Legislature(2015 - 2016)HOUSE FINANCE 519

02/15/2016 01:30 PM FINANCE

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Audio Topic
01:33:19 PM Start
01:34:08 PM HB245
03:34:32 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+= HB 245 PERM. FUND:DEPOSITS;DIVIDEND;EARNINGS TELECONFERENCED
Heard & Held
+ Bills Previously Heard/Scheduled TELECONFERENCED
                  HOUSE FINANCE COMMITTEE                                                                                       
                     February 15, 2016                                                                                          
                         1:33 p.m.                                                                                              
                                                                                                                                
                                                                                                                                
1:33:19 PM                                                                                                                    
                                                                                                                                
CALL TO ORDER                                                                                                                 
                                                                                                                                
Co-Chair Thompson called the House Finance Committee                                                                            
meeting to order at 1:33 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 Cathy Munoz                                                                                                      
Representative Lance Pruitt                                                                                                     
Representative Tammie Wilson                                                                                                    
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
Representative Scott Kawasaki                                                                                                   
                                                                                                                                
ALSO PRESENT                                                                                                                  
                                                                                                                                
Randall Hoffbeck, Commissioner, Department of Revenue;                                                                          
Craig Richards, Attorney General, Department of Law;                                                                            
Representative Cathy Munoz; Representative Mike Chenault.                                                                       
                                                                                                                                
SUMMARY                                                                                                                       
                                                                                                                                
HB 245    PERM. FUND:DEPOSITS;DIVIDEND;EARNINGS                                                                                 
                                                                                                                                
          HB 245 was HEARD and HELD in committee for                                                                            
          further consideration.                                                                                                
                                                                                                                                
Co-Chair Thompson reviewed the meeting for the day.                                                                             
                                                                                                                                
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."                                                                          
                                                                                                                                
1:34:08 PM                                                                                                                    
                                                                                                                                
RANDALL  HOFFBECK,  COMMISSIONER,   DEPARTMENT  OF  REVENUE,                                                                    
indicated he would  spend just a few  minutes recapping what                                                                    
was  covered in  the previous  meeting  up to  Slide 11.  He                                                                    
relayed  that  the  Alaska  Permanent  Fund  Protection  Act                                                                    
(APFPA)  was  one  of  three major  components  of  the  New                                                                    
Sustainable  Alaska Plan,  the  governor's plan  to reach  a                                                                    
sustainable  long-term budget  and  revenue  stream for  the                                                                    
State of  Alaska. The Alaska  Permanent Fund  Protection Act                                                                    
only dealt  with one piece having  to do with how  the state                                                                    
used its Permanent  Fund (PF) earnings. It  also contained a                                                                    
portion which restructured the dividend.                                                                                        
                                                                                                                                
Vice-Chair  Saddler asked  if there  was an  old sustainable                                                                    
Alaska   plan.  Commissioner   Hoffbeck  responded   in  the                                                                    
negative.  He continued  that the  plan sought  to do  three                                                                    
things:  to close  a  budget  gap, to  solve  the issues  of                                                                    
spending  down savings,  and to  have a  long-term plan  for                                                                    
sustaining government.                                                                                                          
                                                                                                                                
1:36:19 PM                                                                                                                    
                                                                                                                                
CRAIG  RICHARDS,   ATTORNEY  GENERAL,  DEPARTMENT   OF  LAW,                                                                    
relayed he  would be  presenting the plan  in the  bill: the                                                                    
Alaska Permanent  Fund Protections  Act. As he  reviewed the                                                                    
elements  of the  bill package  he would  be discussing  the                                                                    
reasoning behind  certain decisions that were  made relative                                                                    
to other options. He would  conclude his presentation with a                                                                    
brief sectional review of HB 245.                                                                                               
                                                                                                                                
Attorney General  Richards began with slide  12: "Overview."                                                                    
He suggested  that the APFPA  was fairly simple  when viewed                                                                    
in  relation to  how the  PF was  currently structured.  The                                                                    
plan changed three  things. First, it took  out $3.3 billion                                                                    
per year  from the  PF as  an endowment  fund and  placed it                                                                    
into the general fund (GF).  He explained that currently the                                                                    
only external money drawn from  the PF was the dividend. The                                                                    
governor's plan  added a spend  rule to the  existing rules-                                                                    
based framework  around the PF. The  second change reflected                                                                    
in the bill was that it  placed 100 percent of royalties and                                                                    
100 percent  of production taxes  directly into the  PF fund                                                                    
each year.  Currently under the constitution,  25 percent of                                                                    
all royalties  went directly into  the corpus. The  plan did                                                                    
not   propose  changing   that   provision   since  it   was                                                                    
constitutionally  mandated. He  added  that  there had  been                                                                    
some  statutory   rules  that  had   historically  deposited                                                                    
slightly  more  than  25  percent,   about  30  percent,  of                                                                    
royalties  into  the  corpus. The  plan  he  was  presenting                                                                    
placed 100  percent of royalty and  production taxes percent                                                                    
into the  PF in  order to address  volatility and  to create                                                                    
some sustainable spending options.  The third piece the bill                                                                    
changed was how the dividend  was paid. The bill changed the                                                                    
dividend  payout  rule,  the   method  by  which  the  state                                                                    
calculated  how   it  paid  the  dividend.   Currently,  the                                                                    
dividend was  based on  a five-year average  of half  of the                                                                    
earnings of  the fund. Historically, the  formula had worked                                                                    
fine.  However, the  governor was  proposing an  alternative                                                                    
formulation where  the dividend was  based on 50  percent of                                                                    
the year's royalties.                                                                                                           
                                                                                                                                
Co-Chair  Thompson  acknowledged that  Representative  Lance                                                                    
Pruitt   had    joined   the   committee    and   recognized                                                                    
Representative Cathy Tilton in the audience.                                                                                    
                                                                                                                                
Representative Guttenberg referred to  number 3 on Slide 12.                                                                    
He asked if Attorney General  Richards had done a comparison                                                                    
of  the  dividend  payout  with  the  suggested  50  percent                                                                    
royalties  paid from  the  Earnings  Reserve Account  (ERA).                                                                    
Attorney    General   Richards    clarified   whether    the                                                                    
representative  was asking  if the  Department of  Law (DOL)                                                                    
had gone  back historically  to see  what the  divided would                                                                    
have been  if the state had  based the dividend payout  on a                                                                    
50 percent royalty.                                                                                                             
                                                                                                                                
Representative  Guttenberg  responded  in  the  affirmative.                                                                    
Attorney  General Richards  had seen  such a  comparison and                                                                    
would provide it to his office through the chairman.                                                                            
                                                                                                                                
1:40:17 PM                                                                                                                    
                                                                                                                                
Attorney  General   Richards  reviewed  slide   13:  "Alaska                                                                    
Permanent Fund Protection Act":                                                                                                 
                                                                                                                                
        1. Protect the corpus                                                                                                   
        2. Protect the dividend                                                                                                 
        3. Grow the fund                                                                                                        
        4. Stabilize the budget                                                                                                 
        5. Stabilize the economy                                                                                                
                                                                                                                                
                                                                                                                                
Attorney General Richards indicated  that the slide laid out                                                                    
the  goals   developed  for  the  administration   with  the                                                                    
consideration  of adopting  an endowment  model for  the PF.                                                                    
The goals  included protecting the  corpus of the  fund, the                                                                    
constitutionally protected principle of  the fund that could                                                                    
not  be spent.  Another  aim  was to  ensure  and protect  a                                                                    
dividend. He pointed  out that without change  in the status                                                                    
quo, funding for dividend payouts  would run out by about FY                                                                    
22. One focus  of the legislation was on  continuing to grow                                                                    
the  fund  to   avoid  a  static  value  over   time  -  the                                                                    
administration  wanted to  ensure  the  fund maintained  its                                                                    
relative value for the next  generation. The bill would also                                                                    
adopt a spending rule, tapping  PF earnings in some capacity                                                                    
to help stabilize  the budget shortfall, moving  from an oil                                                                    
based  economy  to  one  that  was based  on  both  oil  and                                                                    
financial  assets   for  budgeting  purposes.   Lastly,  the                                                                    
administration hoped that, throughout the  use of all of the                                                                    
changes in  the governor's plan  including the PF,  the plan                                                                    
would help to stabilize Alaska's economy.                                                                                       
                                                                                                                                
Attorney  General Richards  quoted Governor  Jay Hammond  in                                                                    
slide 15: "The Permanent Fund."                                                                                                 
                                                                                                                                
     "I wanted to transform oil wells pumping oil for a                                                                         
     finite period into money wells pumping money for                                                                           
     infinity."                                                                                                                 
                                                                                                                                
Attorney General  Richards thought  the quote  captured what                                                                    
Governor Hammond  was thinking when the  PF was established.                                                                    
He realized  that oil was fundamentally  a depletable asset.                                                                    
Given  a  long  enough  period  of  time  with  conventional                                                                    
reservoirs, production  levels would be lower  than when the                                                                    
development  of   the  basin  first  began.   The  following                                                                    
generation  would  not have  access  to  the same  level  of                                                                    
natural resources that the prior generation enjoyed.                                                                            
                                                                                                                                
Co-Chair  Neuman  referred  back  to  item  5  on  Slide  13                                                                    
regarding stabilizing the economy.  He commented that in the                                                                    
previous year the State of  Alaska placed approximately $1.4                                                                    
billion of  cash into Alaska's  economy through the  PFD. He                                                                    
asked  if there  had been  any analysis  about the  economic                                                                    
impact of  less cash  going into Alaska's  economy. Attorney                                                                    
General Richards  deferred to  Commissioner Hoffbeck,  as he                                                                    
had worked with Dr. Gunnar Knapp on the issue.                                                                                  
                                                                                                                                
Commissioner Hoffbeck reported that  Dr. Knapp had completed                                                                    
an analysis  in a report  that was pending and  was expected                                                                    
to be  delivered in the  current day.  He had looked  at the                                                                    
impacts of  reducing the  size of  the dividend  compared to                                                                    
the other options in the plan.                                                                                                  
                                                                                                                                
Co-Chair Neuman wondered if  Commissioner Hoffbeck had asked                                                                    
Mr. Knapp to  do an analysis on the impact  of Alaskans with                                                                    
different  levels of  income losing  the dividend.  It would                                                                    
impact Alaskans  with and  income of  $20 thousand  per year                                                                    
much  differently  than  Alaskans  with an  income  of  $200                                                                    
thousand per  year. Commissioner  Hoffbeck confirmed  that a                                                                    
less detailed analysis had been  requested. It would outline                                                                    
how it would  affect people with different  levels of income                                                                    
as well as how it would affect different regions of Alaska.                                                                     
                                                                                                                                
Co-Chair Neuman looked forward  to receiving the information                                                                    
as soon as possible.                                                                                                            
                                                                                                                                
1:44:39 PM                                                                                                                    
                                                                                                                                
Representative  Wilson  asked  to  return to  page  15.  She                                                                    
agreed that the reserves  were established to potentially be                                                                    
used for  spending. However, the current  discussion was not                                                                    
only  about using  the  reserves but  also  about using  PFD                                                                    
monies. She was uncertain  Governor Hammond ever intended to                                                                    
use  the PFD  monies for  government spending.  She wondered                                                                    
where in any  of Governor Hammond's comments  he thought the                                                                    
dividends should  be changed  or were  not a  high priority.                                                                    
She saw the money that went  into the corpus as the peoples'                                                                    
money. The Permanent Fund Dividend  (PFD) was the payoff for                                                                    
Alaskans  annually. She  did not  believe the  sentiment was                                                                    
being reflected in the quote.                                                                                                   
                                                                                                                                
Attorney General Richards explained  that the quote was from                                                                    
1976 before the PF had  been designed.  The Earnings Reserve                                                                    
Account had  not been set up  at that time and  the dividend                                                                    
payout formulation  that was first adopted  (Alaska Inc. and                                                                    
ultimately rejected by  the U.S. Supreme Court)  had not yet                                                                    
been adopted. He  thought it had been a  formational time in                                                                    
terms of people's  thinking about the PF.  His personal view                                                                    
aligned  with  something  David   Rose,  one  of  the  first                                                                    
executive directors, had  told him a number  of years prior:                                                                    
one of the successes of the  PF was that not every piece was                                                                    
defined as to its  purpose. Different people could interpret                                                                    
its  utility in  different ways.  Mr. Rose  thought how  the                                                                    
dividend played  relative to what  amount it should  be, how                                                                    
it should  be calculated, and ultimately  determining a fair                                                                    
share  between supporting  government versus  direct payouts                                                                    
to the people were  things different people could rationally                                                                    
differ on.                                                                                                                      
                                                                                                                                
Representative  Wilson could  agree  somewhat with  Attorney                                                                    
General  Richards's  rationale  if the  government  had  not                                                                    
already received its share. However,  because Alaska did not                                                                    
own the subsurface rights on  most of its properties and the                                                                    
dividend  was there  to help  offset that  circumstance, she                                                                    
thought the  whole of the state  would be able to  receive a                                                                    
royalty payment. She  wanted to make sure  that when quoting                                                                    
Governor Hammond  no one should  try to make it  appear that                                                                    
the governor had ever thought  the dividend portion would go                                                                    
away.                                                                                                                           
                                                                                                                                
Attorney General  Richards understood her point.  He did not                                                                    
mean to suggest that Governor  Hammond or any other governor                                                                    
had rigidly  defined what share  belonged to the  people and                                                                    
what share was properly usable for governmental services.                                                                       
                                                                                                                                
Representative   Guttenberg  returned   to   slide  13.   He                                                                    
commented that  he thought all  of the money  (the Permanent                                                                    
Fund monies) belonged to the  people. He suggested that when                                                                    
stabilizing the  budget and dealing  with the  operations of                                                                    
the state  government it  was simply  about the  delivery of                                                                    
services to the  people of the state. He asked  if there was                                                                    
an  analysis about  cutting  the PFD,  which  he was  deeply                                                                    
concerned  about having  represented  a  sizable portion  of                                                                    
Rural Alaska. He  wondered about the impacts  of budget cuts                                                                    
and  about how  the deletion  of services  would affect  the                                                                    
private economy.                                                                                                                
                                                                                                                                
1:49:00 PM                                                                                                                    
                                                                                                                                
Commissioner   Hoffbeck   stated    that   the   information                                                                    
Representative  Guttenberg  was  inquiring  about  would  be                                                                    
included in the forthcoming  analysis. The analysis included                                                                    
looking at the impact of  reducing the size of the dividend,                                                                    
using earnings, making cuts to  services, and imposing taxes                                                                    
including  an income  tax. They  were compared  against each                                                                    
other as far as the relative impacts on the economy.                                                                            
                                                                                                                                
Representative Guttenberg  asked if the "do  nothing" option                                                                    
would  be included  in the  analysis. Commissioner  Hoffbeck                                                                    
suggested that the  impacts of the changes  were compared to                                                                    
the status quo.                                                                                                                 
                                                                                                                                
Representative  Gara referred  back to  slide 15.  He wanted                                                                    
the  administration to  refrain from  speaking for  Governor                                                                    
Hammond.  He  had become  very  good  friends with  Governor                                                                    
Hammond in his  later years. He suggested  that the governor                                                                    
had said  many things based on  the context of the  time. He                                                                    
relayed that one of the  things the former governor had said                                                                    
to him frequently was that if  the state was going to have a                                                                    
fiscal  plan  and  there  was a  problem  the  state  should                                                                    
address  it by  getting a  fair  share for  the state's  oil                                                                    
first,  then impose  an income  tax, and  if needed  tapping                                                                    
into the PF.  He did not feel that it  was useful for people                                                                    
to co-op Governor  Hammond. The governor had  said things at                                                                    
various times. He discouraged  others from invoking Governor                                                                    
Hammond as the supporter of anyone's plan.                                                                                      
                                                                                                                                
Co-Chair  Thompson  thanked   Representative  Gara  for  his                                                                    
statement.                                                                                                                      
                                                                                                                                
Attorney  General   Richards  noted   Representative  Gara's                                                                    
feedback  and   would  be  removing   the  slide   from  the                                                                    
presentation.                                                                                                                   
                                                                                                                                
Attorney  General Richards  jumped  to  slide 17:  "Defining                                                                    
"Sustainable""  indicating he  would come  back to  slide 16                                                                    
later   in  his   presentation.   He   explained  that   the                                                                    
administration  posed the  question  that if  the state  was                                                                    
going to create a spending rule  that put some amount of the                                                                    
PF  earnings into  the GF  the state  would have  to clearly                                                                    
define "sustainable." The state was  aware it wanted to have                                                                    
a PF that  was sustainable; loosely meaning it  would have a                                                                    
like or  greater value for  the next generation  of Alaskans                                                                    
in perpetuity.  In financial modeling  it was not  enough to                                                                    
have  a vague  idea  of  the meaning  of  a sustainable  PF.                                                                    
Ultimately,  the administration  broke  it  down into  three                                                                    
parts. The first key piece was  leaving the corpus of the PF                                                                    
untouched, consistent with the constitution.                                                                                    
                                                                                                                                
Attorney General Richards explained  the second part. If the                                                                    
state  was  going to  adopt  an  endowment model  where  the                                                                    
government  relied on  funds  from the  PF  for its  ongoing                                                                    
operations,  there  had to  be  a  durable earnings  reserve                                                                    
account (a  consequence of  the first  part that  the corpus                                                                    
could not be spent). In other  words, if the state was going                                                                    
to rely  on PF monies  from year-to-year, then  there needed                                                                    
to be assurances in place  that the money would be available                                                                    
each year. In  anticipation of a couple of  bad market years                                                                    
or  other unexpected  events, the  earnings reserve  account                                                                    
initially  needed   to  be  large   enough  to   ensure  its                                                                    
durability  to  avoid  falling below  zero.  Otherwise,  the                                                                    
state  would simply  be  exchanging one  budget  hole for  a                                                                    
different kind of budget hole.                                                                                                  
                                                                                                                                
Attorney General  Richards relayed  that the third  part was                                                                    
the definition [of  sustainable] the administration adopted.                                                                    
In order to  be sustainable the PF value  needed to maintain                                                                    
its real  value. He explained  that a nominal value  did not                                                                    
take  inflation into  consideration. Whereas,  a real  value                                                                    
did. The fund's value would grow  at an amount that at least                                                                    
equaled  inflation.  The  state's  sustainability  rule  was                                                                    
designed with a target of  maintaining the real value of the                                                                    
fund or growing it over time.                                                                                                   
                                                                                                                                
Attorney General Richards  furthered that the administration                                                                    
had  an inflation  rule embedded  in  its economic  modeling                                                                    
that accounted  for inflation. He  explained that  the state                                                                    
went farther to provide a  mechanism that not only protected                                                                    
the total value of the  fund against inflation, but actually                                                                    
adopted  a mechanism  of inflation-proofing  similar to  the                                                                    
current system where inflation-like  funds were put into the                                                                    
corpus so  the corpus,  itself, grew.   He would  be talking                                                                    
about how  the formulation used  in the plan of  growing the                                                                    
corpus  for inflation  adjustments was  different than  what                                                                    
was currently in place.                                                                                                         
                                                                                                                                
1:54:42 PM                                                                                                                    
                                                                                                                                
Co-Chair  Neuman mentioned  the earnings  reserve durability                                                                    
and  expressed  his  concern about  having  members  of  the                                                                    
cabinet  on  the board  of  the  Permanent Fund  Corporation                                                                    
(PFC). He  presented a hypothetical  situation in  which the                                                                    
corporation ended up in a  deficit situation. He wondered if                                                                    
the PFC  board would  be inclined to  sell assets  to ensure                                                                    
that there  was available funding  for the state to  pay its                                                                    
bills.  He  suggested  that  in   the  governor's  plan  the                                                                    
Permanent Fund's  sole purpose  was to fund  government. The                                                                    
Permanent Fund  Dividend check would be  solely dependent on                                                                    
production  taxes  and royalty  revenues.  There  was a  big                                                                    
switch  in how  things would  be done  in the  new plan.  He                                                                    
asked  Attorney General  Richards if  he had  contemplated a                                                                    
way in  which the  administration and the  legislature could                                                                    
work  together in  resolving the  issue  of how  the PF  was                                                                    
managed and by whom.                                                                                                            
                                                                                                                                
Attorney General  Richards stated that after  having visited                                                                    
in Co-Chair Neuman's  office he had had time  to think about                                                                    
their conversation.  He and Commissioner Hoffbeck  were both                                                                    
members of the PF  board. As a member of the  board he had a                                                                    
legal fiduciary obligation  to manage the fund  as a trustee                                                                    
under  fairly well-defined  legal standards.  The obligation                                                                    
superseded  the obligation  as a  member  of the  governor's                                                                    
cabinet.   It  was   the  same   obligation,  in   terms  of                                                                    
management, that a person would  have as a cabinet member or                                                                    
a non-cabinet member appointed by  the governor. In his mind                                                                    
the trade-off  of having commissioners sitting  on the board                                                                    
aware  of  what  the  administration   was  doing  was  more                                                                    
beneficial  than  having  increased  political  independence                                                                    
with non-cabinet members sitting on the board.                                                                                  
                                                                                                                                
Co-Chair Neuman reported  that his point was  to ensure that                                                                    
other members of  the finance committee and  the public were                                                                    
aware of the conversations he  had had with Attorney General                                                                    
Richards.  He reiterated  his concerns  with having  cabinet                                                                    
members sitting on the PFC board.                                                                                               
                                                                                                                                
1:58:04 PM                                                                                                                    
                                                                                                                                
Representative Munoz  asked if  the PFC  board or  its staff                                                                    
considered mandatory changes in  the investment mix with the                                                                    
requirements  of  an  annual  cash  draw.  She  was  unclear                                                                    
whether there would be a change in management.                                                                                  
                                                                                                                                
Commissioner  Hoffbeck stated  that  currently the  trustees                                                                    
and the managers of the fund  had not looked at changing the                                                                    
mix of  investments. As  part of  the plan,  the corporation                                                                    
and board of  trustees would have to  remain autonomous from                                                                    
government intervention.  He asserted  that it was  the only                                                                    
way  a rules-based  system worked.  The board's  focus would                                                                    
have to be on generating  returns rather than specific money                                                                    
generating components.  The size  of the cash  portion would                                                                    
be larger than  in the past because  previously the dividend                                                                    
was  the  only item  being  paid  from  the draw.  With  the                                                                    
governor's plan in place it  would pay something essentially                                                                    
2 to 2.5 times the amount  of the prior year's dividend. The                                                                    
corporation would have to manage  for more cash annually but                                                                    
there would be  a known draw in the future  and the PF could                                                                    
be  managed  accordingly. Overall  he  did  not believe  the                                                                    
underlying investment portfolio would change to any extent.                                                                     
                                                                                                                                
Co-Chair  Thompson  argued that  it  would  be difficult  to                                                                    
remain autonomous with a governor  trying to draw additional                                                                    
money  out with  a  number  of his  cabinet  members on  the                                                                    
board.                                                                                                                          
                                                                                                                                
2:00:18 PM                                                                                                                    
                                                                                                                                
Attorney General  Richards commented  that the  amount drawn                                                                    
from  the  fund  was  a  legislative  prerogative.  The  two                                                                    
potential outflows  were monies to  the GF and  the dividend                                                                    
amounts. Both amounts were determined by the legislature.                                                                       
                                                                                                                                
Attorney  General Richards  continued  to  slide 18:  "APFPA                                                                    
Cash Flows." He  pointed out that the slide  showed a visual                                                                    
depiction of the governor's plan.  It showed how cash flowed                                                                    
in and  out of the system.  He drew attention to  the corpus                                                                    
of  the PF  on the  left  and the  earnings reserve  account                                                                    
(ERA) in the middle of the  slide. In the governor's plan 25                                                                    
percent  of mineral  royalties automatically  went into  the                                                                    
corpus  of  the  fund,  a  constitutional  requirement.  The                                                                    
remaining  75  percent  of  royalties  and  100  percent  of                                                                    
production  taxes   would  be  placed  into   the  ERA.  Two                                                                    
different  cash flows  would come  out of  the ERA.  A fixed                                                                    
amount  of $3.3  billion would  be placed  into the  GF. The                                                                    
payment  of  dividends  would  also come  out  of  the  ERA.                                                                    
Currently,  what came  out  of the  corpus  was the  state's                                                                    
statutory net income  (the earnings of the  principle of the                                                                    
fund) and  an allowance  for inflation-proofing  (taken from                                                                    
the ERA and returned to the corpus).                                                                                            
                                                                                                                                
Attorney General Richards explained  how the governor's plan                                                                    
changed how  the ERA functioned.  In the plan the  ERA would                                                                    
hold statutory  net income,  royalty monies,  and production                                                                    
tax funds.  These monies would  remain in the ERA  until the                                                                    
account reached four times the size  of the payout (4 x $3.3                                                                    
billion). It was  a mechanism that would allow  the state to                                                                    
have 4 years  of anticipated draws in the  ERA providing for                                                                    
a high level of durability even  if the state had poor stock                                                                    
market  years or  the price  of oil  went down  further. The                                                                    
state would  have a very  robust smaller tank of  savings to                                                                    
be  able to  make the  dividend payments  in a  $3.3 billion                                                                    
draw each year.  Once the target was  reached, anything over                                                                    
the target would be placed back  into the corpus of the fund                                                                    
as  a  form of  inflation-proofing.  He  concluded that  the                                                                    
governor's plan changed the plumbing of the system.                                                                             
                                                                                                                                
Attorney  General Richards  addressed why  the governor  was                                                                    
proposing  the change.  The proposal  put the  state's three                                                                    
largest sources  of income (income on  financial assets from                                                                    
the PF, production taxes, and  royalties) into a common pot.                                                                    
The plan included monitoring the  three cash flow sources to                                                                    
determine the amount  to draw as an  annuity year-to-year at                                                                    
a level  such that  it could be  done in  perpetuity. Rather                                                                    
than  trying to  live on  the summation  of three  different                                                                    
volatilities  from  year-to-year,   the  administration  was                                                                    
suggesting  drawing down  a fixed  amount.  He compared  the                                                                    
idea  to  a person  might  have  two  options to  draw  from                                                                    
financial  assets  in retirement.  A  person  could draw  an                                                                    
amount that  equaled a percentage of  financial assets every                                                                    
year.  It would  mean that  a person  would be  living on  a                                                                    
variable income based  upon asset size. A  person could also                                                                    
draw  a fixed  amount based  on a  person's total  amount of                                                                    
assets,  taking  only  an amount  that  would  perpetuate  a                                                                    
stable fixed  income. He viewed the  governor's plan similar                                                                    
to  the later  providing  stability to  the budget  year-to-                                                                    
year.                                                                                                                           
                                                                                                                                
2:05:43 PM                                                                                                                    
                                                                                                                                
Attorney General Richards moved to  slide 19: "How to handle                                                                    
the  draw."  He reported  that  the  administration had  not                                                                    
known what it would view  as the more optimal approach until                                                                    
modeling was applied trying many  different things. Prior to                                                                    
addressing volatility,  the administration posed  a question                                                                    
about the  definition of sustainability. The  answer it came                                                                    
up with was  that under a Percentage of  Market Value (POMW)                                                                    
about  $2.4 could  be taken  out of  the PF  in the  current                                                                    
year. Out  of the $2.4  billion historically about  $1.4 had                                                                    
been  allocated for  dividends. Currently  about $1  billion                                                                    
could be  placed into the  GF.  The administration  opted to                                                                    
do  it  a  little  differently  by  placing  production  and                                                                    
royalty  taxes  into the  Permanent  Fund  to stabilize  the                                                                    
amount and  help close the gap.  If the state were  to adopt                                                                    
an endowment  model for the PF,  the issue of how  to handle                                                                    
the  draw had  to  be  addressed: should  it  be  done as  a                                                                    
percentage  value of  the  fund  or as  a  fixed amount.  He                                                                    
encouraged  the legislature  to review  the consequences  of                                                                    
both options.                                                                                                                   
                                                                                                                                
Attorney  General Richards  stated that  it was  not obvious                                                                    
which option  was better.  He relayed  that there  were pros                                                                    
and cons  to both  a percentage system  and a  fixed system.                                                                    
The  advantage to  the POMV  system, the  percentage system,                                                                    
was that  there would  be less certainty  to the  budget but                                                                    
more  certainty to  the fund.  In other  words, if  the fund                                                                    
went down  the amount drawn to  the budget would go  down as                                                                    
well.  Conversely, if  the  value  of the  PF  went up,  the                                                                    
amount  drawn into  the budget  would  go up.  It created  a                                                                    
self-adjusting  mechanism for  the PF.  The mechanism  would                                                                    
help to protect the fund against  the risk of being run down                                                                    
as  quickly if  there was  a  string of  bad luck.  However,                                                                    
variability  would be  housed  in  the state's  year-to-year                                                                    
budget rather than in the fund itself.                                                                                          
                                                                                                                                
Attorney  General  Richards  moved  on to  discuss  a  fixed                                                                    
system,  reflected in  the governor's  plan  and lacking  an                                                                    
automatic adjusting mechanism. If there  was a period of bad                                                                    
years, then $3.3  billion might be too big of  an annuity to                                                                    
draw.  Under  such circumstances,  the  state  would need  a                                                                    
method  to  adjust  the  draw down.  He  reported  that  the                                                                    
periodic review was included as  part of the governor's plan                                                                    
as a  means to  adjust the draw  down. The  periodic review,                                                                    
conducted every  4 years, was a  way to look at  whether the                                                                    
amount the state would be drawing was sustainable.                                                                              
                                                                                                                                
Attorney General Richards maintained  that the main question                                                                    
was  whether  the  state   wanted  stock  market  volatility                                                                    
residing in the  payment to the budget or  whether the state                                                                    
wanted the payment  to the budget to be fixed  and the stock                                                                    
market volatility to  reside more in the  PF. The governor's                                                                    
plan  chose  to have  more  stability  in  the GF  and  more                                                                    
volatility  in the  PF. He  concluded that  both plans  were                                                                    
reasonable.                                                                                                                     
                                                                                                                                
2:09:31 PM                                                                                                                    
                                                                                                                                
Co-Chair Neuman  relayed that  the one  thing the  state had                                                                    
was historical numbers on the  investments for the Permanent                                                                    
Fund. He asked  if Attorney General Richards  had taken both                                                                    
the  fixed  system and  the  percentage  system methods  and                                                                    
applied them  to historical data  for comparison. If  so, he                                                                    
requested to  see those  numbers. Attorney  General Richards                                                                    
relayed  that the  administration  had done  the modeling  a                                                                    
number  of ways  and would  provide the  information to  the                                                                    
committee.                                                                                                                      
                                                                                                                                
Co-Chair Neuman asked for the information.                                                                                      
                                                                                                                                
Co-Chair  Thompson   reiterated  that  the   information  be                                                                    
provided to the committee.                                                                                                      
                                                                                                                                
Attorney General Richards continued  to address slide 19. He                                                                    
relayed that there were two  decisions that would have to be                                                                    
made by  the legislature if  it adopted an  endowment model.                                                                    
The first  was whether to  choose a  fixed draw system  or a                                                                    
percentage value  system. He stated that  petroleum revenues                                                                    
were  not  static  due to  production  levels  changing.  He                                                                    
recommended that, in looking at  the POMV system option, the                                                                    
legislature  should take  into account  that the  percentage                                                                    
that  could  be  withdrawn  currently   was  less  than  the                                                                    
percentage that  could be drawn  in the future  if petroleum                                                                    
production  declined.  Conversely, if  petroleum  production                                                                    
increased,  then in  the future  the sustainable  percentage                                                                    
draw  would  be  slightly  higher. He  recommended  using  a                                                                    
periodic review as a  mechanism for measuring sustainability                                                                    
with the  POMV system.  He also noted  that the  PF, itself,                                                                    
held debt.  It was  not just  cash or equity,  the PF  had a                                                                    
large  real estate  portfolio  using  debt: the  corporation                                                                    
borrowed money to invest in  real estate. The consequence of                                                                    
that was when a percentage  draw was defined the state would                                                                    
have to make  sure to draw on a percentage  of the net value                                                                    
of assets and not on the value of assets with debt.                                                                             
                                                                                                                                
Co-Chair Neuman  asked Attorney General  Richards to  give a                                                                    
more   coherent  explanation.   Attorney  General   Richards                                                                    
explained  that about  6 months  ago the  PF had  a debt  of                                                                    
roughly $7  billion in  its portfolio.  The debt  resided in                                                                    
the PFC's real estate, hedge  funds, and some of its private                                                                    
equity portfolio. The state would  not want to borrow money,                                                                    
then calculate  the total draw  based on the value  with the                                                                    
debt included. The  state would end up  borrowing money then                                                                    
immediately  paying it  out. The  state would  need to  make                                                                    
sure that it  was paying either dividends or  the payment to                                                                    
the government  using a  method that did  not payout  on the                                                                    
borrowed monies.                                                                                                                
                                                                                                                                
Co-Chair  Neuman  did  not  believe  the  PFD  [calculation]                                                                    
accounted  for  unrealized assets  or  debt  at present.  He                                                                    
wondered  why the  corporation would  want to  start such  a                                                                    
process.  Attorney General  Richards explained  that if  the                                                                    
state did not  change the dividend formula, it  would not be                                                                    
an  issue.  However,  if  the  legislature  adopted  a  POMV                                                                    
approach to  the fund  draw down  then the  definition would                                                                    
need to  be clear. The  debt would need  to be taken  out of                                                                    
the total  calculation of  a POMV draw  of 4.5  percent, for                                                                    
example.                                                                                                                        
                                                                                                                                
Co-Chair Neuman  did not  believe it  could be  done legally                                                                    
anyway.                                                                                                                         
                                                                                                                                
2:14:11 PM                                                                                                                    
                                                                                                                                
Representative  Gara had  not  seen the  math  on paper  but                                                                    
understood  that  the  governor's   plan  promised  a  $1000                                                                    
dividend  for  the  first 2  years.  There  was  significant                                                                    
concern that the 50 percent  of Alaskans whom earn the least                                                                    
amount of  money received about  20 percent of  their income                                                                    
from the dividend. He reported  hearing about $400 dividends                                                                    
following the  first 2  years of  $1000 dividends,  based on                                                                    
some  oil   price  scenarios.   He  asked   about  potential                                                                    
scenarios after  the first 2  years that would  decrease the                                                                    
dividend to $400.                                                                                                               
                                                                                                                                
Co-Chair Thompson  asked him to  also comment  on production                                                                    
scenarios accounting for increased production.                                                                                  
                                                                                                                                
Commissioner Hoffbeck  made a  correction that  the governor                                                                    
only guaranteed  $1000 for  the first  year rather  than for                                                                    
the first 2 years. He added  that if the revenue forecast in                                                                    
the Revenue Sources  Book was used for  price and production                                                                    
the  dividend would  decrease to  between $700  and $800  in                                                                    
year 2. If  the calculation was based on  current oil prices                                                                    
at about $30  per barrel then the dividend  would decline to                                                                    
between $400 and $500 in  the second year. Much would depend                                                                    
on oil price recovery over  the following year. The dividend                                                                    
would track  with the state's overall  economic health under                                                                    
the governor's plan.                                                                                                            
                                                                                                                                
Attorney General  Richards reported  that slide 20:  "How to                                                                    
handle the draw:  A simple endowment draw  adds revenue, but                                                                    
does  not  address  volatility":  reflected  a  hypothetical                                                                    
scenario.  He  explained  that the  blue  bars  demonstrated                                                                    
historically what  the unrestricted petroleum  revenues were                                                                    
to the  state. Like other  oil based economies, it  was very                                                                    
difficult for  Alaska to  budget year-to-year  with volatile                                                                    
fluctuations in  the unrestricted petroleum revenues  (70 to                                                                    
90   percent  of   the  total   state  budget).   The  slide                                                                    
demonstrated  a problem  with the  classical POMV  system as                                                                    
Alaska   had  currently   contemplated.   The  yellow   bars                                                                    
reflected what the  POMV would have added into  the GF after                                                                    
the dividend  payment had  the state  adopted a  4.5 percent                                                                    
POMV in  2002. It  was an  exercise going  back in  time. He                                                                    
furthered that the  slide demonstrated that in  years of low                                                                    
oil  prices the  classical POMV  endowment model  was useful                                                                    
because the  state would be getting  revenues from financial                                                                    
assets when  needed because of  oil prices being low  in the                                                                    
classical system.  In poor  years it  helped close  the gap.                                                                    
However,  without a  rule-based  system  that accounted  for                                                                    
high oil price years the  POMV model compounded the problem.                                                                    
In  the years  when  the state  was  getting more  petroleum                                                                    
revenues than  needed the  state had  the tendency  for pro-                                                                    
cyclical  spending resulting  in large  capital budgets  and                                                                    
growing operating budgets that would  have to be clawed back                                                                    
in later years.  He suggested that the state  might not want                                                                    
a  POMV  that  paid  from  its  financial  assets  when  oil                                                                    
revenues were  high because  more aggressive  spending would                                                                    
likely take place. He advised  that if the legislature opted                                                                    
for the POMV  system, members should be  cognizant of making                                                                    
sure a rule was in  place preventing money from being pumped                                                                    
in from the  state's financial assets into  the budget which                                                                    
would otherwise compound the pro-cyclical spending pattern.                                                                     
                                                                                                                                
2:19:09 PM                                                                                                                    
                                                                                                                                
Representative  Wilson asked  what the  dividend would  have                                                                    
been in  2012 under  the governor's plans.  Attorney General                                                                    
Richards did not  know the exact number but  estimated it to                                                                    
be roughly $1300. He elaborated  that royalties in 2012 were                                                                    
about $2 billion.                                                                                                               
                                                                                                                                
Representative  Wilson asked  what the  dividend would  have                                                                    
been  in 2008.  There  would  be a  difference  in the  POMV                                                                    
addition. She  wondered if  it would  be greater  than $1300                                                                    
due to the unrestricted  petroleum revenue. Attorney General                                                                    
Richards responded  that the dividend would  have been large                                                                    
in 2008.                                                                                                                        
                                                                                                                                
Representative Wilson  commented that  in 2008 and  2009 the                                                                    
dividend  amount was  not  very exciting  due  to the  stock                                                                    
market.  She  wondered if  the  plan  would change  how  the                                                                    
dividend  was handled.  Although the  state did  not receive                                                                    
extra in the  big years such as 2008 and  2012, she wondered                                                                    
what the  justification would be  to change when  looking at                                                                    
low numbers in the following couple of years.                                                                                   
                                                                                                                                
Attorney General Richards remarked  that the governor's plan                                                                    
proposed  changing the  way the  dividend was  paid so  that                                                                    
individual  Alaskans  were  rewarded when  the  economy  was                                                                    
doing well  as opposed  to a  dividend system  that rewarded                                                                    
Alaskans  for financial  market success.  Either system  was                                                                    
rational  but  the  governor felt  that  Alaska  was  better                                                                    
aligned if its  people were successful when  the economy was                                                                    
doing well.                                                                                                                     
                                                                                                                                
Representative  Wilson commented  that  she would  otherwise                                                                    
agree with the governor's position  if the state was looking                                                                    
at an increase going forward.  However, the state was facing                                                                    
a decrease. She  felt that the people of  Alaska had already                                                                    
taken a hit  because of the stock market. She  felt that the                                                                    
administration  was asking  Alaskans  to take  a second  hit                                                                    
because of the change in oil revenue.                                                                                           
                                                                                                                                
Commissioner Hoffbeck  replied that  the state had  to start                                                                    
somewhere. He  asserted that  the state  was in  a situation                                                                    
driven  by  economics  where  the state  had  to  make  some                                                                    
decisions  that  would  otherwise   not  be  required  under                                                                    
different circumstances.                                                                                                        
                                                                                                                                
Attorney  General Richards  added  that there  was a  fairly                                                                    
conservative   20   year   production  forecast   from   the                                                                    
Department  of  Revenue  (DOR). It  assumed  steady  decline                                                                    
because it  anticipated that the  state would not  have much                                                                    
success in  the form of  new fields, a  gas line, or  in the                                                                    
Arctic National  Wildlife Refuge (ANWR). He  thought it made                                                                    
sense from  a budgetary perspective to  have a conservative-                                                                    
based  assumption.  He  thought that  a  really  pessimistic                                                                    
assumption about the future would  carry over to the royalty                                                                    
dividend.  Conversely, if  there was  a positive  outlook at                                                                    
higher oil prices  or more success in  Alaska's petroleum or                                                                    
mining  sectors in  the future,  then  the royalty  dividend                                                                    
would look higher.                                                                                                              
                                                                                                                                
2:22:59 PM                                                                                                                    
                                                                                                                                
Co-Chair Neuman  asked how the dividend  would be calculated                                                                    
in the POMV example.                                                                                                            
                                                                                                                                
Attorney   General  Richards   responded  that   it  was   a                                                                    
historical  actual  payout.   The  numbers  were  historical                                                                    
numbers and the actual payout was already known.                                                                                
                                                                                                                                
Co-Chair  Neuman confirmed  that the  payout was  calculated                                                                    
under  the  current  dividend calculation  method.  Attorney                                                                    
General Richards responded in the affirmative.                                                                                  
                                                                                                                                
Vice-Chair Saddler  asked why nominal dollars  would be used                                                                    
over  a 40-year  period rather  than using  real dollars  to                                                                    
account for  inflation. Attorney General  Richards suggested                                                                    
that originally  the chart  used real  dollars but  he later                                                                    
decided  to stick  with one  convention in  the presentation                                                                    
choosing  to use  nominal figures  to  avoid confusion.  The                                                                    
real dollar chart communicated similar information.                                                                             
                                                                                                                                
Vice-Chair  Saddler  noted  that the  Attorney  General  had                                                                    
stated  earlier  that  he  wanted   to  make  the  PFD  more                                                                    
connected to the  people based on the health  of the economy                                                                    
(oil royalties). He asserted  that Attorney General Richards                                                                    
wanted  to  make the  PFD  work  well  when oil  wells  were                                                                    
pumping oil rather  than when money wells  were pumping more                                                                    
money, which they were currently.                                                                                               
                                                                                                                                
Representative  Gara mentioned  talking  about the  dividend                                                                    
amount.  Two of  the largest  parts of  the governor's  plan                                                                    
were the  dividend change and  the income tax.  He indicated                                                                    
that  everyone  was  looking  for   a  plan  that  would  be                                                                    
comprehensive  and  fair to  everyone.  He  wondered how  he                                                                    
would explain  the current plan  to his constituents  in the                                                                    
low income parts  of his district who would  be affected the                                                                    
most.                                                                                                                           
                                                                                                                                
Commissioner Hoffbeck responded that  there was some balance                                                                    
between the income  tax and the dividend in  that the income                                                                    
tax  impacted people  earning higher  wages more  than those                                                                    
earning lower  wages. Conversely,  reducing the size  of the                                                                    
dividend impacted  lower wage earners  more than it  did for                                                                    
those  earning higher  wages. However,  he  argued that  the                                                                    
income  tax impacted  the higher  wage earners  at a  higher                                                                    
percentage. One  of the things  the administration  tried to                                                                    
recognize was that  the dividend had been  volatile over the                                                                    
years.  The  dividend  would  go   up  and  down  under  any                                                                    
scenario. The  bill changed the dynamics.  The bill provided                                                                    
for  a smaller  dividend than  did the  current system,  but                                                                    
doing  nothing   created  the  possibility  of   losing  the                                                                    
dividend altogether  within 4 years.  He added that  part of                                                                    
the  intent of  the  bill  was to  be  able  to sustain  the                                                                    
dividend long-term.                                                                                                             
                                                                                                                                
2:27:38 PM                                                                                                                    
                                                                                                                                
Representative  Gara   thought  the  state  should   have  a                                                                    
balanced  plan but  he  took issue  with  the definition  of                                                                    
balanced.                                                                                                                       
                                                                                                                                
Vice-Chair Saddler  asked about  the threshold for  a person                                                                    
to have a  net payment of federal  taxes notwithstanding the                                                                    
earned income tax.  He was looking for a  perspective on how                                                                    
much  income a  person who  was heavily  dependent on  a PFD                                                                    
would actually pay in taxes.  Commissioner Hoffbeck put into                                                                    
perspective that  someone with a  family of 4 that  made $50                                                                    
thousand per  year would pay  about $47 in state  tax, close                                                                    
to the tax threshold.                                                                                                           
                                                                                                                                
2:28:42 PM                                                                                                                    
                                                                                                                                
Representative Gara  spoke to the reduction  of the dividend                                                                    
to $500  or $800 in  the out years.   The revenue  the state                                                                    
would be  generating by  reducing the  dividend was  about 4                                                                    
times  as much  as the  $200  million towards  a $4  billion                                                                    
deficit that the  state would raise from the  income tax. He                                                                    
asked if the income tax would generate about $200 million.                                                                      
                                                                                                                                
Commissioner  Hoffbeck   replied  in  the   affirmative.  In                                                                    
looking at  the federal tax  liability, since the  state was                                                                    
tied to it, between 40 and  50 percent of people did not pay                                                                    
federal tax. The same dynamic  would apply to a state income                                                                    
tax. About half of the reduction  in the dividend was out of                                                                    
the  higher wage  earner. In  looking at  the impact  of the                                                                    
lower wage  earner about  $350 million  would be  taken from                                                                    
the  dividend  system. A  state  income  tax would  generate                                                                    
about $200 million.                                                                                                             
                                                                                                                                
Co-Chair Thompson reminded members  that the committee would                                                                    
be  addressing  a separate  bill  on  income tax.  Committee                                                                    
members  would be  supplied with  more  explanations on  the                                                                    
numbers in the future.                                                                                                          
                                                                                                                                
Attorney General Richards mentioned  that in the following 2                                                                    
slides  he  would  be  reviewing   the  assumptions  of  the                                                                    
governor's plan  used in the  model. He addressed  slide 21:                                                                    
"Calculating the  Draw: The  Financial Model."  He explained                                                                    
that the  governor's plan  relied on  probabilistic modeling                                                                    
for many of its inputs. It  meant that rather than picking a                                                                    
discrete  oil  price  or  return  assumption,  the  economic                                                                    
modelers  built a  range of  potential  prices and  assigned                                                                    
probabilities  of  being at  certain  prices  over time.  It                                                                    
created  a  more sophisticated  way  of  doing the  modeling                                                                    
rather  than  choosing  static variables.  He  relayed  that                                                                    
Mackenzie  [Wood  Mackenzie]  would   provide  a  much  more                                                                    
detailed  presentation  to the  committee  at  a later  time                                                                    
outlining how  they vetted all  of the assumptions  in great                                                                    
detail,  why certain  assumptions were  reasonable, and  why                                                                    
other assumptions were changed to reflect better thinking.                                                                      
                                                                                                                                
Attorney General  Richards continued. He explained  that the                                                                    
PF  modeling assumed  that the  starting assets  equaled $55                                                                    
billion. The $55 billion included  the PF projected value as                                                                    
of  the end  of the  fiscal year  (FY 16).  A point  in time                                                                    
needed  to  be chosen  in  order  to  build the  models.  He                                                                    
reported that  the PF had lost  a value of about  $3 billion                                                                    
in the  previous 3 to 4  months.  He thought  the number was                                                                    
higher than in  the current day. If there  was an assumption                                                                    
of  $2  billion  less  than   the  starting  assets  in  the                                                                    
governor's  plan, then  there was  about  $100 million  less                                                                    
than the state  could have in its sustainable draw.   It was                                                                    
possible  in  the decision  that  the  state would  use  $53                                                                    
billion rather  than using $55 billion,  for instance, which                                                                    
would  result  in a  draw  of  $3.2  billion versus  a  $3.3                                                                    
billion draw.  He believed that getting  the exact beginning                                                                    
principle accurate  was not as  important as it was  to make                                                                    
reasonable  assumptions  about  long term  returns  for  the                                                                    
state. It was important to  make good assumptions about what                                                                    
would  likely occur  over time.  He  noted that  of the  $55                                                                    
billion, $3  billion was  an assumed  transfer from  the CBR                                                                    
into  the ERA.  The $3  billion was  to provide  a level  of                                                                    
confidence  to ensure  that the  ERA was  going to  be large                                                                    
enough  to compensate  for a  couple of  years of  bad stock                                                                    
market  returns. It  would provide  a  cushion enabling  the                                                                    
state to make a $3.3 billion draw each year.                                                                                    
                                                                                                                                
2:33:28 PM                                                                                                                    
                                                                                                                                
Co-Chair   Neuman  asked   about   the  sustainable   budget                                                                    
baseline. He wondered if it  was the governor's current $5.4                                                                    
billion budget.                                                                                                                 
                                                                                                                                
Attorney   General  Richards   replied   that  the   current                                                                    
legislation did  not assume  any particular  budget. Instead                                                                    
it determined what could be pulled  out of the PF every year                                                                    
that  met  the  definition of  sustainability.  The  number,                                                                    
under the  way the  governor's plan  was calculated  for the                                                                    
PF, was  $3.3 billion regardless  of the budget  every year.                                                                    
For  instance,  if  the  budget was  $6  billion  only  $3.3                                                                    
billion could  be withdrawn.  If the  budget was  $4 billion                                                                    
only $3.3 billion  could be taken out.  The sustainable draw                                                                    
amount of $3.3 billion was independent of the budget.                                                                           
                                                                                                                                
Co-Chair Neuman  assumed a starting  budget of  $5.4 billion                                                                    
like the  governor's proposed budget.  He asked if  it would                                                                    
prove  to  be   more  beneficial  for  the   budget  if  the                                                                    
legislature  could  reduce  it   to  $4.5  billion  or  $4.7                                                                    
billion.                                                                                                                        
                                                                                                                                
Attorney   General   Richards   deferred   to   Commissioner                                                                    
Hoffbeck.                                                                                                                       
                                                                                                                                
Commissioner  Hoffbeck  answered  that  if  the  budget  was                                                                    
reduced by only  $700 million of about $2.1  billion to $2.3                                                                    
billion needed  to balance the  budget, it would  reduce the                                                                    
state's future draw  by about $100 million  to $120 million.                                                                    
The state would  have to draw down on saving  to make up the                                                                    
remaining funding. The amount  the budget fell short reduced                                                                    
the amount that the state  would have going into the future.                                                                    
He had received a matrix  immediately before the meeting and                                                                    
had not  had a  chance to vet  it. It would  be part  of the                                                                    
packet the DOR would be providing to members.                                                                                   
                                                                                                                                
Co-Chair Neuman  asked if the  commissioner had  just stated                                                                    
that if legislators  did not take any action  in the current                                                                    
year  the  required  draw  down would  be  reduced  by  $100                                                                    
million.                                                                                                                        
                                                                                                                                
Commissioner Hoffbeck replied  that if the state  did not do                                                                    
anything in  the current year  except to pass the  budget it                                                                    
would reduce  the sustainable portion  of the draw  by about                                                                    
$150  million  annually. The  state's  draw  would be  $3.15                                                                    
billion  rather  than  the current  year's  figure  of  $3.3                                                                    
billion. He  added that  the state  would never  recover the                                                                    
difference.                                                                                                                     
                                                                                                                                
Attorney General  Richards added that it  was accurate based                                                                    
on his understanding of the  modeling from the DOR. However,                                                                    
there were also consequences to  delaying in addition to the                                                                    
reduced  sustained   draw.  He   would  be   discussing  the                                                                    
consequences of delay at Representative Edgmon's request.                                                                       
                                                                                                                                
2:37:03 PM                                                                                                                    
                                                                                                                                
Representative  Munoz   asked  if  he  had   looked  at  the                                                                    
financial model without  the $3 billion CBR  draw. She asked                                                                    
for the  specific number of  a sustainable draw  without the                                                                    
investment.                                                                                                                     
                                                                                                                                
Attorney General Richards  stated that he had  looked at the                                                                    
model  and  claimed  that  the  draw  would  be  reduced  by                                                                    
approximately  $150 million.  The negative  impact would  be                                                                    
that the amount in the ERA  might be less robust rather than                                                                    
impacting the  amount of the  sustainable draw. The  risk of                                                                    
running the  ERA down to  zero would intensify if  the stock                                                                    
market did poorly  in the following 2 years.  The $3 billion                                                                    
was not  added to increase  the total amount  of sustainable                                                                    
draw.  It was  inserted to  ensure a  robust ERA  balance of                                                                    
approximately $10 billion.                                                                                                      
                                                                                                                                
Representative Munoz  asked if  the plan required  an annual                                                                    
draw from the CBR.                                                                                                              
                                                                                                                                
Attorney General  Richards responded that it  was a one-time                                                                    
draw from the CBR to  make the earnings reserve sustainable.                                                                    
He reported that there were  aspects of the plan not related                                                                    
to the APFPA that had some different assumptions.                                                                               
                                                                                                                                
Commissioner  Hoffbeck replied  that  there  was an  ongoing                                                                    
draw  from the  PF  because  the administration  anticipated                                                                    
needing  about $100  million  to $150  million  per year  in                                                                    
investment  returns out  of the  CBR. If  money did  not get                                                                    
drawn from the  CBR and placed into the ERA  the state could                                                                    
still make  the draw from  the CBR annually. The  draw would                                                                    
be smaller from the ERA and  make the difference with a draw                                                                    
from the  CBR. Once the plan  was in place the  CBR would be                                                                    
invested similarly to the PF.  The instability of having the                                                                    
money in  the CBR was  having to  access it with  a required                                                                    
three-quarter vote of the legislature.                                                                                          
                                                                                                                                
Attorney General Richards added  that the true advantage was                                                                    
having  the $3  billion  in  the PF  rather  than the  money                                                                    
residing in the  CBR. The Permanent Fund  would become self-                                                                    
sustaining generating  the dividends and about  $3.3 billion                                                                    
on its  own without  having to pull  from another  piece. He                                                                    
mentioned the importance of  having a rules-based framework.                                                                    
The  success  of this  part  of  the  plan, dependent  on  a                                                                    
political element  such as a  successful CBR vote,  made the                                                                    
plan a little less robust from a rules-based perspective.                                                                       
                                                                                                                                
2:40:52 PM                                                                                                                    
                                                                                                                                
Representative Edgmon  wanted to  make clear that  the total                                                                    
return in  the statutory net  income was part and  parcel of                                                                    
one  portfolio,  the  corpus  of the  PF  and  the  earnings                                                                    
reserve  being managed  as one  entity. He  saw nods  at the                                                                    
table.  He  asked  whether  the  modeling  demonstrated  the                                                                    
corpus continuing  to grow proportionately, looking  4 years                                                                    
down the road and after drawing  down each year, so to avoid                                                                    
having a larger amount of  investments in more liquid assets                                                                    
such  as the  Earnings Reserve.  He wanted  a quick  comment                                                                    
about what  the modeling showed.  He was thinking  about the                                                                    
portfolio  and  the  make-up of  the  asset  allocation.  He                                                                    
suggested  that  a  more   aggressive  investment  might  be                                                                    
necessary to  meet the  targets of  the Earnings  Reserve if                                                                    
the corpus was not keeping pace.                                                                                                
                                                                                                                                
Attorney  General  Richards   responded  that  the  earnings                                                                    
reserve and  the corpus  of the fund  were managed  the same                                                                    
and, he  did not see  any change.  The way the  PF accounted                                                                    
for the two was an accounting  exercise on paper. It was not                                                                    
as  if  they  were  managed as  separate  funds  managed  in                                                                    
different ways. In  terms of how money was  accounted for in                                                                    
the  corpus versus  the earnings  reserve, it  was not  very                                                                    
impactful  from a  management standpoint.  It  came down  to                                                                    
whether  the money  was available  to draw  when needed.  He                                                                    
addressed  Representative  Edgmon's   second  question.  The                                                                    
growth of the  corpus, under the governor's  plan, went back                                                                    
into   the  corpus   after  the   making  payments   to  the                                                                    
government's GF, paying out the  PFD's, and reaching the 4:1                                                                    
target level. It  was not the same  as an inflation-proofing                                                                    
type of  growth that the  corpus had currently, it  would be                                                                    
less in the early years until  the target of $13 billion was                                                                    
reached.  Once  the  target  was  reached  the  inflationary                                                                    
growth would go into the corpus.                                                                                                
                                                                                                                                
Representative  Edgmon thought  there would  plenty of  room                                                                    
for comments  because the permutations  were endless  at the                                                                    
current stage of discussion.                                                                                                    
                                                                                                                                
Representative  Gara asked  if $13  billion (4  years x  the                                                                    
draw)  was the  amount recommended  to keep  in the  ERA. He                                                                    
commented that every time he  looked at the constitution and                                                                    
at Legislative Research's analysis  of the issue they stated                                                                    
that GF available for appropriations  at the end of the year                                                                    
should be swept into the  CBR. Currently, there was about $6                                                                    
billion  in  the CBR.  Under  the  proposed legislation  the                                                                    
state would  have $13 billion at  the end of every  year. If                                                                    
the Legislative  Finance Division (LFD) was  correct the $13                                                                    
billion would  get swept into  the CBR. If  Attorney General                                                                    
Richards was correct the money  would not get swept into the                                                                    
CBR. He thought that LFD's  interpretation was closer to the                                                                    
constitution. The  legislature would be left  with needing a                                                                    
three-quarter vote  every year  to make the  governor's plan                                                                    
work. He  thought the requirement  made it less  stable with                                                                    
changing  legislators at  different  times  and wondered  if                                                                    
Attorney General Richards agreed.                                                                                               
                                                                                                                                
Attorney General  Richards responded  that if one  looked at                                                                    
the  history of  the  CBR  sweep and  the  reverse sweep  in                                                                    
particular,  the   legislature  had  always   exercised  the                                                                    
reverse  sweep. He  suggested that  the  question would  not                                                                    
come  up about  the  provision applied  to  the ERA,  unless                                                                    
there  was a  change in  how the  legislature conducted  its                                                                    
business. If the  state did not do a reverse  sweep it would                                                                    
not only impact the ERA, it  would also affect a wide number                                                                    
of  accounts.  He  listed a  number  of  examples  including                                                                    
pension assets  and some of  the mental health  trust funds.                                                                    
He surmised that  it would be a big change  in the system to                                                                    
arrive  at  the  question.  The  administration  viewed  the                                                                    
option of  the legislature  not doing a  reverse sweep  as a                                                                    
low-probability  event.  If  the legislature  did  not,  the                                                                    
state  would  be  in  a situation  in  which  someone  could                                                                    
challenge whether the ERA was  subject to a sweep. The state                                                                    
already had  a Supreme Court  decision that stated  that the                                                                    
earnings reserve  was not subject  to a sweep.  The question                                                                    
about the  ERA changing  the nature  of the  Supreme Court's                                                                    
decision  could   come  up  if   the  state   did  something                                                                    
differently than  it did  traditionally; either  monies were                                                                    
coming  out  of  the  ERA   into  the  GF,  or  monies  from                                                                    
production taxes and royalties were  going into the ERA. The                                                                    
Department of  Law did not  believe the Supreme  Court would                                                                    
change its  mind. If two  low-probably events  occurred, the                                                                    
state  did not  do a  reverse sweep,  and the  Supreme Court                                                                    
changed  its  mind  then potentially  the  earnings  reserve                                                                    
could  go  to  the  CBR  and the  Supreme  Court  held.  The                                                                    
administration  went  forward  with  the  plan  as  designed                                                                    
because  the probability  of the  two  events occurring  was                                                                    
low.   Even if the  very low probability event  occurred the                                                                    
state would have a Supreme  Court ruling that stated how the                                                                    
system worked  and the  state would  redesign the  system to                                                                    
accommodate it in a way that made sense.                                                                                        
                                                                                                                                
2:47:19 PM                                                                                                                    
                                                                                                                                
Co-Chair  Thompson  relayed  that  the  committee  would  be                                                                    
addressing the question at a later meeting.                                                                                     
                                                                                                                                
Representative  Gara understood  that the  subject would  be                                                                    
addressed  later  and commented  that  the  court would  not                                                                    
reverse  its opinion.  The court's  previous opinion  on the                                                                    
earnings reserve was  based on it being used  solely for the                                                                    
PFD and  inflation-proofing. Under the plan  currently being                                                                    
proposed the earnings reserve would  be used to fund general                                                                    
government.  He  added  that the  Supreme  Court  would  not                                                                    
change its  opinion, but  rather change  the purpose  of the                                                                    
ERA which was the Legislative Finance Division's analysis.                                                                      
                                                                                                                                
Attorney General  Richards commented that he  looked forward                                                                    
to   a  future   opportunity  to   debate  the   issue  with                                                                    
Representative Gara.                                                                                                            
                                                                                                                                
Vice-Chair Saddler suggested  that the SBR and  CBR had been                                                                    
the state's emergency "go-to"  money for deficit situations.                                                                    
The legislation would get rid of  the CBR by placing it into                                                                    
the  ERA.  He  wondered  about the  emergency  capacity  for                                                                    
spending if  the state experienced  an earthquake,  a flood,                                                                    
or oil prices went down to  $8 or $4 per barrel. He wondered                                                                    
if the money would be in the ERA.                                                                                               
                                                                                                                                
Attorney  General  Richards  responded that  the  governor's                                                                    
plan only  placed about half  of the  CBR into the  ERA. The                                                                    
most recent  balance in  the CBR was  about $7  billion. The                                                                    
plan would  place $3 billion  in the ERA leaving  $4 billion                                                                    
in  the  CBR  which  would either  be  appropriated  in  the                                                                    
current year or  remain in a stabilization  account: a short                                                                    
term  account  used to  meet  emergency  needs or  to  close                                                                    
current year budget gaps. The  plan did not eliminate all of                                                                    
the funds by placing the funds  into the PF, only $3 billion                                                                    
of the $7 billion.                                                                                                              
                                                                                                                                
Vice-Chair Saddler clarified  that Attorney General Richards                                                                    
was talking about  $3 billion of the $7 billion  in the CBR.                                                                    
He noted  he was only seeing  $3 billion in the  CBR, not $7                                                                    
billion. He saw $7 billion in the ERA.                                                                                          
                                                                                                                                
Attorney General  Richards relayed  that one  represented an                                                                    
amount and  one represented  a cash  flow. He  reported that                                                                    
there would still  be about $2 billion in the  CBR to fill a                                                                    
need.                                                                                                                           
                                                                                                                                
Attorney   General   Richards    advanced   to   slide   22:                                                                    
"Calculating  the Draw:  The Petroleum  Model." He  informed                                                                    
the committee  that the administration used  a probabilistic                                                                    
method in its petroleum modeling.  There had been a question                                                                    
about  why the  petroleum revenue  projections in  the APFPA                                                                    
modeling  were  slightly  different  than  in  some  of  the                                                                    
budgetary projections. He explained  that rather than basing                                                                    
all of the  projections on one price, a range  of oil prices                                                                    
was  used  and each  price  was  assigned a  probability  of                                                                    
occurrence.  The consequence  of applying  a range  was that                                                                    
the  revenue collected  differed  from when  an average  was                                                                    
applied.  The  state  had a  progressive  tax  system.  Less                                                                    
revenues would  be collected at  $50 per barrel of  oil than                                                                    
if $50 per barrel was the  mean with the chance of the price                                                                    
of oil  reaching $100  per barrel.  At progressive  rates it                                                                    
was a much larger number than  the mean $50. In other words,                                                                    
by capturing a  range of oil prices (rather  than one price)                                                                    
future projections were more accurately captured.                                                                               
                                                                                                                                
Attorney  General  Richards  continued that  for  production                                                                    
forecasting a range was not  used, but rather the model took                                                                    
the DOR's production  forecast out to 2040 adopting  it as a                                                                    
static. He  believed it created  a conservative bias  to the                                                                    
model. The Department of  Revenue projected development from                                                                    
known  fields and  deposits currently  in production,  and a                                                                    
small amount of  non-currently producing oil in  the form of                                                                    
future  development   in  field.  It  did   not  assume  any                                                                    
development  from some  of the  future potential  additional                                                                    
new  fields:  ANWAR,  offshore, and  the  Outer  Continental                                                                    
Shelf (OCS). It was a conservative view of Alaska's future.                                                                     
                                                                                                                                
Co-Chair Thompson acknowledged Speaker  Mike Chenault in the                                                                    
audience.                                                                                                                       
                                                                                                                                
Attorney  General Richards  summarized the  calculation from                                                                    
the governor's bill  and explained how the  $3.3 billion was                                                                    
determined. It started with the balance  of the PF as of the                                                                    
projected end of  the period plus the $3  billion assumed in                                                                    
the model to  be transferred to the ERA.  It then calculated                                                                    
how much the state projected  in PF investment earnings over                                                                    
time,  how  much  would  be   deposited  into  the  PF  from                                                                    
production  taxes  in the  future,  and  how much  would  be                                                                    
deposited into the PF from  royalties in the future. It also                                                                    
accounted  for  the  fact  that the  PF  had  expenses,  the                                                                    
dividend payout, and  a draw from the PF that  went into the                                                                    
GF under and  endowment model. Using the  50 percent royalty                                                                    
dividend formulation  the state  would be  able to  take out                                                                    
$3.3 billion  per year from the  PF to the GF.  The 2 draws,                                                                    
(the dividend and the fixed draw)  allowed the PF to grow at                                                                    
the rate of inflation over time.                                                                                                
                                                                                                                                
2:53:42 PM                                                                                                                    
                                                                                                                                
Representative   Munoz  asked   about  other   projected  GF                                                                    
revenues  outside  of  the $3.3  billion  sustainable  draw.                                                                    
Attorney  General Richards  responded  that  there were  two                                                                    
parts to his  answer. First, there were  revenues already on                                                                    
the books such as state  income taxes and petroleum property                                                                    
taxes. Second,  the governor's total  plan placed  other new                                                                    
revenue measures  on the table  which would not go  into the                                                                    
PF.                                                                                                                             
                                                                                                                                
Commissioner  Hoffbeck confirmed  that the  corporate income                                                                    
taxes  and the  petroleum  property taxes  were the  largest                                                                    
revenues. There  were other revenues that  would equal about                                                                    
$800 million  to $850  million in fees  and taxes  that were                                                                    
currently on the books. The  Department of Revenue projected                                                                    
an  additional $100  million to  $150 million  in investment                                                                    
earnings  outside of  the PF.  He concluded  that there  was                                                                    
about $1 billion in other revenues that flowed into the GF.                                                                     
                                                                                                                                
Representative  Munoz  noted  that  Commissioner  Hoffbeck's                                                                    
figures  brought  the total  up  to  about $4  billion.  She                                                                    
wondered  how the  plan  balanced  the budget.  Commissioner                                                                    
Hoffbeck  mentioned new  revenues of  about $450  million in                                                                    
new taxes proposed by the  governor and additional cuts. The                                                                    
governor's plan had about $500 million in reductions.                                                                           
                                                                                                                                
Co-Chair  Thompson  referred back  to  the  barrel chart  on                                                                    
slide  18.  He  noted  that   the  PFD  would  be  based  on                                                                    
royalties. Statements had  been made that 50  percent of the                                                                    
royalties  would  go  towards   the  PFD  payments.  In  the                                                                    
scenario on the barrel chart  it appeared that 25 percent of                                                                    
royalties were  placed into the  corpus and 75  percent into                                                                    
the ERA.  He wondered if  50 percent of the  total royalties                                                                    
would go towards  dividends or 50 percent of  the 75 percent                                                                    
that were going into the ERA.                                                                                                   
                                                                                                                                
Attorney General  Richards responded that it  was 50 percent                                                                    
of total  royalties. He  added that the  50 percent  did not                                                                    
have to run through  the PF. It made sense to  do so from an                                                                    
asset  management   perspective  as  well  as   keeping  the                                                                    
dividend tied to  the PF. The administration  thought it was                                                                    
part of Alaska's psyche which made sense to maintain.                                                                           
                                                                                                                                
2:56:39 PM                                                                                                                    
                                                                                                                                
Attorney General  Richards scrolled  to slide  24: "Earnings                                                                    
Reserve Durability."  He indicated that the  slide addressed                                                                    
the sustainability  of the  earnings reserve.  He emphasized                                                                    
that  whatever  endowment  model   was  adopted  (POMV,  the                                                                    
governor's plan,  or another plan) needed  to be accompanied                                                                    
by a  high level  of confidence that  enough money  would be                                                                    
available in  the earnings reserve  to pay the  dividend and                                                                    
the  payout to  the GF  each year  because the  constitution                                                                    
stated that the corpus of the  fund could not be touched. If                                                                    
the state  were to run  its savings  down to zero  the state                                                                    
would be faced  with a fiscal hole that could  be plugged by                                                                    
sending less  to the GF  then planned  or by not  paying the                                                                    
dividend  as  planned.  In   the  administration's  plan  it                                                                    
created a  high level of  certainty by maintaining  a target                                                                    
balance in the  ERA of four times the annual  payout. Such a                                                                    
target provided  the state  4 years  of cash-on-hand  to pay                                                                    
the total  draw down each  year. He  asserted that it  was a                                                                    
fairly robust  target figure. He  had heard that  the Alaska                                                                    
Mental  Health Trust  used a  similar system,  the ratio  of                                                                    
which was smaller.  They had been successful  in having less                                                                    
than four times in their payout account.                                                                                        
                                                                                                                                
Vice-Chair Saddler  asked if  the same  conservative, short-                                                                    
term, cash-based  investment standards  would be  applied to                                                                    
the  funds available  to pay  dividends. He  wondered if  it                                                                    
would  decrease  the overall  take  on  the corpus  and  the                                                                    
earnings reserve.                                                                                                               
                                                                                                                                
Attorney General Richards relayed  that the earnings reserve                                                                    
was  typically managed  the same  as the  corpus of  the PF.                                                                    
However,  if money  needed  to be  withdrawn  every year  in                                                                    
addition  to  the  dividends  the funds  would  need  to  be                                                                    
managed  for  more liquidity.  Some  amount  of money  would                                                                    
possibly be  managed shorter  term, but  most likely  only a                                                                    
small  percentage.  He  had discussed  the  issue  with  the                                                                    
Permanent Fund Corporation.                                                                                                     
                                                                                                                                
Vice-Chair  Saddler commented  that he  would have  accepted                                                                    
accounting for  more volatility at  an amount of  four times                                                                    
the expected draw.                                                                                                              
                                                                                                                                
2:59:37 PM                                                                                                                    
                                                                                                                                
Co-Chair Thompson  wondered why  any excess funds  above the                                                                    
targeted  reserve  amount  would  be placed  in  the  corpus                                                                    
rather than in the SBR or the CBR for emergency purposes.                                                                       
                                                                                                                                
Attorney   General  Richards   stated  that   Representative                                                                    
Thompson's  suggestion   was  feasible  and  was   a  policy                                                                    
decision. However,  it would impact  the model by  no longer                                                                    
reaching the sustainability goals.  If the money was removed                                                                    
from  the  PF above  the  target  reserve amount  (used  for                                                                    
inflation-proofing  the  corpus)  the corpus  would  not  be                                                                    
growing the size of the  PF equal to inflation. He furthered                                                                    
that the  definition of sustainability would  have to change                                                                    
to exclude  inflation-proofing or  draw less to  account for                                                                    
the growth in the system.                                                                                                       
                                                                                                                                
Attorney General  Richards advanced  to slide  25: "Earnings                                                                    
Reserve Durability." He noted  that regarding durability the                                                                    
4:1  target  amount was  conservative  and  provided a  high                                                                    
level of confidence and coincided  with the state's periodic                                                                    
review. In  the following  year and in  every 4  years after                                                                    
there  would be  an analysis  of the  sustainability of  the                                                                    
plan, whether the draw amount  needed adjusting, and whether                                                                    
the  ERA was  sufficiently  durable. Having  the 4:1  target                                                                    
ratio in place meant that  the state would have about enough                                                                    
money to provide  for the period of time between  the 4 year                                                                    
review cycles.                                                                                                                  
                                                                                                                                
Representative Guttenberg  was unsure whether the  4:1 ratio                                                                    
was the  proper proportion.  He assumed that  the investment                                                                    
board  conducted  the modeling  and  the  reviews. He  asked                                                                    
whether  the sufficient  time to  react had  to do  with the                                                                    
investing   or   the   legislature's  ability   to   provide                                                                    
solutions.                                                                                                                      
                                                                                                                                
Attorney  General  Richards  reported that  the  legislation                                                                    
called for  the DOR to  conduct periodic reviews  with input                                                                    
from  the   PF  Board   of  Trustees.  The   Permanent  Fund                                                                    
Corporation  was not  doing the  modeling but  providing the                                                                    
return assumptions  and the statutory return  assumptions to                                                                    
be used in  the modeling. It was expected that  the PF would                                                                    
not  manage to  the model.  If an  adjustment was  needed it                                                                    
would be at the direction  of the legislature. The Permanent                                                                    
Fund Corporation  did not dictate  how much money  should be                                                                    
in the fund or how it  was spent. It took direction from the                                                                    
legislature.                                                                                                                    
                                                                                                                                
3:03:45 PM                                                                                                                    
                                                                                                                                
Representative  Guttenberg  conveyed  that  discussions  had                                                                    
been going  on about the  management of  the PF to  meet the                                                                    
state's budget level.                                                                                                           
                                                                                                                                
Commissioner Hoffbeck mentioned  hearing two complaints most                                                                    
frequently  about  the  governor's   plan  relating  to  the                                                                    
dividend.  First,  it changed  the  value  of the  dividend.                                                                    
Second, the volatility was transferred  to the dividend even                                                                    
though  it created  a sustainable  draw  for government.  He                                                                    
believed that the concerns were  addressed in slide 26: "How                                                                    
to Handle  the Dividend: Historic Dividends."  He noted that                                                                    
the dividend  had always  been volatile  never having  had a                                                                    
fixed  price. Over  a period  of the  previous 12  years the                                                                    
dividend reached  over $1500 on  4 occasions,  between $1000                                                                    
to  $1500  on 4  occasions,  and  below  $1000 4  times.  He                                                                    
furthered that  the dividend would  continue to  be volatile                                                                    
in the  future, no matter  the formula. He pointed  out that                                                                    
the dividend had  been high for the previous  2 years: $1800                                                                    
dividend 2  years previously and  the highest  dividend ever                                                                    
in the prior  year. The median payout over  the 34-year life                                                                    
of  the dividend  was about  $1000. The  average payout  was                                                                    
$1140.  He also  noted  that the  dividend  payout had  only                                                                    
reached above $2000 twice in  34 years. Secondly, the fiscal                                                                    
plan included  a balance  of the  earnings from  the state's                                                                    
wealth,  its   spending,  new   taxes,  and   the  dividend.                                                                    
Increasing  the  size of  the  dividend  would decrease  the                                                                    
amount  of  earnings  that  could  be  used  for  government                                                                    
services which  would require more  new taxes  or additional                                                                    
reductions.  He reiterated  that a  $2000 assumption  of the                                                                    
dividend payout was not consistent with historic data.                                                                          
                                                                                                                                
3:06:41 PM                                                                                                                    
                                                                                                                                
Commissioner Hoffbeck advanced to slide 27:  "How  to Handle                                                                    
the  Dividend:  The  current   formula  distributes  50%  of                                                                    
realized gains." He relayed that  the dividend was generated                                                                    
by a  formula. The  constitution stated that  all of  the PF                                                                    
earnings were to  be deposited into the  general fund unless                                                                    
otherwise provided  by law. The earnings  have always flowed                                                                    
out of  the dividend  and made  accessible. The  current law                                                                    
provided that  the earnings  were to be  used for  4 things:                                                                    
dividend payments,  inflation-proofing the  corpus, earnings                                                                    
reserves, or savings. The funds  in the earnings reserve had                                                                    
always  been available  for  appropriation. The  legislature                                                                    
created a  stable and durable circumstance  by following the                                                                    
rules established by a legislature 35 years previously.                                                                         
                                                                                                                                
Vice-Chair Saddler  had heard  criticism from  some Alaskans                                                                    
that the legislature had "Spent  like drunken sailors, spent                                                                    
every dollar available to them."  He thought the information                                                                    
that  Commissioner Hoffbeck  had presented  made it  clearly                                                                    
evident  that  the legislature  had  been  prudent with  the                                                                    
large  influx  of revenue,  spending  only  half of  it  and                                                                    
saving  the  other  half. Commissioner  Hoffbeck  responded,                                                                    
"Absolutely."                                                                                                                   
                                                                                                                                
Representative Edgmon  commented that  with the  downturn in                                                                    
oil  revenues there  would  be a  shrinkage  in the  overall                                                                    
gross domestic product of Alaska.  He wondered if any of the                                                                    
modeling  pointed  to  a  decrease  in  Alaska's  population                                                                    
resulting in an increase in  dividend payouts in the future.                                                                    
Commissioner Hoffbeck  commented that in doing  the modeling                                                                    
the DOR considered  that there would likely be  a decline in                                                                    
population in future years.                                                                                                     
                                                                                                                                
Representative Gara referred to  the previous page where the                                                                    
commissioner  talked about  the  historical  average of  the                                                                    
dividend being about $1100. He  relayed that for most of the                                                                    
life of  the dividend  the PF  balance had  not been  at $50                                                                    
billion. He  did not  feel it  was fair  to factor  in years                                                                    
when the PF did not have a high balance.                                                                                        
                                                                                                                                
Attorney  General  Richards  made  the  point  that  no  one                                                                    
expected investment  returns such as  in the '80s  and '90s.                                                                    
The historic  growth of the  fund was over 9  percent during                                                                    
that time. Currently the projection was 6.9 percent.                                                                            
                                                                                                                                
3:10:08 PM                                                                                                                    
                                                                                                                                
Commissioner   Hoffbeck  explained   the  current   dividend                                                                    
formula. The  state took a  5-year average of  the statutory                                                                    
net income (using a 21  percent figure) that flowed into the                                                                    
ERA.  Half  of the  5-year  average  was  taken to  pay  the                                                                    
dividend. In  using the previous year's  numbers the balance                                                                    
of  the PF  was $13  billion times  21 percent  equaled $2.7                                                                    
billion.  Half   of  $2.7  billion   or  $1.4   billion  was                                                                    
transferred  from  the ERA  into  the  dividend fund.  After                                                                    
adjustments the dividend  fund was divided by  the number of                                                                    
eligible   applicants,   more  than   644,000.   Individuals                                                                    
received   a  check   for  $2072   [in  2015].   It  was   a                                                                    
legislatively derived formula from 35 years previously.                                                                         
                                                                                                                                
Commissioner  Hoffbeck  turned  to  slide  28:  "APFC  Board                                                                    
Resolution 03-05."                                                                                                              
                                                                                                                                
     "The Board recognizes that … a POMV spending limit                                                                         
     methodology … may necessitate changes to … the                                                                             
     Permanent Fund Dividends"                                                                                                  
                                                                                                                                
Commissioner  Hoffbeck   concluded  that  people   began  to                                                                    
recognize that  once earnings were  used in any  fashion the                                                                    
dividend payout  would change. The formula,  inputs, or both                                                                    
would  change along  with the  payout. The  earnings reserve                                                                    
would have  to be  used in some  portion to  fund government                                                                    
services. If a person allowed for  the fact that some of the                                                                    
earnings  would be  used going  forward,  then the  dividend                                                                    
formula would change no matter what.                                                                                            
                                                                                                                                
Commissioner Hoffbeck  pointed to  slide 29: "How  to Handle                                                                    
the Dividend." He relayed that  the governor's proposal tied                                                                    
the dividend to royalties,  50 percent of Alaska's ownership                                                                    
share  in oil  revenues. It  connected the  dividend to  the                                                                    
success of the state and tied  Alaskans to the economy. As a                                                                    
resource  state  the  better  it  was  doing  with  resource                                                                    
development  the better  for the  state. The  dividend would                                                                    
increase  or  decrease according  to  what  the state  could                                                                    
afford to  pay by tying it  to the royalty. The  state could                                                                    
also  payout a  flat  dividend of  $1000  or $1200  dividend                                                                    
going  forward. It  would  just change  the  amounts of  the                                                                    
other  components. He  reported  that  $1000 dividend  would                                                                    
equal about $650 million per  year based on Alaska's current                                                                    
population. Compared to the 50  percent royalty dividend, it                                                                    
would  drop  the  state's sustainable  draw  by  about  $200                                                                    
million per year.                                                                                                               
                                                                                                                                
Co-Chair Thompson  asked for a  report on what had  been the                                                                    
royalty  value  over  the previous  10  years.  Commissioner                                                                    
Hoffbeck would provide the information.                                                                                         
                                                                                                                                
3:14:18 PM                                                                                                                    
                                                                                                                                
Representative  Wilson asked  about  the  connection of  the                                                                    
dividend  to  the  state's success.  She  wondered  why  the                                                                    
state's success was not related to its spending.                                                                                
Commissioner Hoffbeck replied that  was his third option not                                                                    
listed on  the slide. The  state could  tie the size  of the                                                                    
dividend to the fixed draw linking it to state spending.                                                                        
                                                                                                                                
Representative Wilson  interjected that her question  had to                                                                    
do with  why the success of  the state was not  connected to                                                                    
its spending.  Commissioner Hoffbeck suggested that  to some                                                                    
extent he felt  that as part of the plan  state spending had                                                                    
to drop.  The budget  could not be  balanced by  only taking                                                                    
one  element  of  the  plan, but  rather  all  three:  cuts,                                                                    
revenues, and the use of the earnings reserve.                                                                                  
                                                                                                                                
Representative Wilson  agreed that the state  could not rely                                                                    
solely on  oil revenues. She thought  there were sustainable                                                                    
numbers  with  the  right  size of  government  down  to  $4                                                                    
billion  or  $4.5  billion.  She   was  hearing  more  about                                                                    
generating  new   revenue  rather  than   controlling  state                                                                    
spending.  She opined  that a  balance  between revenue  and                                                                    
spending was lacking.  She did not believe  the reduction of                                                                    
$100  million was  enough. She  wondered if  there were  any                                                                    
formulas  being  discussed having  to  do  with the  state's                                                                    
spending levels.                                                                                                                
                                                                                                                                
Co-Chair Thompson  reported that the subcommittees  would be                                                                    
coming  back   to  the  finance  committee   with  suggested                                                                    
sustainable  spending levels.  Additional revenues  were the                                                                    
current focus.                                                                                                                  
                                                                                                                                
Commissioner  Hoffbeck opined  that the  APFPA started  with                                                                    
determining the  sustainable draw.  The other  targets would                                                                    
be   decided  once   establishing  the   draw  amount.   The                                                                    
administration  had $1  billion  dollars to  account for  to                                                                    
balance the  budget. He suggested that  the discussion would                                                                    
become  about   reducing  the  size   of  government   or  a                                                                    
combination of that and generating new revenues.                                                                                
                                                                                                                                
Attorney General  Richards invited  members to  consider the                                                                    
options on  slide 30: "Periodic  Review." He thought  he had                                                                    
already covered  the key points  and would move to  the next                                                                    
slide.  He added  that a  periodic  review was  a good  idea                                                                    
regardless of what plan was decided upon.                                                                                       
                                                                                                                                
3:18:02 PM                                                                                                                    
                                                                                                                                
Attorney General Richards scrolled  to slide 32: "Government                                                                    
Spending  &  the Economy."  He  suggested  that the  state's                                                                    
current  situation was  due to  the volatility  of commodity                                                                    
prices and perhaps long-term declines  in oil production. He                                                                    
relayed that  there were other  oil-based economies  such as                                                                    
Africa,  the Middle  East, Wyoming,  and  Alberta that  were                                                                    
experiencing  similar  types  of   issues  that  Alaska  was                                                                    
encountering.  He  wondered  how   to  have  a  sustainable,                                                                    
predictable, rational  budget when 70 percent  to 90 percent                                                                    
of revenue  was based  upon a commodity  that could  jump 50                                                                    
percent in price from year-to-year.                                                                                             
                                                                                                                                
Attorney  General Richards  noted  that  recently there  had                                                                    
been a  significant amount of academic  and other literature                                                                    
available on  how to address  the problem. He  reported that                                                                    
in  October  the  International Monetary  Fund  finalized  a                                                                    
report that  compared 85  economies over  3 decades.  It was                                                                    
determined  that the  devil was  pro-cyclical spending.  The                                                                    
state needed  to address its pro-cyclical  spending; the way                                                                    
in which  commodity-based economies tended to  spend more on                                                                    
government at times when commodity  prices were high and the                                                                    
economy was  doing well. There were  typically large capital                                                                    
budgets, growth  in operating budgets,  and growth  in other                                                                    
service  budgets.  At  times   when  commodity  prices  fell                                                                    
without a designed fiscal system  to handle the fall capital                                                                    
budgets were reduced and operating  budget growth was clawed                                                                    
back. The  report stated that  for economies that  were able                                                                    
to design  rules-based systems or diversified  their revenue                                                                    
bases  through  other  forms  of  taxation  to  address  the                                                                    
commodity rollercoaster,  the net result was  an increase in                                                                    
.3  percent year-to-year  GDP  growth -  a  huge number.  If                                                                    
there  were booms  and busts  in an  economy accompanied  by                                                                    
contraction  in  investor confidence,  consumer  confidence,                                                                    
and  governmental spending,  an  economy's long-term  growth                                                                    
would be hampered significantly.                                                                                                
                                                                                                                                
3:20:54 PM                                                                                                                    
                                                                                                                                
Attorney General  Richards turned  back to slide  16: "Rule-                                                                    
Based Fiscal  Policy" referring  to it  as his  capstone. He                                                                    
explained that  the slide talked  about some of  the factors                                                                    
the administration believed  the legislature should consider                                                                    
if  the state  was going  to adopt  an endowment  model that                                                                    
spent PF earnings  in a way other than  paying dividends. He                                                                    
framed the policy in terms  of rules. In looking at Alaska's                                                                    
history and  hearing from Mr.  Rietveld who  testified about                                                                    
sovereign wealth  funds, the  administration found  that the                                                                    
critical   components   that   made   the   legislature   so                                                                    
disciplined  with  the  PF   were  rules-based  systems  and                                                                    
customs that were in place  defining when the PF money could                                                                    
be  spent.  Following  the rules-based  systems  the  Alaska                                                                    
Legislature  had done  an amazing  job by  always inflation-                                                                    
proofing the  fund (even though it  was not constitutionally                                                                    
mandated), methodically following  a dividend payout formula                                                                    
(also not constitutionally mandated),  and never tapping the                                                                    
earnings reserve  in an ad-hoc  manner to pay for  a capital                                                                    
project  or  to make  up  some  short-term budget  shortfall                                                                    
(even in the  '90s when it needed to).  It showed incredible                                                                    
discipline for a body to  follow a rules-based system if the                                                                    
rules were  well defined. Even though  inflation-proofing, a                                                                    
dividend payout, and  no ad-hoc spending were a  result of a                                                                    
majority vote. The legislature  had followed the rules-based                                                                    
system for the previous 30  plus years.  The governor's plan                                                                    
hoped to take  the current-rules based system  and modify it                                                                    
to a  slightly different rules-based system  that maintained                                                                    
the equal  level of  respect and  custom by  the legislature                                                                    
even  though  it  was  subject  to  an  appropriation  of  a                                                                    
majority vote going forward, much like the old PF system.                                                                       
                                                                                                                                
Attorney  General  Richards  continued  that  when  thinking                                                                    
about the  proposed plan he  encouraged members  to consider                                                                    
the  rules for  addressing each  problem. The  first problem                                                                    
had to do with whether the  proposal had a way to remove the                                                                    
roller  coaster  consequences  to  the  budget  and  to  the                                                                    
economy   associated   with   oil  price   volatility.   The                                                                    
governor's  plan  accomplished  this by  placing  production                                                                    
taxes  and royalties  into  the  PF and  by  having a  fixed                                                                    
amount withdrawn as  an annuity. There were  other ways such                                                                    
as a  spending rule  or some other  mechanism that  might be                                                                    
used  to similarly  or  differently  address volatility.  He                                                                    
thought the question should be  about how the plan addressed                                                                    
volatility. The second rule was  a new spending rule. If the                                                                    
state was going to draw funds out  of the PF to go to the GF                                                                    
then  a rule  was  needed  such as  a  POMV  or a  fix-based                                                                    
system.  He   reasoned  that   many  different   rules  were                                                                    
defensible, but having a rule was critical.                                                                                     
                                                                                                                                
Attorney  General  Richards  reviewed the  third  rule.  The                                                                    
savings rule would  be different depending on  the plan. The                                                                    
baseline would always be 25  percent of royalties because it                                                                    
was constitutionally  mandated. There  were also  other ways                                                                    
of having savings included. He  provided an example from the                                                                    
governor's  plan which  would include  additional taxes  and                                                                    
royalty revenues  into the PF.  The fourth rule,  the growth                                                                    
rule,  required  sustainability.  In  looking  at  different                                                                    
proposals  to use  the PF,  sustainability needed  to be  an                                                                    
important factor.  In other words,  the long-term  growth of                                                                    
the PF needed consideration for  each of the potential plans                                                                    
under evaluation.  Under the governor's  plan growth  had to                                                                    
be  at least  at a  level equal  to inflation-proofing.  The                                                                    
final rule he encouraged members  to look at were protection                                                                    
rules. He  asked what rules-based  system would be  in place                                                                    
to  prevent  ad-hoc  rates.  The   current  system  and  the                                                                    
governor's system  were similar because in  both plans there                                                                    
was a  constitutional protection of the  corpus, a statutory                                                                    
rules-based  protection,  and  a  custom  built  around  the                                                                    
earnings reserve. He  thought that the 5 rules  in the slide                                                                    
provided a good framework  to assist legislators in thinking                                                                    
about  and  comparing  different  proposals to  tap  the  PF                                                                    
earnings.                                                                                                                       
                                                                                                                                
3:25:58 PM                                                                                                                    
                                                                                                                                
Attorney General Richards referred  to slide 36: "Delay will                                                                    
. . ."                                                                                                                          
                                                                                                                                
     Delay will . . .                                                                                                           
                                                                                                                                
        · Risk the sustainability of an endowment plan                                                                          
        · Reduce the sustainable draw                                                                                           
       · Risk a downgrade of Alaska's credit rating                                                                             
        · Damage Alaska's economy                                                                                               
                                                                                                                                
Attorney General Richards told  the committee that the slide                                                                    
was   included  at   Representative  Edgmon's   request.  He                                                                    
reported   that    particular   question   posed    to   the                                                                    
administration was  whether there  was a  cost of  delay. He                                                                    
defined delay to  be "kicking the can down the  road" or not                                                                    
making any decisions in the  current year. He responded that                                                                    
it  would be  difficult  to quantify  or capture  everything                                                                    
that  could be  affected.  The  administration identified  4                                                                    
costs to delaying making decisions.  The first he identified                                                                    
as the  sustainability of the  endowment plan.  He explained                                                                    
that  currently  DOR  projected   that  without  making  any                                                                    
changes (status  quo) the state would  completely spend down                                                                    
the CBR  and the earnings  reserve by FY 22.  However, there                                                                    
was  a 20  percent  chance that  it could  happen  by FY  21                                                                    
depending on the  stock market performance and  the price of                                                                    
oil. The  state would not have  enough money by FY  21 or FY                                                                    
22  if changes  were not  made  to meet  the state's  budget                                                                    
holes with the  CBR and the earnings reserve. There  was a 5                                                                    
percent chance that  the state would run out of  money by FY                                                                    
20.  Another  cost of  delaying  the  implementation of  the                                                                    
governor's plan or another plan  in place was that the state                                                                    
would  spend   down  more   savings  reducing   the  state's                                                                    
sustainable draw. If the state  waited 1 year the draw would                                                                    
decrease  by $100  million to  $150 million.   If  the state                                                                    
waited 3 years  the sustainable draw would  decrease by $400                                                                    
million to $500 million.                                                                                                        
                                                                                                                                
Attorney General  Richards reported that the  last two costs                                                                    
included  the downgrade  of Alaska's  credit rating  and the                                                                    
overall  damage to  Alaska's economy.  Both risks  were more                                                                    
qualitative than  the first 2  items. The Department  of Law                                                                    
had asked the DOR to quantify  the actual costs to Alaska in                                                                    
terms of  an increased  interest as a  result of  any credit                                                                    
downgrades.  He reported  that  Standard  and Poor's  stated                                                                    
that  the state's  credit rating  would decrease  if nothing                                                                    
changed.  Lastly, the more  qualitative problem of delay was                                                                    
that  if investors  and individual  Alaskans did  not see  a                                                                    
path forward  that gleaned confidence  they would  likely be                                                                    
less willing to invest. There  could be a potential rippling                                                                    
effect of  higher unemployment  and a  drop in  home values:                                                                    
consequences   of  the   economy  not   moving  forward.   A                                                                    
sustainable  budget was  such a  large part  of the  state's                                                                    
economy. He would be providing  some of the actual financial                                                                    
costs in borrowing if the state was downgraded.                                                                                 
                                                                                                                                
3:30:07 PM                                                                                                                    
                                                                                                                                
Representative Edgmon  appreciated the slide. He  thought it                                                                    
captured  the macro  factors involved  with kicking  the can                                                                    
down the road.  He was most concerned with  the fourth item,                                                                    
damaging  Alaska's economy.  He  wanted to  hear more  about                                                                    
item four  and suggested also  hearing from people  from the                                                                    
private sector  about damaging Alaska's economy.  It was new                                                                    
for  the legislature  to have  to entertain  such a  drastic                                                                    
level of new revenues, budget  reductions, taxes, and all of                                                                    
the  pejorative things  imaginable in  an election  year. He                                                                    
thought it to be a  watershed proposition if the legislature                                                                    
were  to  endow  an  endowment   plan.  He  wanted  to  hear                                                                    
additional  comments  on  how delay  would  damage  Alaska's                                                                    
economy.                                                                                                                        
                                                                                                                                
Co-Chair  Thompson   remarked  that  there  would   be  more                                                                    
detailed  vetting  of the  bill  along  with others  in  the                                                                    
future.                                                                                                                         
                                                                                                                                
Vice-Chair Saddler referred to  the governor's comment about                                                                    
how the  plan was written in  pencil rather than in  ink. He                                                                    
asked how  much of the bill  (HB 245, version A)  was in ink                                                                    
and in  pencil. He wondered  how committed the  governor was                                                                    
to each  element of the plan  or to the general  concept. He                                                                    
noted that there were competing concepts.                                                                                       
                                                                                                                                
Attorney General Richards  responded that the administration                                                                    
and the governor  were committed to the plan  and thought it                                                                    
was the best  plan in terms of addressing  the issues listed                                                                    
on his  capstone slide (growth, volatility,  protection, and                                                                    
spending rules). He suggested that at  the end of the day it                                                                    
was  the  legislature's prerogative  to  adopt  a bill  they                                                                    
thought  was best.  He added  that the  administration would                                                                    
work  with the  legislature  to come  to  a compromise  that                                                                    
addressed  all the  items on  the capstone  slide. Both  the                                                                    
governor's  plan  and  a  POMV plan  worked  under  any  PFD                                                                    
formulation. The dividend could be  set at any level. Future                                                                    
dividends could be  based on a number  of calculations which                                                                    
would be  part of the  dialogue. At the  end of the  day the                                                                    
consequence  would  be how  much  could  be taken  from  the                                                                    
system for GF spending.                                                                                                         
                                                                                                                                
Vice-Chair Saddler asked  if there were any  elements of the                                                                    
bill  that, if  not passed  into law,  the Attorney  General                                                                    
Richards would advise the governor to veto.                                                                                     
                                                                                                                                
Attorney General Richards  had not had such  a dialogue with                                                                    
the governor.                                                                                                                   
                                                                                                                                
HB  245  was  HEARD  and   HELD  in  committee  for  further                                                                    
consideration.                                                                                                                  
                                                                                                                                
Co-Chair  Thompson  indicated   there  would  be  additional                                                                    
hearings  on  HB  245  and a  sectional  analysis  would  be                                                                    
provided  for  review.  He  conveyed   the  agenda  for  the                                                                    
following day.                                                                                                                  
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
3:34:32 PM                                                                                                                    
                                                                                                                                
The meeting was adjourned at 3:34 p.m.                                                                                          

Document Name Date/Time Subjects
HB 245 - Alaska Permanent Fund Protection Act (Feb 15 2016 HF).pdf HFIN 2/15/2016 1:30:00 PM
HB 245
HB 245 NEW FN DOA VCCB 2-15-16.pdf HFIN 2/15/2016 1:30:00 PM
HB 245
HB 245 - Dividend comparison - response to HFIN (2 25 16).pdf HFIN 2/15/2016 1:30:00 PM
HB 245