
model's methodology and construction, including
appropriateness of use of Monte Carlo analysis
Assessment of the reasonableness of key baseline
assumptions (oil price, oil production,
investment returns) affecting the sustainable
draw
Perspective on best practices of other SWFs which
inform consideration of the proposed model
Not in scope:
Holistic evaluation of the proposed budget or
budget deficit
Perspectives relating to current or future tax
regimes (e.g., Petroleum Value model)
Assessment of the Permanent Fund's mandate or its
investment management processes
Macroeconomic study of future market fundamentals
Recommendations for alternative funding models
Mr. Baily relayed that the study had looked at how
sovereign wealth funds were managed and what the best
practices were. He shared that it was not the task of the
study to recommend what the policy should be. He wanted to
be careful to make it clear the study focused on the
validity of the model and whether it did what it was
supposed to do. He moved to slide 6 and discussed other
countries and how they had addressed the issue.
1:46:31 PM
Mr. Baily turned to slide 6, "SWFs benefit from
establishing a clear set of disciplined saving and spending
rules to invest for the long-term":
Establishes a clear set of disciplined saving and
spending rules as well as a predefined capital plan
Singapore's SWF, GIC, has developed a proprietary
internal model projecting 20-year sub-asset class
level returns
Government of Singapore is allowed to spend 50
percent of the annualized 20-year expected
returns giving Government flexibility on a year-
by-year basis on how much to draw, but capping
outflows at a low enough level to grow the corpus
The National Fund of Kazakhstan had previously
suffered from discretionary draws from the
corpus. Under 2010 reforms annual draw is fixed
at $8 billion for use both to reduce budget
deficits and for economic development. Government
can adjust the annual draw by 15 percent (as it
did in 2013)
If the balance of the National Fund falls below
20 percent of Kazakh GDP in a given fiscal year
the Government must reduce the annual draw until
the balance has returned to 20 percent of GDP
Norway has a bipartisan balanced budget consensus
which limits government non-oil deficits to 4
percentage points. This prevents the government
from drawing down the corpus of Norway's
Government Pension Fund Global unless Norges Bank
Investment Management beats the long-run expected
investment returns of 4 percent
Temporary increases in withdrawals are allowed under
only limited circumstances, but requires a specific
parliamentary resolution
Mr. Baily discussed slide 7, "The DOR model was built to
establish and test the sustainability of a fixed annual
draw from the Earnings Reserve":
What are the major inflows into the Fund?
Production tax revenues
Royalty revenues
Investment returns
What are the most important drivers of future inflows?
Oil production
Oil price
Investment returns (total statutory)
What is the projected spendable output based on cash
flow projections?
Sustainable draw amount must ensure:
less than 50 percent confidence that real
value of starting assets is preserved over
time
Earnings Reserve durability (confidence that
the annual draw can be taken from ER)
1:50:36 PM
Mr. Baily looked at slide 8, "The DOR conducted advanced
probabilistic ("Monte Carlo") modeling to better understand
the Fund's ability to sustain the draw." which showed three
graphs for a high-level description of the DOR modeling
process":
Step 1
Understand the critical revenue drivers of the
model - in terms of restricted and unrestricted
revenue sources
Step 2
Build a probabilistic model of expected oil price
and investment returns fluctuations
Step 3
Understand impact on revenue flows into the Fund and
Earnings Reserve available for the annual draw
Mr. Baily spoke to slide 9, "Over 4 weeks, a detailed
review of the most critical elements of the DOR's modeling
methodology and assumptions was conducted":
SWF Model
Assumptions and Methodology
The existing DOR sovereign wealth fund model
was reviewed along 2 dimensions: methodology
and assumptions
Oil revenues (oil price and
production); Investment returns (total
and statutory net income); Structure of
model; Logic and conceptual soundness;
Process
Key elements of the model were
prioritized and pressure-tested
using industry experts, third-
party projections and proprietary
modelling assessment framework
1:57:34 PM
Mr. Baily displayed slide 11, "The DOR model implies a 69
percent cumulative confidence that a $3.3B annual draw can
be made from the Earnings Reserve each year through 2040":
Earnings Reserve acts as a buffer to short-term
investment return and oil revenue volatility
$10B starting balance means near 100 percent
confidence of being able to draw $3.3B per year for
first four years even with negative investment returns
APFC has only had negative total investment returns
four times in the past 30 years
Effects of cumulative volatility and declining oil
production reduce confidence over time - but even in
2040 cumulative confidence that a $3.3B annual draw
can be made from Earnings Reserve is 69 percent
(confidence would be even higher if adjusted for
periodic review)
Mr. Baily discussed slide 12, "The DOR model predicts that
the Permanent Fund will be $96B in 2040 with an
interquartile range of $34B and $196B":
Permanent Fund balance will grow or shrink in any
given year because of volatility in investment returns
and oil revenues
DOR goal is to maintain the real value of starting
assets by seeing the median balance grow with
inflation of 2.25 percent
Modelled output meets this threshold, predicting
median balances rising to ~$96B in 2040 (nominal
value)
Given expected volatility, 2040 ending balance is
predicted to be between $34B and $196B with a 50
percent confidence level (the threshold set by DOR)
Mr. Baily moved to slide 14, "Review of the DOR model
indicates that the assumptions and methodology underlying
Fund projections are sound":
Conclusions from the review
· The DOR modeling assumptions and methodology are
reasonable
o Key assumptions on future oil price, oil
production, and investment returns (total
and statutory) were obtained from objective
sources and are within the range of
reasonableness
o The methodological approach taken, including
use of Monte Carlo simulations, is
reasonable, and the model logic is generally
robust in testing the likely impact of a
$3.3B draw
Future iterations of the model could benefit from
the following changes: Build functionality to
account for second-order relationships (e.g.,
year-on-year correlation between variables1 and
the impact on production of reaching certain
breakeven prices for crude2)
Establish consistent process and ownership for model
construction and sources
Assumptions may be periodically revisited based on
changes to Fund strategy and investment management, or
changes to the tax regime affecting Fund inflows
2:03:01 PM
Mr. Baily discussed slide 15, "The review considered the
modeling methodology and assumptions behind critical
drivers of inflows to the Fund":
Crude selling price
Explanation of DOR approach
DOR has employed a Monte Carlo analysis
using ERG crude oil price projections to
determine the likelihood of price evolution
in the future based on a survey of expert
forecasts
How approach was assessed
Comparison of projections with multiple
third-party objective sources (e.g.,
Woodmac, Rystad)
Production volume
Explanation of DOR approach
DOR has employed a deterministic analysis
using ERG oil production projections - this
approach takes a fairly conservative
approach (e.g., approach reflects the
uncertainty of future production projects)
How approach was assessed
Comparison of projections with multiple
third-party sources
Total return rate and Statutory net income rate
Explanation of DOR approach
DOR has relied on Monte Carlo analysis based
on projections from Callan Associates (the
third-party financial consultant that the
Permanent Fund has used for 20+ years) to
estimate the likelihood of future Fund
performance based on current Fund strategy
How approach was assessed
Comparison of projections with historic
performance and third-party projections
Interviews with Permanent Fund investors to understand
view of projections and potential for change to future
fund performance
Mr. Baily displayed slide 16, "Two types of analysis are
used in the DOR model: "probabilistic" and "deterministic"
analysis":
Deterministic
Explanation
Describes the outcome of some scenario given
appropriate inputs (in this case, based on the
average or median value and the degree to which
that value varies over time)
When is it best used
When projections are based on an assumed trend
given variance from that trend within certain
standard deviation (e.g., use of a conservative
baseline case for oil production)
Probabilistic "Monte Carlo"
Explanation
Monte Carlo analysis is a modeling technique that
runs multiple trials and gives a distribution of
potential outcomes. Running a Monte Carlo model
creates a probability distribution that indicates
the likelihood that an outcome will occur
When is it best used
When attempting to project highly volatile and
less predictable drivers where the impact of
"randomness" is important to understanding risk
(e.g., oil price, investment returns)
2:08:51 PM
Mr. Baily moved to slide 17, "Model methodology is robust,
with some potential opportunities for future improvement":
Structure
Check for errors
Explanation:
No major mechanical errors found
Potential steps to improve model:
None
Dependencies on other models
Explanation:
Petroleum Model model sub-optimally
structured
Oil production projections are not linked to
price projections
Potential steps to improve model:
Consider full audit of Petroleum Model
(particularly in light of tax / royalty
regime)
Wire model to account for price/production
relationship in future model iterations
Single use of source
Explanation:
Sources consistently used with exception of
some oil price inputs (e.g., median used in
Petroleum Model vs. probabilistic price used
in SWF model)
Potential steps to improve model:
Validate Petroleum Model for consistency in
oil pricing (e.g., using probabilistic model
vs. median)
Logic and conceptual soundness
Calculation of inputs
Explanation:
Underlying data sources are objective (e.g.,
Callan)
Does not account for impact of unrealized
returns on Earnings Reserve balance)
Potential steps to improve model:
Consider impact unrealized returns that are
apportioned to Earnings Reserve on the funds
available for spend
Deterministic vs. probabilistic
Explanation:
Current use of Monte Carlo methods is
defensible given behavior of oil price and
investment returns
Potential steps to improve model:
None
Probabilistic methodology
Explanation:
Pert distribution of oil price (i.e., 3
points) is sufficient but highly sensitive
to accuracy of underlying inputs to the
distribution (P10, P50, P90)
Does not account for year-on-year
correlations in oil prices (e.g., "gamblers
dilemma")
Potential steps to improve model:
Consider exploring more sophisticated
probabilistic methodology (e.g., revisit
accuracy of Delphi-style method used in PERT
distribution)
Account for year-on-year correlations in
probabilistic analysis
Process
Repeatable and consistent process
Explanation:
Informal construction process (partly driven
by ongoing iterative policy process)
Governance procedures to ensure systematic
auditing/updating not yet developed
Potential steps to improve model:
For future sustainable draw re-visitations,
create set of rules / guidelines for
timeline / triggers of update and develop
design principles to guide construction
Ownership
Explanation:
Unclear future ownership (partly driven by
unclear end use of model)
Potential steps to improve model:
For future sustainable draw re-visitations, articulate
clear owner(s) with auditing / updating rights
2:13:30 PM
Mr. Baily turned to slide 18, "Each of the modeling
methodology used by the DOR model to project critical fund
inflow drivers is technically sound":
Crude selling price
Description of DOR model methodology:
Use of probabilistic analysis (PERT distribution)
based on P10=$31/bbl, P50=$56/bbl, P90=$87/bbl
Rationale for methodology:
Probabilistic analysis accounts for volatility
Distribution method leverages preexisting DOR/ERG
crude oil price projections
Production volume
Description of DOR model methodology:
Use of deterministic analysis based on
conservative base case (e.g., assuming no new
project-driven increase in production)
Rationale for methodology:
Not much volatility in the projections and hence
no need for probabilistic analysis
Total return rate
Description of DOR model methodology:
Use of probabilistic analysis (normal
distribution) based on 6.9 percent mean rate of
return and 13.9 percent standard deviation
Rationale for methodology:
Objective and transparent methodology
Distribution method based on mean reversion
methodology used by Callan
Statutory net income rate
Description of DOR model methodology:
Use of probabilistic analysis (PERT distribution)
based on based on P10=3.7 percent, P50=6.01
percent, P90=8.14 percent
Rationale for methodology:
Probabilistic analysis accounts for volatility
Distribution based on data available from Callan
statutory model (P10/50/90 distribution)
Mr. Baily spoke to slide 19, "Based on the recommendations
that came out of the model review, a series of actions were
executed":
Improvement identified:
Build Earnings Reserve sufficiency test into the
master model (versus using separate models to
test Fund balance and ER sufficiency)
Adapt fully objective, repeatable source for
investment returns (versus prior use of blended
projected and historic returns rates)
Update standard deviation of returns assumption
to match Fund returns projections
Use most technically correct formulas and @Risk
functions (e.g., calculation for geometric mean,
@Risk and risk target function cross check)
Changes made to model
Expanded model to include ER sufficiency analysis
Changed source from a 50 percent historic/50 percent
projected return to a 10 year deterministic projection
from 3rd party (Callan)
Changed standard deviation from use of Power Cost
Equalization Fund deviation to deviation matched to
returns source (Callan)
Executed tactical improvements (e.g., updated the
formula to calculate geometric mean, revised at risk
function to calculate cumulative confidence)
Mr. Baily discussed slide 20, "Assumptions appear generally
reasonable; returns projections are perhaps aggressive in
the near term":
Crude oil price
Assumption
10th percentile @ $31/bbl
Median @ $56/bbl
90th percentile @ $87/bbl
Source
Annual expert conference held by DOR/ERG1
Explanation
Roughly in-line with third-party estimates,
albeit conservative
Objective use of DOR/ERG projections
Crude production
Assumption
Declining from 500k bbl/day in 2017 to 112k
in 2040
Source
Survey of O and G companies (with likelihood
adjustments)
Explanation
In line with or below third-party estimates
in short term; below 3rd parties in long-
term due to AK LNG exclusion
Objective use of DOR/ERG projections
Total returns
Assumption
Mean 6.9 percent
Standard deviation 13.9 percent
Source
Callan deterministic model (Dec 2015)
Explanation
In line with other available projections
(e.g., 6.4 percent historic returns, 7.45
percent alternative probabilistic
projection)
Statutory net returns
Assumption
10th percentile at 3.7 percent
Median @ 6.01 percent
90th percentile @ 8.14 percent
Source
Callan probabilistic model (Dec 2015)
Explanation
Only viable estimate available (e.g., no other multi-
year projections available)
Mr. Baily turned to slide 21, "Future iterations of the
model could account more rigorously for future trends and
second-order relationships":
Future shifts in fund target or mandate
Description
SWF proposal requires Permanent Fund to
manage toward fixed stream of liabilities
(i.e. like a pension fund)
Likely to entails shift in strategy and
potentially returns projections
Observations on impact
Investment earnings are single largest
driver of success of SWF (vs. O and G taxes
and royalties)
Even small percentage changes in earnings
therefore imply significant changes to fund
value and sustainability
Future shifts in fund allocation strategies
Description
Permanent Fund will likely change investment
strategies in due course
SWF proposal considers possibility of
bringing more investment in-house
Observations on impact
Changes in investment strategy for a given
asset class will alter risk/return
distributions
Investing in-house will reduce fees
Liquidity constrains
Description
Clearer liability stream will allow for more
appropriate level of liquidity
Liability driven investing may introduce
greater leverage to portfolio
Observations on impact
Reduced levels of liquidity and/or higher
leverage may exacerbate risk on extremes of
market return distribution
New tax proposals
Description
Current proposal would amend the tax credit
system and directly impact O and G revenues
going to the State
Observations on impact
O and G revenues are a relatively small
percent of revenue in SWF model
Short-term impact, however, could be
significant to ensure stability of fund
2:18:24 PM
Co-Chair Neuman stated that there was currently $6.2
billion in the earnings reserve. He wondered if all of the
modeling assumed a $3 billion transfer from the CBR to
equal $10 billion.
Mr. Baily replied in the affirmative.
Co-Chair Neuman asked what would occur without the
transfer.
Mr. Baily answered that the model could be run with
different numbers. He stressed that the current model was
run with $10 billion. He shared that a $7 billion model
would exhaust the probability for the earnings reserve. He
stressed that the 100 percent may be shortened by
approximately one year. The draw must also be reduced in
order to make the model sustainable in the long-term. He
reiterated that adjustments could be made every four years.
Co-Chair Neuman noted that the model assumed there was $10
billion in the earnings reserve. He asked whether the model
was based solely on the $10 billion in the earnings reserve
at 6.9 percent to spend off $3.3 billion per year.
Mr. Baily replied in the affirmative.
Co-Chair Neuman asked wondered whether the model included
the baseline of the Permanent Fund itself.
Mr. Baily replied that it was his understanding.
Co-Chair Neuman noted that the volatility in the Permanent
Fund Dividend was approximately $50 billion, and wondered
how that was considered in the Monte Carlo assessments on
the payback of the $3.3 billion assessment.
Mr. Baily replied and deferred to Commissioner Hoffbeck for
further detail.
Commissioner Hoffbeck explained that there was some
additional modeling required without the $3.3 billion draw.
He stated the draw would be reduced by approximately $150
million per year without the $3.3 billion. There would be a
plateau approximately one or two years earlier off the 100
percent confidence. He stated that the total uncertainty in
2040 was between two and four percent different than what
would occur with the $3.3 billion. He stated that the
Permanent Fund Corporation published a report that
indicated that their ten year forecast had reduced from 6.9
to 5.8 percent. He stated that Department of Revenue (DOR)
had requested additional information from Callan to
understand the basis of that reduction. He stated that the
forecast was published at the end of January, at the time
when the markets had dropped dramatically. He stated that
there was a factor of seven months of low returns into the
ten year forecast, so it reduced their ten year forecast
based on the one year of low revenue. He remarked that the
other nine years were still at the 6.9 percent, and
furthered that the last five months of their analysis used
their long term return rate. He shared that it was only a
recognition of the period from FY 16 to FY 25, the lower
rate of return was seen on the investments. He stressed
that since the reports publication, the markets had
recovered. He stressed that the current value of the fund
was approximately $53 billion.
2:25:02 PM
Co-Chair Neuman asked if $3.3 billion could be "spun off" -
theoretically, to understand that the Permanent Fund would
"spin off" that revenue to replenish the earnings reserve.
Commissioner Hoffbeck answered that it was a combination of
the permanent fund and oil and gas revenues could equal
$3.3 billion per year.
Co-Chair Neuman asked if the oil and gas returns were
calculated on the governor's new assumptions.
Commissioner Hoffbeck answered that it had used the
probabilistic model, which had a range of prices.
Representative Gara spoke to oil prices projected at the
$40 range. He asked how it did not impact the amount coming
out of the new sovereign wealth fund.
Commissioner Hoffbeck replied that there were two separate
processes. He shared that, within the sovereign wealth
modeling, there was the probabilistic model - examining a
range of prices throughout the life of the model. He stated
that there was a deterministic number in the Revenue
Sources Book, with a set data point each year.
Representative Gara stated that if the prices in the 10-
year forecast - he surmised that it would impact the payoff
from the fund somewhat dramatically.
Commissioner Hoffbeck answered that it would be accurate
under the probabilistic model; best guess of what they
thought, which was why to use the probabilistic model.
Mr. Baily replied that it showed the advantage of using the
probabilistic model. Oil prices fluctuated and would
continue to do so. It was not desirable to make changes to
the program every six months.
Representative Gara queried the payout using the price
forecast from the spring Revenue Sources Book. He recalled
that, after the guaranteed dividend, the PFD would be in
the $500 range. He queried the PFD by year three, assuming
the oil price forecast in the spring.
Commissioner Hoffbeck replied that the dividend would be in
the $450 to $500 range.
Representative Wilson asked looked at page two, and
wondered whether the budget should be reduced in order to
be covered.
Mr. Baily replied that the analysis was not trying to
recommend a specific budget.
Representative Wilson queried the spending cap in the
model.
Mr. Baily replied that the model did not include a spending
cap. He explained that the model was designed to determine
what was required to ensure a stable amount.
Representative Wilson observed that the state already had
the system in the Permanent Fund. She remarked that a
policy could be made to access the funds, with the same
result.
Commissioner Hoffbeck replied that, by comingling the oil
and gas revenue with the earnings reserve, there was an
allowance to draw more than the deposit in years of low
revenue.
Representative Wilson asked for verification that under the
model they would not spend anything from the corpus of the
fund.
2:35:28 PM
Vice-Chair Saddler believed that the state could withdraw
without any restructuring of the Permanent Fund. He
stressed that the legislature could make the calculations
and make appropriations under current law.
Commissioner Hoffbeck replied that the calculation could
occur without the legislation. He explained that the bill
would provide a rules based ongoing process.
Vice-Chair Saddler noted that under one of the assumptions
the production decline was a steady rate. He did not
believe that the pipeline reduction was accurate, and
wondered whether the assumption considered the technical
challenges of a small amount of oil in the pipeline.
Mr. Baily replied that it was his understanding that there
were technical difficulties if the flow fell below a
certain level. He remarked that he was not an engineer, and
would not want to challenge the assertions.
Vice-Chair Saddler felt that necessary additional
investments to maintain oil flow would change the net cash
revenue, and therefore change some of the model's
assumptions about oil income. He remarked that the fund's
current returns, assumed the current investment guidelines
for long-term capital growth. He noted that slide 21 said
that the sovereign wealth proposal would shift to more
pension-like strategy for investment, which meant more
fixed investments that assumed less risk and therefore less
return. He wondered if that clouded the model's
conclusions.
Mr. Baily replied that the basis was that if there was a
more stable funding process, the corporation could actually
manage the investment funds that were more systematic if
the plan went into effect. He relayed that the study had
not done an analysis on the investment policy.
2:40:00 PM
Vice-Chair Saddler expressed caution about setting a
specific amount to draw, which may affect the investment
strategy. He remarked that the Permanent Fund Board of
Directors was fairly independent when determining an
investment strategy. He stressed that changing the
permanent fund may influence the investment strategy. He
queried models of other consumer price index inflation
rates.
Mr. Baily replied that he did not model different inflation
rates. He shared that most in Washington D.C. worried that
inflation was too low, and could not reach 2 percent. He
stated that the Federal Reserve target was 2 percent. He
felt that 2.25 percent was higher than the target. He did
not believe that the Federal Reserve would inflate the
dollar.
Vice-Chair Saddler recalled that inflation could reach 2.5
percent.
Mr. Baily agreed.
Representative Munoz queried the impact on the model, if
the same calculation was used with the 50 percent draw. She
also queried the impact of changing the calculation from 21
percent average to a 10 percent average, but tied to the
earning power of the corpus.
CRAIG RICHARDS, ATTORNEY GENERAL, DEPARTMENT OF LAW,
replied that the impact of the sustainable draw would go
from paying out approximately $700 million to approximately
$1.4 billion per year; which would impact the sustainable
draw by about $400 million per year. He pointed out that
maintaining an earnings based dividend was undesirable
policy, when there was also earnings reserve revenues for
the general fund. He explained that a dividend calculated
on earnings was highly variable. He remarked that every
time the dividend "jumps up" the share to the government
was reduced.
2:45:12 PM
Representative Munoz clarified that there would be a 4400
million reduction in the current calculation.
Attorney General Richards agreed to follow up with the
exact number.
Representative Munoz noted that the model assumed a $3.3
billion draw, and a continued tax revenue from existing
taxes of approximately $850 million.
Attorney General Richards stated she was incorrect. He
explained that the model assumed that, over time, the
revenues would be highly variable.
Commissioner Hoffbeck furthered that there was
approximately $850 million of other taxes available for
government spending. He stated that the money was not put
into the earnings reserve, because it was not volatile.
Representative Munoz wondered whether $4.285 billion was
the total with existing revenue under the new model.
Commissioner Hoffbeck responded in the affirmative.
2:47:50 PM
Representative Guttenberg looked at slide 5. He felt that
there were some things left out of the scope. He wondered
if there was alternative modeling to proof the assumptions.
Mr. Baily replied that he had looked at only one model.
Representative Guttenberg wondered if there was an attempt
to see if the model would not happen.
Mr. Baily responded affirmatively. He shared that creating
this type of model resulted in various outcomes.
Representative Guttenberg commented that his concern was
that although the state had done some modeling on taxes,
but never believed that the current economic situation
would occur.
Representative Edgmon supported the concept going forward.
He commented that it seemed that the state was shifting the
onus onto the Permanent Fund.
Mr. Baily did not believe it was the way the model was set
up and did not believe it was undermining the Permanent
Fund.
Attorney General Richards.
2:55:00 PM
Mr. Baily believed that the intent of setting up the fund
was to create a sovereign wealth fund that would allow the
benefits from the oil to be there in perpetuity.
Vice-Chair Saddler remarked on Mr. Baily's job for the
analysis.
Mr. Baily answered that it was necessary to revisit the
plan every three years.
Vice-Chair Saddler remarked on the state's flexibility.
3:01:04 PM
Representative Wilson asserted that the model showed a high
amount of oil money, but was put into the earnings reserve.
She stressed that the model required a lower dividend to
work. She remarked that the model did not show the lower
dividend amount impact to the state. She stressed that the
model did not solve the budget problem. She hoped that the
model would have shown the overall impact to the state as a
whole.
Commissioner Hoffbeck remarked that there were other
aspects that generated the $3.3 billion. He stated that,
under the model, the dividend was a "pass through."
Representative Wilson stated that she did not understand
what was different. She remarked that largest factor was
the lower dividend.
Commissioner Hoffbeck answered that three things had
changed: the size of the dividend, what revenues brought
in, and how much would be spent.
Attorney General Richards added that it was true in the
long-term, but not in the short term.
3:05:43 PM
Representative Wilson believed that the bill lowered the
dividend substantially, with the hopes that the cuts would
made with no guarantee. She announced that she did not
support POMV.
Representative Gara noted that the Legislative Finance
Division (LFD) model showed that, under POMV, savings would
extend for a decade, with a period review of oil prices. He
remarked that the PFD projections were high: $1800 to
$2000. He remarked that maintaining the current formula for
the PFD resulted in $1.2 billion into the dividend for an
$1800 dividend. He surmised that the proposal was for a
dividend based on oil revenue. He stressed that the
forecasts showed that it would result in a PFD of
approximately $500. He remarked that there was a
presentation that asserted that there would be 900 jobs
lost for every $100 million lost in the dividend. He
queried more information about that assertion.
3:13:37 PM
Representative Gara noted that there was not a 4.5 percent
draw from the fund, based on the expectation of future oil
revenues. He remarked that the price and revenue forecasts
did not yield the same result. He wondered if the forecast
numbers were used in the mode.
Commissioner Hoffbeck replied the deterministic numbers
were not used in the model.
Vice-Chair Saddler wondered whether it should be considered
a lump sum.
Commissioner Hoffbeck replied in the affirmative.
Attorney General Richards furthered that $3.3 billion may
not be considered alone in the governor's plan. He stated
that the plan worked as a POMV. He explained that the POMV
in the plan was 6 percent, rather than 4.5 percent, because
the 1.5 percent difference was accounting for the petroleum
revenues. He explained that there could be a fixed draw of
3.3 billion, or a POMV draw of 6 percent. He explained
that, as long as the petroleum revenues were flowing into
the fund, the math worked out the same.
Vice-Chair Saddler surmised that Attorney General Richards
was only offering a separate way to examine the plan.
Attorney General Richards answered that the letter
circulated the prior week did propose that the
administration would work with the committee to adjust the
fixed draw to a percentage draw.
Co-Chair Thompson thanked the presenters. He discussed the
schedule for the following meeting.
ADJOURNMENT
3:17:25 PM
The meeting was adjourned at 3:17 p.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| HB 245 - Ensuring a Sound Fiscal Future - McKinsey Presentation 040516 FINAL.pdf |
HFIN 4/5/2016 1:30:00 PM |
HB 245 |