Legislature(2003 - 2004)
04/25/2003 07:13 AM House W&M
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* first hearing in first committee of referral
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+ teleconferenced
= bill was previously heard/scheduled
ALASKA STATE LEGISLATURE
HOUSE SPECIAL COMMITTEE ON WAYS AND MEANS
April 25, 2003
7:13 a.m.
MEMBERS PRESENT
Representative Mike Hawker, Co-Chair
Representative Jim Whitaker, Co-Chair
Representative Cheryll Heinze
Representative Vic Kohring
Representative Norman Rokeberg
Representative Bruce Weyhrauch
Representative Peggy Wilson
Representative Max Gruenberg
Representative Carl Moses
MEMBERS ABSENT
All members present
OTHER LEGISLATORS PRESENT
Representative Dan Ogg
Representative Ralph Samuels
Representative Paul Seaton
COMMITTEE CALENDAR
HOUSE JOINT RESOLUTION NO. 26
Proposing amendments to the Constitution of the State of Alaska
relating to and limiting appropriations from and inflation
proofing the Alaska permanent fund by establishing a percent of
market value spending limit.
- HEARD AND HELD
PREVIOUS ACTION
BILL: HJR 26
SHORT TITLE:CONST. AM: PF APPROPS/INFLATION-PROOFING
SPONSOR(S): RLS BY REQUEST OF LEG BUDGET & AUDIT BY
Jrn-Date Jrn-Page Action
04/17/03 1025 (H) READ THE FIRST TIME -
REFERRALS
04/17/03 1025 (H) W&M, JUD, FIN
04/17/03 1025 (H) REFERRED TO WAYS & MEANS
04/22/03 (H) W&M AT 7:00 AM HOUSE FINANCE
519
04/22/03 (H) Heard & Held
MINUTE(W&M)
04/24/03 (H) W&M AT 7:00 AM HOUSE FINANCE
519
04/24/03 (H) Heard & Held
MINUTE(W&M)
04/25/03 (H) W&M AT 7:00 AM HOUSE FINANCE
519
WITNESS REGISTER
MARC LANGLAND, Chair, President, and CEO
Northrim Bank;
former trustee
Alaska Permanent Fund Corporation
Anchorage, Alaska
POSITION STATEMENT: Testified in support of HJR 26 and answered
questions from the members.
ROBERT BARTHOLOMEW, Chief Operating Officer
Alaska Permanent Fund Corporation
Juneau, Alaska
POSITION STATEMENT: Testified in support of HJR 26 and answered
questions from the members.
RON LORENSEN, Attorney at Law
Simpson, Tillinghast, Sorensen, and Longenbaugh
Juneau, Alaska
POSITION STATEMENT: As counsel to the Alaska Permanent Fund
Corporation, testified in support of HJR 26 and answered
questions from the members.
ACTION NARRATIVE
TAPE 03-14, SIDE A
Number 0001
CO-CHAIR JIM WHITAKER called the House Special Committee on Ways
and Means meeting to order at 7:13 a.m. Representatives Hawker,
Whitaker, Heinze, Kohring, Weyhrauch, Wilson, Gruenberg, and
Moses were present at the call to order. Representative
Rokeberg arrived as the meeting was in progress.
Representatives Ogg, Seaton, and Samuels were also present.
HJR 26-CONST. AM: PF APPROPS/INFLATION-PROOFING
Number 0157
CO-CHAIR WHITAKER announced that the first order of business
would be HOUSE JOINT RESOLUTION NO. 26 Proposing amendments to
the Constitution of the State of Alaska relating to and limiting
appropriations from and inflation proofing the Alaska permanent
fund by establishing a percent of market value spending limit.
Number 0209
MARC LANGLAND, Chair, President, and CEO, Northrim Bank; former
trustee, Alaska Permanent Fund Corporation, testified in support
of HJR 26 and answered questions from the members. He told the
members that because of his experience with the Alaska Permanent
Fund Corporation [Board of Trustees], he would like to comment
on the endowment process and let members know that he favors
moving in that direction. In [moving toward an endowment
process] there will be a steady flow of cash and a predictable
flow of revenues to the state versus the current system, he
explained. He pointed out that this would take politics out of
process of managing the fund and remove the temptation on the
part of the legislature to use inflation-proofing dollars
instead of putting the money back into the fund. Mr. Langland
noted that when he was a trustee there was not the same pressure
on the fund as there is now with respect to producing earnings.
He explained that there is an opportunity under the current
system for decisions to be made that would create more or less
cash earnings for the fund such as taking appreciation and
assets as a profit to create new cash or take losses. He said
sometimes those decisions could be influenced by politics and
pressures to influence the flow of cash. Although he said he is
not sure that has ever happened, it could occur. The
[endowment] approach would allow trustees to provide better
management of the assets of the fund by making decisions based
on long-term proper asset allocation and [base] decisions on
whether to take profits from an index fund or not, without the
influence of political pressure to create cash. Mr. Langland
recalled that during the last election he heard a number of
people discuss the notion of not inflation-proofing the fund,
and using that cash to close the budget gap; thereby, not
impacting the dividend. The aforementioned is a good example of
how, in times of stress, politics could influence the overall
integrity of the fund by not inflation-proofing it.
Number 0636
MR. LANGLAND said that in the future the pressure to create
revenues and use earnings from the fund to fill the [budget] gap
will be great. He reiterated that the endowment idea would
produce a predictable flow of cash no matter what happens in a
more volatile stock market and unpredictable economic
situations. The endowment would also provide the legislature
with better knowledge on how to manage the state's fiscal
issues, he said. He asked the members to consider that the
state is facing very unpredictable revenue sources from the
price of oil. In managing a business it is important to
mitigate the volatility of the revenue stream, he explained.
Under the current system, oil revenues are unpredictable and
volatile and financial markets are also unpredictable and
volatile; however, with an endowment method at least one-half of
the revenue stream for the state will be off of the volatile
list and make [the fund] more predictable. Mr. Langland
summarized his comments by saying that from the standpoint of
managing government revenues and being able to use those funds
for government, it is in the [best interest] of the state and
its citizens to understand what the permanent fund can produce
on a regular basis when the fund is not influenced by political
pressure. Mr. Langland urged members to pass HJR 26.
Number 0908
REPRESENTATIVE GRUENBERG asked Mr. Langland if he read Mike
Doogan's column where he criticized this approach [to managing
the fund].
MR. LANGLAND replied that he does not read [Mr.] Doogan's
column.
REPRESENTATIVE GRUENBERG commented that Mr. Doogan raised some
interesting issues with respect to this [method of management].
One issue he raised is the assumption that there will be an 8
percent return. Mr. Doogan asked what will happen if there is
not that rate of return, since the fund is not earning 8 percent
now. Representative Gruenberg asked Mr. Langland to respond to
Mr. Doogan's question.
Number 1043
MR. LANGLAND replied that in looking at the permanent fund it is
important to look at it as a long-term asset. The statistical
data on a long-term basis [reflects that] an 8 percent return is
a reasonable expectation through various economic cycles with
the proper asset allocation of the fund. Although there will be
times when real returns are less than 8 percent, there will also
be times that the return will be more than that. Mr. Langland
pointed out that it is very difficult to predict the future and
that is why it is very important to think prospectively.
Unfortunately, the political arena does not look at the long
term and [Mr. Doogan's] comment is a very good example of why
the endowment and payout formula is so important.
CO-CHAIR WHITAKER told the members that he does not want [Mr.
Doogan's] column to be the subject matter of the committee's
discussion.
Number 1302
CO-CHAIR HAWKER commented that across [the state] there are
criticisms [voiced] with respect to making changes [to the
permanent fund]. There is [a perception] that the current
structure of permanent fund is absolutely the best and only
structure in which it should be organized. He asked Mr.
Langland what years he served on the Alaska Permanent Fund Board
of Trustees.
MR. LANGLAND replied that he served from 1986 through 1990. The
1990's were very big years and the real rate of return was about
4 percent.
CO-CHAIR HAWKER asked if the trustees were looking at a change
in the methodology at that time.
MR. LANGLAND replied that the biggest issue he recalls was the
requirement that dividend calculations were the first call on
the earnings versus inflation-proofing. The trustees tried to
get the legislature to look at switching that order, although
they were not able to achieve it. Another important issue that
was being discussed was the change from 50 percent to 25 percent
on new oil revenues. Mr. Langland pointed out that there has
been a change in the definitions in accounting principles which
makes the current system more complicated. He commented that at
that time [1986-1990] there was no political pressure to use
earnings from the fund to close the budget gap.
Number 1550
CO-CHAIR HAWKER asked if Mr. Langland believes the legislature
is being too reactive in considering this as a tool in
addressing the fiscal gap. He asked if, as a financial
professional and economist, this [change] would make sense to
Mr. Langland if he were still a trustee on the board.
MR. LANGLAND replied that he absolutely would support [HJR 26].
He explained that when he was on the board there was a lot of
index fund management instead of individual managers for the
stock portfolio. The markets were good then and the fund
accumulated hundreds of millions of dollars in appreciated stock
values. Mr. Langland told the members that the [board] had the
opportunity to directly influence the size of the dividend over
time by taking the profits and turning them into cash which
would have created larger payouts of dividends. Tremendous
political pressure could have resulted in influenced decisions,
he commented. Mr. Langland told the members that [the fund]
took profits for the right reason and it had nothing to do with
dividends. As the appointments of the trustees are politicized,
it is a big concern that they [may] feel pressure [to increase]
earnings when there is the opportunity to change how much cash
flows into the state coffers for dividends or operations [of
state government]. At the time he was a trustee, Mr. Langland
said he did not like it and believed it would be a major problem
in future. He reiterated that he does not believe the
legislature is being over reactive because this method is a very
sound, long-range plan. The prudence of this concept is
defensible and understandable to both institutional investors
throughout the country and recipients of cash that flows out of
different types of endowments, he said.
Number 1846
CO-CHAIR HAWKER referred to Mr. Langland's earlier comments on
the importance of maintaining a mechanism to inflation-proof the
fund. He asked if he would clarify his conclusion that the
proposed method would institutionalize inflation-proofing of the
fund. Would it in fact, result in the preservation of capital,
or does the ultimate mechanism result in an erosion of capital,
he asked.
MR. LANGLAND replied that there is no absolute answer to that
question. It all depends on the time [period in which] the
market is looked at, and what the payout formula percentage is.
He recalled a study that was done on inflation-proofing while he
was on the board. The trustees looked at every method, and
there was no conclusion about what [would be the] absolute right
way to protect the principal of the fund from inflation.
Because there is no absolute answer, he suggested looking at how
most people address this issue. The endowment method is
certainly a proven way that addresses the issues, although it is
not perfect and does not totally inflation-proof the fund at any
given time because it depends on the payout percentage that is
used. If taking a conservative [approach], the payout should be
less than 5 [percent]. If there is a desire to take an
aggressive approach, then the payout would be more than 5
[percent], he said. The current system is totally subjective
because no one has any idea what real inflation is and
inflation-proofing is totally subject to the discretion of
legislature, which creates more risk to the principal in the
long run. However, the endowment theory, provided the
legislature does not get carried away with the payout
percentage, [would provide stability]. Mr. Langland stated that
a 5 percent [payout] is about right or a little above the
average [of other endowment payouts].
Number 2159
CO-CHAIR HAWKER noted that Mr. Langland's perspective on the 5
percent payout factor as the key to the success of this model is
an issue he would like to discuss further. It is important that
capital is preserved and not eroded, he said. Co-Chair Hawker
asked for Mr. Langland's opinion on the 5 percent payout factor
and the [constitutional] amendment. For the record he stated
that [HJR 26] has language that states the payout would not
exceed 5 percent, rather than a definitive 5 percent. Co-Chair
Hawker emphasized that he believes it is important to ensure the
long-term value of the fund.
Number 2310
MR. LANGLAND replied that statistical information is readily
available on the long-term average of inflation. Many of the
studies that he has seen say inflation has been around 3.1
percent since about 1926, and real returns are generally in the
3 to 4 percent range. If earnings are in the 7 to 8 percent
range on an average basis, the fund would be in good shape, he
said. Mr. Langland explained that on a long-term basis stocks
generally produce about a 9 percent return, and bonds [produce]
about a 3.5 to 4.5 percent [return]. He commented that a 5
percent payout over the long term is probably a very good
number, but he emphasized that he would not be in favor of any
number in excess of 5 percent. On a short-term basis, 5 percent
will probably be excessive, but he stressed the importance of
structuring this [endowment] as a long-term concept. Mr.
Langland commented that no one can predict with any degree of
certainty, beyond a couple of years, [what earnings will be].
For example, stocks did not produce dividends in the 1990s;
however, currently there is pressure for stocks to produce
dividends. On a historical basis stocks have returned 4 to 5
percent over the long term in dividends, he said. There is a
major shift right now in how income comes in stocks versus the
importance of appreciation in value in the 1990s.
MR. LANGLAND pointed out that there are many issues that are
important in the management of the fund. It is extremely
important that a trustee can focus on the long term when making
[investment] decisions [because the impact of those choices]
will allow for the proper allocation of assets to protect the
fund. Mr. Langland summarized his comments by saying that
stability is very important when managing funds like this. He
stated that the process currently in place creates instability,
which increases risk, both in asset allocation and ultimately in
inflation.
Number 2698
CO-CHAIR HAWKER commented that Mr. Langland touched on capital
erosion; however, the fund has had years when there have been
earnings in excess of the 5 percent level. He asked Mr.
Langland if he is comfortable that this mechanism would keep the
earnings "off the table" in good years.
MR. LANGLAND responded that he is comfortable with this
legislation because, as an endowment, it provides that there
would only be a 5 percent payout of the current market value of
the fund. Asset allocations are moved around depending on a lot
of different factors, he said, and that is the key to producing
revenues that are less volatile in the long term. The
aforementioned is one of the most important parts to consider in
how this piece of legislation [could benefit the] management of
the fund. Mr. Langland stated that he could not over-emphasize
how important that is because the way volatility is reduced in a
fund is through the proper allocation of those assets. That is
the most critical and positive element for the management of the
fund and preservation of capital. He explained that allocation
of assets refers to the different kinds of stocks in the
portfolio, [how much is invested] in bonds, how much [is
invested] in international funds, and how much in real estate,
et cetera.
Number 2926
REPRESENTATIVE WEYHRAUCH asked him if his reference to
preservation of capital actually meant to protect the fund from
inflation and ensure that the real value of the permanent fund
is preserved.
MR. LANGLAND replied that is the correct interpretation.
Number 3011
REPRESENTATIVE WEYHRAUCH asked if Mr. Langland, as a banker and
former trustee of the fund, believes this amendment [HJR 26]
would provide certainty of dividend calculations.
MR. LANGLAND prefaced his comments by saying that he has a
prejudice [concerning dividends]. He explained that he does not
look at the fund and the way it is managed with any [thought] to
dividends. He acknowledged that politically that does not go
over well; however, he said he does not believe that [dividends]
should be the focus. The focus should be on a predictable
revenue stream that the legislature can use for whatever purpose
is deemed necessary. He opined that [dividends] will not be an
issue for very long because he believes it will be necessary to
use the money for state government. He emphasized that he would
not look at this resolution [based] on how it may or may not
affect dividends and pointed out that this resolution would give
a more predictable annual source of cash and that could be
interpreted to help the dividend.
REPRESENTATIVE WEYHRAUCH highlighted that the resolution talks
about protecting the fund from inflation and ensuring the real
value of the permanent fund. He asked how Mr. Langland defines
real value.
Number 3211
MR. LANGLAND commented that it is a loose term. He said he
relates it to inflation in the sense of real value and the
ability to properly allocate the assets of the fund to protect
and reduce the volatility of the fund over the long term. He
stated that he does not believe there is any way anyone can say
that there is a formula or process that will absolutely protect
the real value of the fund or real principal of the fund. Mr.
Langland said that he believes this piece of legislation would
clear up a lot of these definitions and eliminate a lot of the
misconceptions and misinterpretations of terms. He urged the
members to focus on what this legislation does or does not do
for the preservation [of the fund].
Number 3404
REPRESENTATIVE WEYHRAUCH commented that in public forums
questions such as these come up. He said he appreciates Mr.
Langland's insight, as it will assist him in intelligently
answering questions from the public. Representative Weyhrauch
surmised that Mr. Langland views this resolution as a provision
to improve the administration of the fund and thus improves the
flow of permanent fund earnings to the state general fund. He
asked if that is an accurate summary [of his views].
MR. LANGLAND replied that he is exactly right.
REPRESENTATIVE WEYHRAUCH went on to say that this legislation
would help the legislature to provide appropriations for
permanent fund dividends, if the legislature makes that policy
choice, and to help close fiscal gap.
MR. LANGLAND responded that is correct.
Number 3516
CO-CHAIR WHITAKER noted that as a banker Mr. Langland has a huge
stake in the economy. He asked what will happen in the larger
economic picture if the legislature does not take action such as
that prescribed by HJR 26.
MR. LANGLAND explained that he has been active in trying to
persuade the legislature and the administration to face up to
the fiscal crisis and deal with it earlier rather than later.
He said the argument that he puts forth is there would be less
impact on the economy if action is taken sooner to ease into a
transition from no responsibility on the part of citizens to one
in which citizens gradually become responsibile for funding
state government. He said he is unsure whether that action
would include using part of the earnings and lowering the
dividends [to fund] state government or some sort of tax system
in which individuals would participate.
MR. LANGLAND expressed concern that the legislature might wait
until [the state] runs out of money in the Constitutional Budget
Reserve Fund (CBR) and then take dividends totally off the table
and/or impose very large taxes. He said in either of those
[scenarios] there will be a negative impact on the economy.
There is no way that the state can get through this knot hole
without having a negative impact on the state's economy.
However, how serious that impact will be depends on the
legislature's approach to closing the [fiscal] gap, which will
be closed because constitutionally the legislature is required
to balance the budget. One argument he opposes is to take
inflation-proofing dollars and use those [funds to balance the
budget]. In this case the dividend would still be paid out.
The danger he sees [with the legislature failing to] close the
gap is that it will affect people coming into the state or
people already here who are trying to expand their businesses.
For example, if a businessperson coming into Alaska knows that
there is a billion dollar [fiscal] gap, it would be clear that
there will be taxes and it will have an impact in some way. Mr.
Langland cautioned that this is a dangerous situation that is
easy to keep putting off because the legislature has the cash to
deal with the deficit, but it is a very dangerous process
economically. Phasing in [a method of closing the budget gap]
would provide a smoother transition with less impact on the
economy. He urged the members to let citizens make adjustment
personally. Mr. Langland summarized his comments by saying he
understands the political realities that the members must face,
but leadership [should not] take polls, and going to the vote of
the people is not a very practical way to close the [fiscal]
gap.
Number 4046
CO-CHAIR WHITAKER asked if the budget is not balanced, where
will that path lead us. He surmised that [if the budget is not
balanced] economic growth will be stifled and in combination
with the shock or reality that must be faced when the CBR is
gone [will lead the state to an economic crisis].
MR. LANGLAND agreed that is the path [the state] is on. He said
he is not very hopeful that the administration and the
legislature will provide a transition [in addressing this
problem]. Politically it will be necessary to do a combination
of major reductions in the permanent fund [dividends] and have
taxes to fill the gap. Mr. Langland commented that a
combination of these two steps would be less of an impact on
each citizen, although there will be some impact to the economy.
He emphasized that he does not see these steps as having a
devastating impact at all. In some cases, he said he believes
it will be positive for the state to have more participation in
government [from its citizens]. Mr. Langland commented that he
does not see this as a big negative. Although there will be
issues that will have to be worked thorough, Alaska has a strong
enough economy to weather this [storm] without any major
disruptions. However, he cautioned that it may be necessary to
offer some help on the social side to bridge the gap. Still,
Mr. Langland said he believes this is very manageable and he is
optimistic.
Number 4342
CO-CHAIR HAWKER said that this constitutional amendment [HJR 26]
envisions merging the earnings reserve and the principal of the
Alaska permanent fund. Most politicians and economists have
conditioned people to be very protective of the corpus of the
fund. He asked Mr. Langland if he believes it is appropriate to
merge these two aspects of the fund. In doing this will the
state end up with a result that is consistent with preserving
the long-term value of the fund, he asked.
MR. LANGLAND replied the he thinks it is [appropriate]. He
explained that the way the fund works now there is a need for a
depository for those times when there is more cash available
than what the formula needs. The reserve account has been used
to pull off cash in those years when the formula does not work
and it is short of cash. Once the legislature goes to the
payout formula, there will be no need for the reserve account;
it goes away. He said he thinks, from a prudent standpoint,
that merging the reserve account into the principal of the fund,
rather than taking it off the table and using it for other
governmental purposes, would be viewed in a more positive light
politically; philosophically it is the prudent thing to do.
Number 4554
CO-CHAIR WHITAKER asked if this would facilitate asset
management and the implementation of those points addressed
earlier which would mitigate the volatility of the fund.
MR. LANGLAND replied that it would.
TAPE 03-14, SIDE B
Number 4526
CO-CHAIR HAWKER moved to adopt the proposed committee substitute
(CS) for HJR 26, Version 23-LS1006\H, Cook, 4/23/03, as the
working document. There being no objection, it was so ordered.
CO-CHAIR HAWKER noted a [typographical] error on page 2: the
reference to Version A should actually be to Version H.
Number 4437
RON LORENSEN, Attorney at Law, Simpson, Tillinghast, Sorensen,
and Longenbaugh, speaking as outside counsel to the Alaska
Permanent Fund Corporation, testified in support of HJR 26 and
answered questions from the members.
REPRESENTATIVE WEYHRAUCH asked about the language on page 2,
line 2, Section 2(b), which says, "Money should not be
appropriated from the permanent fund." He asked why the words
"should not" were used, instead of "will not."
MR. LORENSEN explained that the change in the draft was
suggested by Tamara Cook, Director, Legal and Research Services.
He recalled that Ms. Cook was concerned that as drafted and
presented in the original version of HJR 26, the first and
second sentences of subsection (b) setup separate and
independent standards for appropriations from the permanent
fund. She was concerned that might create some confusion and
legal issues in the future. Therefore, Ms. Cook drafted the
first sentence basically as a predicate statement to the second
[sentence], he said. Mr. Lorensen noted that while he has not
talked to Ms. Cook directly, that is his understanding of the
change and it makes sense to him when he read it in that
context.
Number 4247
REPRESENTATIVE WEYHRAUCH agreed that it does makes sense,
especially since the second sentence begins with the word
"therefore." Representative Weyhrauch said that he had never
seen a sentence in the constitution start with the word
"therefore" which [makes] it almost a statement of policy or
intent.
MR. LORENSEN reiterated that Ms. Cook is, in this case, using
the first sentence as a predicate or policy statement, as to the
goal of limitations of payouts and the word "therefore" is used
as the transition into the limitation language.
Number 4136
REPRESENTATIVE WEYHRAUCH commented that changing the word
"should" to the word "will" would remove the need for the use of
the word "therefore".
MR. LORENSEN asked the members to compare the original version
of HJR 26. He pointed out that it said "money may not be
appropriated" in the first sentence so the word "therefore" was
not in the second sentence.
REPRESENTATIVE WEYHRAUCH asked about the language on page 2,
lines 6-7, where it says "the first five of the six fiscal
years" and inquired as to the significance of the 5-year period.
He asked if Mr. Lorensen would clarify if this meant any five of
the preceding six years, or the last five of six years. What is
the purpose of selecting five years, he asked.
MR. LORENSEN said that what this calls for is a one-year look
back provision. What this means is when looking back to
determine the 5-year period the current fiscal year is omitted.
In other words if the legislature is making an appropriation for
this year, FY 04, it would mean that FY 03 is not looked at, but
that the five years that ended with FY 02 would be included. He
explained that this is a simpler way of saying that than the
attorney's language. For example, if appropriating funds for FY
04, the legislature would look at the six years before that
year, but only use the first five of those years. This would
ensure certainty at the time of making the appropriation because
the last year used as part of the calculation would be FY 02.
Number 4000
REPRESENTATIVE WEYHRAUCH turned to when the trustees are
determining if there should be a payout on June 30th and
inquired as to the timeframe being used. Is it the close of
business at 5:00 p.m. [Eastern Standard Time] or midnight Alaska
Time?
MR. LORENSEN replied that he believes it is the end of the
business day for financial purposes which is 5:00 p.m., New York
time.
ROBERT BARTHOLOMEW, Chief Operating Officer, Alaska Permanent
Fund Corporation, testified in support of HJR 26 and answered
questions from the members. He told the members historically
when the permanent fund and the custodian bank, the Bank of New
York, determine the fund value of a day they use the last
closing of the markets around the world. When making
calculations on June 30th, the fund will find the last closing
value from all the stock markets all around the world were. For
example, if in the middle of evening on June 30th the stock
market in Tokyo is opening, the fund does not use an opening or
intra-day value in determining the value of the fund. It would
be the last closing day that would be used for all of those
different markets, he reiterated.
Number 3748
REPRESENTATIVE WEYHRAUCH asked if the funds would be
appropriated to the general fund under this scheme.
MR. BARTHOLOMEW responded that the funds are subject to
legislative appropriation so there is no direction in the
constitution as to where those appropriations would go.
MR. BARTHOLOMEW, in response to Representative Weyhrauch,
clarified that the current constitutional provision says income
from the permanent fund shall be deposited in the general fund
unless otherwise provided by law. However, since 1982 the
statutes have provided that all income from the permanent fund
shall be deposited in the permanent fund. So the funds have
been retained in the permanent fund since 1982 and then
appropriations have come from the earnings reserve [account] of
the permanent fund and have gone to the dividend fund, which is
a subfund of the general fund. In further response to
Representative Weyhrauch, Mr. Bartholomew confirmed that the
earnings reserve account and the earnings reserve fund are the
same thing.
Number 3624
CO-CHAIR HAWKER noted that if this constitutional amendment
should pass the legislature, it would be necessary to address
the existing statute which would be incompatible with the
mechanism within the constitution. It would require the
legislature to look for broader enabling statutes to define or
delineate what should be done with those distributions should
they be made, he said.
MR. BARTHOLOMEW said the board's policy resolution, which is in
the members' packets, recommends that the existing statutes be
updated to work better with a payout of market value method.
The legislature could leave the existing statutes, but it does
not work very well. The existing statutes provide for a
calculation of what is available for appropriation using a
realized income approach, and [these statutes] do not direct
where the money goes, he explained. It is the understandiing of
the board that there will be statutory language that implements
constitutional provisions as things work now. Mr. Bartholomew
told the members that the board's recommendation and policy
statement is that the legislature look at the statutes that
determine what is available and write those [statutes] to work
better with the payout of market value [method].
Number 3559
REPRESENTATIVE WEYHRAUCH said that the language in [sub]section
(b) of this amendment indicates that the government of the State
of Alaska has to ensure that the real value of the permanent
fund is preserved over time. He asked if that is a correct. In
response to Mr. Bartholomew's affirmative response,
Representative Weyhrauch asked if this requires the legislature
to ensure the value of the permanent fund reserved over time.
The legislature could not appropriate out funds that would drain
the permanent fund because that would be in violation of the
constitution. He asked if Mr. Bartholomew agrees with his
interpretation of the language.
MR. BARTHOLOMEW agreed that is his understanding of the intent
language. The language is to ensure the focus is on the long-
term period, and then over that long-term period, the policy
statement is to preserve the real value of the permanent fund.
The board of trustees or legislative members use whatever tools
available to them to make a statement or an analysis to look to
the preservation of the value of the fund, he said.
Number 3341
REPRESENTATIVE WEYHRAUCH commented that when the permanent fund
was established and the statutory scheme was setup in 1982, the
intent was to set aside money for government and keep
politicians honest by investing the public through permanent
fund dividends. This ensured that the public [had a] invested
[interest] in the account and the legislature knew the people
would be invested. There was also the intent that the funds
would eventually be there for a rainy day when Alaska ran out of
oil revenues, and therefore the legislature could fund
government when Alaska did not have a huge revenue stream. He
asked Mr. Bartholomew if that is his basic understanding of the
permanent fund's origin.
Number 3257
MR. BARTHOLOMEW responded that he would go back a bit further
and say that there were three major steps that led to the
current situation with the permanent fund. First, there was a
constitutional amendment in 1976 that asked the citizens of the
State of Alaska to set aside mineral wealth, which historically
has been oil wealth. So step one had no conception of a
dividend or what would be done with the earnings. [The 1976
constitutional amendment] said that the state would set aside
earnings that are not needed or oil wealth that was not needed.
The earnings from that oil wealth would be deposited into the
general fund. He pointed out that in 1976 the earnings were
fairly small, but those earnings were deposited into the general
fund. In 1980, after a couple of years of debate and
discussion, the dividend program came into existence. In 1982,
[the constitution] was amended and that is the statutory scheme
that is used today. Mr. Bartholomew turned to the legislative
history of the permanent fund. Governor Hammond was the
governor at the time. The statutes in place since 1982 gave a
better allocated 50 percent of what is available for
appropriation annually to the dividend program. Mr. Bartholomew
noted that inflation-proofing has been in the statutes since
1982, and [there is no mention] about what to do with the funds
available after the dividends have been paid and inflation-
proofing has occurred.
CO-CHAIR WHITAKER noted for the record that Representative
Rokeberg had joined the meeting.
Number 3039
REPRESENTATIVE WEYHRAUCH asked Mr. Bartholomew if he believes
this [HJR 26] is a dramatic departure from the original intent
of the people, legislature, and the administration that setup
the permanent fund.
MR. BARTHOLOMEW responded that the board of trustees does not
feel this is a major change; the permanent fund has changed and
matured. How the money is invested has evolved over the last 25
years, he commented. For example, the funds have evolved to be
100 percent invested in fixed income or bonds that pay interest
income to the holder of the bonds whereas 20 years ago the
general direction was that these bonds were to be held to
maturity so there was not a lot of volatility. The legislature
crafted a statutory scheme that works well in the world of bonds
and fixed income. As the permanent fund has matured and more
learned about the investment industry and capital markets, the
legislature has granted the [Alaska Permanent Fund Corporation]
through statutes the permission to invest in U.S. stocks,
international stocks, international fixed income or bonds, and
real estate. How income is derived from those investments has
evolved, it is not just an interest payment, he explained. As
Mr. Langland testified earlier, the permanent fund now has
capital appreciation in real estate and stocks which were not an
issue with bonds, he said. The [board] characterizes this more
as [addressing] the fund's asset investment strategy which has
matured; [however,] the rules that guide the permanent fund
regarding how to make use of the value have not evolved. The
board has been working for the last eight or nine years to
educate everyone so that a decision will be made to bring the
rules up to speed and in a manner matching the fund's investment
strategy. Originally, the intent was to set aside oil wealth
for some future period, and the decision as to whether the state
is in that future period or not is separate from how to manage
the fund. Mr. Bartholomew told the members that this is purely
the board's recommendation that the rules that help manage the
fund need to be improved. He said he does not see that as a
dramatic change in what was trying to be done in 1982.
Number 2731
REPRESENTATIVE GRUENBERG said that he always thought of the
concept of the fund as a permanent fund, so that the corpus
would be there permanently, but income from the fund could be
used. The amendment to the constitution provides a theoretical
possibility that the corpus could itself be consumed, he said.
He asked if that is not a fundamental change in the purpose of
the fund.
MR. BARTHOLOMEW responded that he believes it is a different
perspective. He asked the members to look at the policy
statement [the board submitted]. He said the board has had a
lot of discussion on the issue of whether to remove the
distinction between principal and income and move to where the
permanent fund is one account of money. He referred to
Representative Weyhrauch's earlier question as to whether the
intent is still to preserve the corpus or principal [of the
fund] over time. Mr. Bartholomew stated that he believes the
board would say it absolutely is the intent and objective to
continue to maintain the principal. He read the following
sentence [from the Alaska Permanent Fund Corporation Board of
Trustees Resolution 03-05, page 3, lines 1-3], which addresses
the proposal to eliminate the distinction between principal and
income and the overall proposal of payout of market value, which
read:
The Board believes that this approach effectively
balances the goal of providing for an annual
distribution from the Fund that is predictable and
limited with the long-term goal of protecting the real
value of contributions to the Fund. [original
punctuation provided]
MR. BARTHOLOMEW pointed out that the board of trustees is trying
to determine the best way to protect the fund and deal with
annual distributions. Some believe that if there were a $22-$23
billion fund it could not make a distribution for a year or two
because the capital markets had taken the value below principal.
There are some dynamics involved. One [dynamic] would be the
effect on the economy, which is not the primary concern of the
board; however, it is something that is reviewed. There is also
a risk of what the public would feel if there is this fund that
is providing no distribution. It is possible that there could
be a move that would say that if there is a fund that is not
doing anything for us let's just divvy it up. Mr. Bartholomew
clarified that the board is not predicting that would happen,
but that was part of the discussion and it is a risk. He told
the members this is the standard method followed by major
endowments and trusts, which have the same intent to preserve
the initial contributions so they will be there in perpetuity
while also providing a distribution. The board wants to balance
those goals and protect the fund with this proposal. It is
important to note, he said, that if capital markets change from
what has occurred over the last 75 years and the real return or
the return in excess of inflation were to be less than 5 percent
over the long term, the legislature would have to look at that
and decide to appropriate less than the maximum that is
available.
Number 2308
REPRESENTATIVE WILSON said that currently the legislature never
knows until the end of the session how much money can be
distributed. However, with the change in language [on page 2,
lines 6-7] means that the legislature will know in January how
much money is available for distribution because the current
fiscal year is not included in that calculation. This change
will make it much easier for the legislature to deal with the
budget. Representative Wilson asked Mr. Bartholomew if her
assumptions are correct.
MR. LORENSEN replied that is correct.
Number 2157
REPRESENTATIVE OGG asked about the 5 year running average. He
pointed out that the date is being set on June 30th, for each of
those years. How does that change from what is presently being
done, he asked. He also asked if there is more flexibility in
determining a particular day that would be used for what the
market value of the fund is.
MR. BARTHOLOMEW responded that the way it is now written, the
permanent fund uses the end of the fiscal year, which is June
30th. This does not change anything unless the State of Alaska
decided to change its fiscal year end. In that case, the
amendment would lock in that date, which is different than [the
way it is done now]. Mr. Bartholomew explained that from
permanent fund's perspective, the constitution will now tell
them to use June 30th, but the State of Alaska could still
decide to change its year-end date, which he said he believes is
a remote possibility. It does take away a little flexibility,
but it is not really something that would have been used, he
said.
Number 2008
REPRESENTATIVE OGG posed a situation in which the permanent fund
had the flexibility to look at the market last year and see that
it was going down and determine a good day to end the fiscal
year as long as it was before June 30. He asked if that kind of
flexibility existed last year.
MR. BARTHOLOMEW responded that there are bylaws and other
corporate documents that currently say the permanent fund fiscal
year [ends] on June 30. He told the members that he never heard
any discussion about using that tool to change what is
available. It is not something that could have been done on the
short term, he said. There are rules that require public notice
to change the bylaws. The notice must be at least one meeting
ahead of time. It would take many months to effect a change, he
said. Theoretically, it is possible, but the fund has been set
on using that consistent fiscal year end. Furthermore, there
are contracts based on those dates. Therefore, many things set
in motion that would make it very difficult to change the date
from June 30 without a very long process.
REPRESENTATIVE OGG commented that there really was not much
flexibility.
MR. BARTHOLOMEW agreed that there is very limited flexibility.
It would have taken two to three months to change the date and
the timeframes. Theoretically, there is some [flexibility], but
for practical purposes there is not, he said.
Number 1745
REPRESENTATIVE SAMUELS asked if any other endowments [distribute
funds the way the permanent fund] does now.
MR. BARTHOLOMEW answered that 70-80 percent of the endowments of
public funds that are out there use a concept based on total
market value of fund rather than realized income. The executive
director testified earlier this week that in his 25 years in the
industry, he is not aware of any other funds that use the payout
formula that is currently used by the permanent fund. The
formula was written specifically for the fund 20 years ago. He
told members the amendment is an accepted payout method;
however, the one currently used is unique to the permanent fund.
REPRESENTATIVE SAMUELS recalled that Mr. Langland testified that
this method is a common sense [approach] and that the crux of
the resolution was whether the legislature picked 4 percent or 5
percent. How did the trustees determine 5 percent [as the
payout], he asked.
MR. BARTHOLOMEW replied that the trustees looked at it in many
ways, but the primary driver of the 5 percent is that over time
the board has [developed] a policy statement [which strives for]
the real rate of return that they are trying to achieve
[through] investment [allocations]. The [rate of return]
started out at 3 percent and has worked its way up to 4 and 5
percent. He pointed out that for many years the permanent fund
used asset allocations specifying the fund would have 55 percent
in equities, 37 percent into bonds, and 10 percent in real
estate. The fund works with a consultant who looks at the
capital markets, looks at the five-year projections, and runs a
calculation. That calculation says, given how the fund has
allocated the assets the expected earnings over a five-year
period will be a 5 percent rate of return. Mr. Bartholomew said
some people questioned why there is a policy statement that says
the earnings should be at least 4 percent, while an asset
allocation policy that [projects] 5 percent was adopted. The
response has been that it gives the fund some leeway. The 5
percent payout statement is an effort to make the policy
statement consistent with the asset allocation policy the fund
has adopted. There has been a little bid of uncertainty, he
said, because the statutes are general in saying the permanent
fund should maximize its return while protecting the principal.
The professional markets have been used to come up with that 5
percent [figure]. The 5 POMV statement [makes it clear] to the
board that there is more than just its understanding of how
[much] the permanent fund should be earning or how much risk the
permanent fund should take. It would be a state policy, that is
boarder than the board of trustees, he remarked.
Number 1344
REPRESENTATIVE SAMUELS commented that the trustees have no
opinion on the legislature's appropriation of available funds
under the old system, and would have no opinion under the new
system. He asked if that is a correct assumption.
Representative Samuels noted that yesterday there was testimony
that this amendment to the constitution is really a raid on the
fund. In truth, the legislature could choose not to fund the
dividend now or under the new system, or fund it under either
system. That issue does not change, he surmised.
MR. BARTHOLOMEW responded that this amendment does not change
the legislature's ability to spend the earnings in any way they
deem appropriate. This is not a change to the way funds are
currently appropriated, he said. However, inflation-proofing is
only done through appropriation by the legislature, so there is
the option to appropriate money to inflation-proof or to protect
the real value of the fund. Under this proposal the fund would
prioritize inflation-proofing as the number one priority because
there is an effort to retain inflation-proofing in the fund,
cover the effects of inflation, and then provide a distribution,
he explained. So the amendment does change the priority of how
inflation-proofing is handled and that would no longer be an
option [for the legislature] because the [fund] would be
automatically [inflation proofed].
MR. BARTHOLOMEW told the members that the only problem the
trustees have had with the distribution or payout of the
permanent fund is regarding [how] to improve its ability to
manage investments in long-term assets [which would be possible]
if there were some constraints or understanding of what the draw
would be. Over the last five years the legislature has had the
ability to take up to $6.5 billion out of the permanent fund at
any time, he pointed out. He recalled that there was discussion
many years ago about taking a large sum of the earnings reserve,
$4 billion, and setting up another fund for education or
government. It is a little bit unnerving for the board of
trustees to say that they have adopted this long-term asset
allocation, and invested in assets that should only be invested
in if they will be held for five, seven, or eight years. The
[trustees] questioned whether they should be invested in those
ways. This proposal says that the fund needs a more predictable
and limited distribution, so the board can better manage the
fund. He explained that with this amendment the board knows
what can be put into long-term assets that cannot be drawn out
except up to five percent per year. Mr. Bartholomew summarized
that it is important that there be a more stable and predictable
payout because it matches how the [trustees] have invested the
fund. The board of trustees' responsibility ends at this point
and they do not take a position on how the payouts are
distributed.
Number 0950
REPRESENTATIVE WEYHRAUCH asked if [5 percent] is the accepted
industry standard of payout.
Number 0934
MR. BARTHOLOMEW responded that the method of payout based on
total market value is the most widely adopted method in
industries or public funds that are established in the form of
endowments to protect the corpus [of a fund]. The percentage
[of payout] varies, he said.
REPRESENTATIVE ROKEBERG asked if this method is widely adopted,
but not the generally accepted standard.
MR. BARTHOLOMEW responded that he did not mean to imply that
this is not generally accepted, it is. It is the most used
method and the industry [standard]. He clarified his statement
by saying that the POMV approach is generally accepted and an
industry standard.
REPRESENTATIVE ROKEBERG asked if the 5 percent payout is
[generally accepted and an industry standard].
MR. BARTHOLOMEW offerred to provide the members with a chart
that shows how many funds are using a 5 percent [payout], how
many are using more than 5 percent, and how many are using less
than 5 percent. There are fewer funds using 5 percent than are
using less than 5 percent.
Number 0735
REPRESENTATIVE ROKEBERG commented that last week he requested
that the corporation prepare a memorandum for the committee on
the current cash situation as is related to the dividend and
allocation formula and also with (indisc.) regarding the
potential attorney general opinion on the unrealized portion.
He asked if the corporation was working on that request.
MR. BARTHOLOMEW replied that the request is being worked on in
two ways. The corporation will make available to the committee
the actual request that went to the attorney general's office
that explains what the different perspectives are that are being
reviewed. The [corporation] will also provide the committee
with the updated balance of the permanent fund that is available
for [appropriation] under the existing rules.
Number 0638
REPRESENTATIVE ROKEBERG told the committee he believes it is
important that the members have time to debate whether adoption
of this amendment will influence the appropriations investment
strategy, and whether [the strategy] will be more conservative
or more aggressive.
REPRESENTATIVE ROKEBERG asked Mr. Lorensen to explain the
language on page 2, Section 2, subsection (b). He asked if this
language was used to explain to the public the intention of the
trustees in this amendment and reassure the public that the
[trustees] were not going to take their money. He asked if
inserting this language, particularly in Version (H), with
respect to real value is a prudent position for the state to
take. Representative Rokeberg added that in his opinion this
[amendment] appears to be constitutionally adopting the
inflation-proofing concept. He asked if that is a fair
statement.
MR. LORENSEN said, in response to the first question, that the
board's intent with the first sentence was to set out a policy
goal that the public would be aware of at the time the
constitutional amendment was being considered. He reminded
members that the language has been modified somewhat due to Ms.
Cook's recommendation that the language should read, "the money
should not be appropriated". Mr. Lorensen told the members he
does not believe the language is inappropriate for a
constitutional provision.
REPRESENTATIVE ROKEBERG asked if the trustees do not wish the
legislature to make a maximum draw from the fund if
circumstances are such that it would diminish its real value
based on inflation-proofing and growth calculations. He pointed
out that there is an implicit statement [in HJR 26] that says do
not [appropriate] up to 5 percent if the fund cannot afford it
under these conditions. Representative Rokeberg stated that
this is a concern and questioned if the trustees want to express
to the public that these are their instructions to the
legislature.
Number 0327
MR. LORENSEN replied that he does not know if he can
characterize [what the trustees intention may or may not have
been], beyond the fact that this language was inserted at the
request of the board. He told the members that he does not want
to guess as to what the board was trying to do. If this
amendment were adopted as it is now, he said he would interpret
this as a statement of a policy goal with respect to the
distribution the fund.
Number 0239
CO-CHAIR WHITAKER commented that his interpretation is that it
is a long-term consideration, and a long-term invasion that the
legislature needs to be very cautious about.
REPRESENTATIVE ROKEBERG commented that he thinks it is important
that the intent of this [language] be crystal clear so everyone
understands what this language means. He said he believes this
is a lawsuit waiting to happen. If the legislature took a
certain action that was (indisc.) to what the intention was
there could be a constitutional challenge that the legislature
did not take enough or took too much. Representative Rokeberg
reiterated his concern about this language.
Number 0133
REPRESENTATIVE GRUENBERG said he is concerned as to whether
there is a considerable change legally from the way it was
originally [written], "may not be appropriated" to "should not
be appropriated." He pointed out that one is legally actionable
and the other may not be. That is a big difference, he stated.
REPRESENTATIVE ROKEBERG said it is the reverse.
CO-CHAIR WHITAKER clarified that [Representative Gruenberg]
meant "may" would be legally actionable, and "should" would not
be legally actionable.
Number 0043
REPRESENTATIVE GRUENBERG commented that aspirational language is
not placed in the constitution; that language is placed in the
preamble of the constitution. Actionable language is placed in
the constitution, he said. Mr. Gruenberg said he believes that
it is the intent to make this language actionable.
MR. LORENSEN responded that he cannot state what the intent was.
[Not on tape, but reconstructed from the committee secretary's
log notes follows.]
REPRESENTATIVE ROKEBERG commented that the word "may" is more
permissive than "should".
REPRESENTATIVE GRUENBERG told the members he wants to see the
language changed so that it is actionable.
REPRESENTATIVE ROKEBERG stated that he would like to see the
language and intent [written] as clearly and consistently as
possible. He said he is concerned about inserting language in
the constitution, and cautioned that the legislature needs to
understand the policy that is chosen.
REPRESENTATIVE GRUENBERG asked for Ms. Cook to work on the
language of the amendment.
ADJOURNMENT
There being no further business before the committee, the House
Special Committee on Ways and Means meeting was adjourned at
8:50 a.m.
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