Legislature(2015 - 2016)BARNES 124

02/18/2015 03:15 PM LABOR & COMMERCE

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Audio Topic
03:29:28 PM Start
03:29:47 PM HB86
03:45:12 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
*+ HB 86 PCE ENDOWMENT FUND INVESTMENT TELECONFERENCED
Heard & Held
                    ALASKA STATE LEGISLATURE                                                                                  
          HOUSE LABOR AND COMMERCE STANDING COMMITTEE                                                                         
                       February 18, 2015                                                                                        
                           3:29 p.m.                                                                                            
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Representative Kurt Olson, Chair                                                                                                
Representative Shelley Hughes, Vice Chair                                                                                       
Representative Jim Colver                                                                                                       
Representative Gabrielle LeDoux                                                                                                 
Representative Cathy Tilton                                                                                                     
Representative Andy Josephson                                                                                                   
Representative Sam Kito                                                                                                         
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
Representative Mike Chenault (alternate)                                                                                        
                                                                                                                                
COMMITTEE CALENDAR                                                                                                            
                                                                                                                                
HOUSE BILL NO. 86                                                                                                               
"An Act relating to investment of the power cost equalization                                                                   
endowment fund; and providing for an effective date."                                                                           
                                                                                                                                
     - HEARD & HELD                                                                                                             
                                                                                                                                
PREVIOUS COMMITTEE ACTION                                                                                                     
                                                                                                                                
BILL: HB 86                                                                                                                   
SHORT TITLE: PCE ENDOWMENT FUND INVESTMENT                                                                                      
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR                                                                                    
                                                                                                                                
01/30/15       (H)       READ THE FIRST TIME - REFERRALS                                                                        
01/30/15       (H)       L&C, FIN                                                                                               
02/18/15       (H)       L&C AT 3:15 PM BARNES 124                                                                              
                                                                                                                                
WITNESS REGISTER                                                                                                              
                                                                                                                                
JERRY BURNETT, Deputy Commissioner                                                                                              
Office of the Commissioner                                                                                                      
Department of Revenue (DOR)                                                                                                     
Juneau, Alaska                                                                                                                  
POSITION STATEMENT:  Testified during the discussion of HB 86.                                                                
                                                                                                                                
PAMELA LEARY, Director, Treasury Division                                                                                       
Department of Revenue (DOR)                                                                                                     
Juneau, Alaska                                                                                                                  
POSITION  STATEMENT:     Answered   questions  and   presented  a                                                             
PowerPoint  on   the  Power  Cost  Equalization   Endowment  Fund                                                               
Investment during the discussion of HB 86.                                                                                      
                                                                                                                                
GARY BADER, Chief Investment Officer                                                                                            
Treasury Division                                                                                                               
Department of Revenue                                                                                                           
Juneau, Alaska                                                                                                                  
POSITION  STATEMENT:     Answered   questions  and   presented  a                                                             
PowerPoint  on   the  Power  Cost  Equalization   Endowment  Fund                                                               
Investment during the discussion of HB 86.                                                                                      
                                                                                                                                
ACTION NARRATIVE                                                                                                              
                                                                                                                                
3:29:28 PM                                                                                                                    
                                                                                                                                
CHAIR KURT  OLSON called  the House  Labor and  Commerce Standing                                                             
Committee meeting to order at  3:29 p.m.  Representatives Colver,                                                               
Kito, Josephson,  Tilton, Hughes  and Olson  were present  at the                                                               
call to  order.   Representatives LeDoux  arrived as  the meeting                                                               
was in progress.                                                                                                                
                                                                                                                                
              HB 86-PCE ENDOWMENT FUND INVESTMENT                                                                           
                                                                                                                                
3:29:47 PM                                                                                                                    
                                                                                                                                
CHAIR OLSON  announced that the  only order of business  would be                                                               
HOUSE BILL  NO. 86, "An Act  relating to investment of  the power                                                               
cost equalization endowment fund;  and providing for an effective                                                               
date."                                                                                                                          
                                                                                                                                
3:30:22 PM                                                                                                                    
                                                                                                                                
JERRY BURNETT,  Deputy Commissioner, Office of  the Commissioner,                                                               
Department  of Revenue,  stated that  HB 86  is a  very important                                                               
bill.   He stated  that Pam  Leary, Director,  Treasury Division;                                                               
and  Gary  Bader,  the  state's  Chief  Investment  Officer  will                                                               
present the bill.                                                                                                               
                                                                                                                                
3:31:15 PM                                                                                                                    
                                                                                                                                
PAMELA LEARY, Director, Treasury  Division, Department of Revenue                                                               
(DOR), offered  to provide a  brief history of the  fund, present                                                               
the bill, and discuss any considerations.                                                                                       
                                                                                                                                
3:31:52 PM                                                                                                                    
                                                                                                                                
MS.  LEARY  stated  that the  original  Power  Cost  Equalization                                                               
Endowment Fund was  established in 2000.  Its purpose  is to fund                                                               
the   Power   Cost   Equalization    (PCE)   &   Rural   Electric                                                               
Capitalization Fund  and to reimburse  the costs  associated with                                                               
managing the  fund [slide  2].   She said that  7 percent  of the                                                               
monthly average market  value of the fund for  the previous three                                                               
fiscal years  may be  appropriated annually.   The  Department of                                                               
Revenue, Treasury  Division provides the Alaska  Energy Authority                                                               
(AEA) with that  figure annually.  She provided  a brief history,                                                               
such  that the  PCE  Endowment  Fund was  established  by a  $100                                                               
million  appropriation from  the  Constitutional Budget  Reserve,                                                               
along with  $89.6 million from proceeds  of the sale of  the four                                                               
dam    pool   hydroelectric    project,   and    two   additional                                                               
appropriations:  $182.7  in 2007, and $400 million in  2012.  The                                                               
current  balance of  the  PCE Endowment  Fund  is $950.7  million                                                               
[slide 1].                                                                                                                      
                                                                                                                                
3:33:11 PM                                                                                                                    
                                                                                                                                
MS. LEARY  directed attention to HB  86 to Section 1  of the bill                                                               
that does two important things [slide  3].  First, it removes the                                                               
stated  nominal return  target of  at  least 7  percent from  the                                                               
statute, which will  allow the commissioner of  the Department of                                                               
Revenue (DOR) to invest the fund  in the manner that can meet the                                                               
objectives of the  fund.  It would also  provide the commissioner                                                               
the ability invest  in less risky investments when  it is prudent                                                               
to do so, but still meet  the financial needs of the fund itself.                                                               
She pointed out that there is  a zero fiscal note associated with                                                               
HB 86 since it will not  require additional funds to continue the                                                               
work.                                                                                                                           
                                                                                                                                
3:33:55 PM                                                                                                                    
                                                                                                                                
GARY   BADER,  Chief   Investment  Officer,   Treasury  Division,                                                               
Department of Revenue  (DOR), stated that the goal  is to achieve                                                               
the  best return  for  the least  amount of  risk.   The  current                                                               
statutes direct the Commissioner of  Revenue to attempt to earn 7                                                               
percent each year without regard to risk.                                                                                       
                                                                                                                                
MR.  BADER directed  attention to  slide 4,  to the  2015 Capital                                                               
Market Expectations  - Return and  Risk.  This shows  the capital                                                               
market assumptions  provided to the Alaska  Retirement Management                                                               
Board by Callan  and Associations.  He directed  attention to the                                                               
top  third bracket  of  the investment  asset  classes or  equity                                                               
investment classes and three columns  over to the column entitled                                                               
"1-year Arithmetic" return,  which shows high rates  of return if                                                               
one considers  the return will  be the mathematical  average over                                                               
several  years,  or  the  mean  average.    The  column  entitled                                                               
"Projected  Risk, Standard  Deviation" means  that two-thirds  of                                                               
the  time the  returns to  the  fund will  be plus  or minus  the                                                               
standard deviation.  Thus, when  viewing broad domestic equity, a                                                               
"1-year arithmetic  return" means that  the fund would  earn 9.15                                                               
percent  over a  10-year  expectation plus  or  minus 19  percent                                                               
[using the  standard deviation].   Therefore,  it is  possible to                                                               
lose 10 percent  during two-thirds of the time,  but during other                                                               
times  the  percentage could  be  far  more  or  far less.    The                                                               
aforementioned standard  deviation affects the  geometric return.                                                               
The column  entitled, "10-year Geometric Projected  Return," is a                                                               
term  that means  when  there  is a  volatility  of returns,  the                                                               
actual amount  one could expect  to gain would be  something less                                                               
than the  arithmetic return.   It is always  true, he said.   For                                                               
example,  an  initial  $100 investment  with  an  expectation  of                                                               
[zero]  percent  on  average  and  a  standard  deviation  of  50                                                               
percent,  could  increase to  $150,  but  if  50 percent  of  the                                                               
investment was lost  the next year, the  initial investment would                                                               
be reduced to $75.  Thus,  while the arithmetic average was zero,                                                               
the actual return  would be far less than zero.   This means that                                                               
how  funds  are   invested  matters  a  lot,  in   terms  of  how                                                               
investments are made,  and the department's goal  is to eliminate                                                               
as much risk as possible.                                                                                                       
                                                                                                                                
3:37:23 PM                                                                                                                    
                                                                                                                                
MR.  BADER  stated  by  looking   down  the  column  of  possible                                                               
investment  returns and  viewing the  arithmetic column,  that in                                                               
order  to earn  7 percent,  nearly 80-90  percent of  investments                                                               
would need be  in equities, since investing in  fixed income with                                                               
returns  of 2  and 3  percent would  average down  the investment                                                               
considerably.  Thus, an attempt to  earn 7 percent has a tendency                                                               
to force  the commissioner  to take  a far  more risky  path than                                                               
he/she might  otherwise choose.   He  highlighted that  the stock                                                               
market has  gone up six years  in a row, which  is unprecedented,                                                               
noting it has  never gone up seven  years in a row.   Although he                                                               
hoped  it  will continue  to  improve  this year,  the  potential                                                               
exists for  the market to go  down and passage of  this bill will                                                               
allow the DOR's  commissioner to adjust asset  allocations of the                                                               
market  conditions  and  risk,  but  still  attempt  to  earn  an                                                               
investment return of 7 percent over time.                                                                                       
                                                                                                                                
3:38:39 PM                                                                                                                    
                                                                                                                                
CHAIR  OLSON asked  what will  happen if  the market  "tanks" and                                                               
with returns of 2-3 percent.   He further asked whether the state                                                               
will make  up the difference in  order to fund the  PCE Endowment                                                               
Fund at 7 percent.                                                                                                              
                                                                                                                                
MR. BADER answered that the  legislature could appropriate the [7                                                               
percent] amount  to the PCE,  but there isn't any  requirement to                                                               
do so, but the PCE Endowment Fund "lives" on its own returns.                                                                   
                                                                                                                                
3:39:09 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  LEDOUX related  her understanding  that the  term                                                               
"nominal return"  typically means  nothing, but it  doesn't sound                                                               
like that  is what is  being discussed  since HB 86  [removes the                                                               
language]  that specifically  stated  7  percent nominal  return.                                                               
She  asked  for  further  clarification   on  the  term  "nominal                                                               
return."                                                                                                                        
                                                                                                                                
MR. BADER  answered that  "nominal return" is  a term  of finance                                                               
and means the real rate of return plus inflation.                                                                               
                                                                                                                                
3:40:03 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  LEDOUX   asked  how  long  the   state  has  been                                                               
investing the PCE Endowment Fund.                                                                                               
                                                                                                                                
MS.  LEARY  answered  that  it  has been  14  years  and  it  was                                                               
established in 2000.                                                                                                            
                                                                                                                                
REPRESENTATIVE  LEDOUX   asked  whether   the  fund   has  always                                                               
attempted to reach the 7 percent rate of return.                                                                                
                                                                                                                                
MS. LEARY answered yes.                                                                                                         
                                                                                                                                
REPRESENTATIVE LEDOUX asked  whether the fund has  lost or gained                                                               
revenue.                                                                                                                        
                                                                                                                                
MS. LEARY answered  that it has fluctuated, and  the returns have                                                               
been  negative  in  some  years  and positive  in  others.    She                                                               
reported  that the  last  five  years the  returns  have been  14                                                               
percent.                                                                                                                        
                                                                                                                                
3:41:01 PM                                                                                                                    
                                                                                                                                
MR. BADER added that when  the statute was written interest rates                                                               
were  higher than  they  are today  so  fixed income  investments                                                               
could earn  7 percent,  plus equity investments  also made  the 7                                                               
percent  return an  attainable goal;  however, under  the current                                                               
low interest rates 10 year  [investments] are earning less than a                                                               
3 percent return, which prompts the need for this bill.                                                                         
                                                                                                                                
3:41:47 PM                                                                                                                    
                                                                                                                                
CHAIR OLSON  asked for the  average annual nominal return  in the                                                               
past 14 years.                                                                                                                  
                                                                                                                                
MS. LEARY  offered to provide the  figures.  She stated  that she                                                               
has actual returns for each year, but not the complete average.                                                                 
                                                                                                                                
3:42:06 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE JOSEPHSON  asked for further clarification  on the                                                               
growth rate and whether it has  grown 14 percent in five years or                                                               
per annum.                                                                                                                      
                                                                                                                                
MS.  LEARY answered  that  the  return has  been  14 percent  per                                                               
annum.                                                                                                                          
                                                                                                                                
3:42:26 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE HUGHES,  referring to  slide 2, understood  that 7                                                               
percent of the  monthly average market value of the  fund for the                                                               
previous  three fiscal  years  may be  appropriated  [to the  PCE                                                               
Endowment  Fund].   She asked  whether  that has  occurred.   She                                                               
further asked  whether the legislature  would need to  adjust the                                                               
amount  under the  bill.    For example,  if  the  state will  be                                                               
earning  less  than  anticipated,  it   may  need  to  lower  the                                                               
percentage of appropriation to the PCE Endowment Fund.                                                                          
                                                                                                                                
MS. LEARY answered that she  does not have the historical figures                                                               
for  the past  14  years;  however, she  said  the  FY 16  budget                                                               
appropriation is  less than 7 percent,  but a little more  than 5                                                               
percent.     She  offered  to   review  and  provide   the  prior                                                               
appropriations  to the  committee.    She said  that  one of  the                                                               
factors for  the target return  of 7  percent is to  consider the                                                               
use of the fund, the cash  flow, and expectations.  She clarified                                                               
that from  the investment perspective  the Department  of Revenue                                                               
is more  concerned about setting  the target and  eliminating any                                                               
undue potential  risk associated  by setting  the rate  too high,                                                               
which could increase risk in certain environments.                                                                              
                                                                                                                                
3:44:08 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE HUGHES asked whether the 7 percent that may be                                                                   
appropriated [to the Power Cost Equalization Endowment Fund] is                                                                 
set in statute.                                                                                                                 
                                                                                                                                
MS. LEARY answered yes; that the calculation that the DOR                                                                       
provides to the Alaska Energy Authority (AES) is 7 percent of                                                                   
the 3-year fiscal year monthly average.                                                                                         
                                                                                                                                
3:44:39 PM                                                                                                                    
                                                                                                                                
CHAIR OLSON held public testimony open on HB 86.                                                                                
                                                                                                                                
[HB 86 was held over.]                                                                                                          
                                                                                                                                
3:45:12 PM                                                                                                                    
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
There being no further business before the committee, the House                                                                 
Labor and Commerce Standing Committee meeting was adjourned at                                                                  
3:45 p.m.                                                                                                                       

Document Name Date/Time Subjects
HB86 ver A.pdf HL&C 2/18/2015 3:15:00 PM
HB 86
HB86 Fiscal Note-DOR-TRS-1-16-15.pdf HL&C 2/18/2015 3:15:00 PM
HB 86
HB86 Supporting Documents-Transmittal Letter to Chenault 01-28-15.pdf HL&C 2/18/2015 3:15:00 PM
HB 86
HB86 Supporting Documents-DOR PCE presentation 2-18-2015.pdf HL&C 2/18/2015 3:15:00 PM
HB 86