Legislature(2003 - 2004)
03/15/2004 01:35 PM Senate FIN
| Audio | Topic |
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
MINUTES
SENATE FINANCE COMMITTEE
March 15, 2004
1:35 PM
TAPES
SFC-04 # 39, Side A
SFC 04 # 39, Side B
CALL TO ORDER
Co-Chair Gary Wilken convened the meeting at approximately 1:35 PM.
PRESENT
Senator Lyda Green, Co-Chair
Senator Gary Wilken, Co-Chair
Senator Con Bunde, Vice Chair
Senator Ben Stevens
Senator Fred Dyson
Senator Donny Olson
Also Attending: Senator John Cowdery; Senator Hollis French;
Senator Gretchen Guess; Senator Ralph Seekins; Senator Bert
Stedman; Senator Gary Stevens; Senator Tom Wagoner; BOB STORER,
Executive Director, Alaska Permanent Fund Corporation; BOB
BARTHOLOMEW, Chief Financial Officer, Alaska Permanent Fund
Corporation;
Attending via Teleconference: There were no teleconference
participants.
SUMMARY INFORMATION
SJR 18-CONST. AM: PF APPROPS/INFLATION-PROOFING
The Committee heard from the Alaska Permanent Fund Corporation. The
bill was held in Committee.
CS FOR SENATE JOINT RESOLUTION NO. 18(STA)
Proposing amendments to the Constitution of the State of
Alaska relating to and limiting appropriations from the Alaska
permanent fund based on an averaged percent of the fund market
value to protect the fund from inflation and assure that the
real value of the fund will be preserved over the long term.
This was the first hearing for this resolution in the Senate
Finance Committee.
Co-Chair Wilken stated this resolution, sponsored by the
Legislative Budget and Audit Committee by request and, "proposes a
constitutional amendment that changes the management of the
Permanent Fund. The resolution establishes an annual payout limit
of five percent of the total market value of the fund and that
market value will be based on a five-year average. The
constitutional amendment proposed would be in front of the voters
for a November 2004."
BOB STORER, Executive Director, Alaska Permanent Fund Corporation,
gave a presentation titled, "Alaska Permanent Fund, Senate Finance
Committee, A Fund overview and discussion of POMV", as follows
[copy on file.]
"To benefit all generations…"
AS 37.13.020(1)
…the Fund should provide a means of conserving a portion
of the State's revenue from mineral resources to benefit
all generations of Alaskans.
Mr. Storer assured the proposed constitutional amendment addresses
this issue.
Permanent Fund market value
Four-year change in realized and reserved accounts
6/30/00 $3.0 billion realized income account
$23.5 billion reserved account (principal
& unrealized gains)
$26.5 billion total
6/30/01 $2.4 billion realized income account
$22.5 billion reserved account
$24.8 billion total
6/30/02 $1.1 billion realized income account
$22.4 billion reserved account
$23.5 billion total
6/30/03 $0.1 realized income account
$24.1 billion reserved account
$24.2 billion
Mr. Storer divided the Fund into two components: principal and
earnings reserve. He further divided the principal into three
components: contributions from mineral wealth, inflation proofing
and legislative appropriations from the earnings reserve fund,
which he noted have occurred on several occasions. He noted the
principal is comprised of approximately equal amounts of the three
aforementioned components.
Mr. Storer stated the amounts listed in the presentation reflect
the "recent" Attorney General's opinion "which has unrealized gains
or losses excluded from the earnings reserve fund." He indicated
the balances listed on June 30, 2000 were almost $20 billion "in
pure principal as I defined it" to include the three components of
mineral wealth, inflation proofing and special appropriations. He
explained the approximately $3 billion balance represents
unrealized gains or appreciation. He informed that the earnings
reserve of the Fund has diminished over time due to the significant
bear market. He stressed the importance of exercising discipline in
years of strong earnings. He stated that the benefit of discipline
has been demonstrated in that although earnings diminished, the
Fund was able to pay dividends and also inflation-proof the Fund
for three years.
Fund's historical asset allocation
[Graph showing the percentage of the assets each year
from 1978 through 2002 in the following categories: US
Fixed Income, US Stocks, Non-US Fixed Income, Non-US
stocks; Real Estate.]
Mr. Storer noted this graph demonstrates how the asset allocation
of the Permanent Fund has changed over time. He stated the current
payout methodology is based on realized income. He defined realized
income as dividends, interest, cash flow from real estate, and "any
profits the managers may take." He stressed the current management
methods were appropriate during the early years of the fund, in the
late 1970s and early 1980s when the Fund was exclusively invested
in fixed income securities and bonds. He specified the
characteristic of bonds "is virtually all of the money that your
earn is through cash flow and not appreciation of assets". He told
of the diversification of investments beginning in 1983 and noted
the Fund is no longer invested to achieve a large cash flow but
rather most of the returns from the Fund are represented in
appreciation.
Trustees' proposal
The APFC Board of Trustees propose a constitutional
amendment to limit annual fund spending to five percent
of the Fund's total market value.
POMV
Mr. Storer stated that as a result of the changes in investments,
the Corporation is recommending changing management to a payout of
market value methodology. In any given year, he stated, this system
would allow appropriation of no more than five percent of the total
value of the assets.
Mr. Storer explained the decision to recommend limitation of
spending to five percent. He told of the study of historical data,
as well as prospective aspects and that the Trustees are
"comfortable" the fund would earn an average of five percent in the
future. He qualified this is not realized earnings, but rather a
reflection of appreciation. He emphasized the calculation of the
value of the Fund would be a five-year average, rather than annual.
He stated this method of managing the fund would provide "greater
predictability and less volatility" in payouts.
What is POMV?
POMV, or "Percent of Market Value," is a formula that
limits spending to a set percent of a fund's total market
value.
The set percent is based on the expected difference
between total annual return on investments and the rate
of inflation.
8% projected average annual return
-3% projected average annual inflation*
5% maximum annual sustainable payout
*retained in the Fund for inflation proofing
Mr. Storer gave the historical average earnings of the Fund at
eight percent, and stated the Trustees' anticipate this average
would continue. He reiterated the Trustees' "comfort" in allowing
payouts based on a five percent annual real rate of return. He
noted the actual earning predictions are 7.6 percent nominal rate
of return, although the Corporation's consultant predicts an annual
inflation rate of 2.6 percent over the next few years. He reported
that inflation is currently slightly above two percent and would
increase slightly over time.
Fund performance
· Historically, Fund returns would have hit their long-
term real rate of return target.
· Fund returns going forward, after adjusting for
inflation, are expected to meet the target payout over
time.
FY 94-03 historical
2.5% Inflation
5.3% Real return
7.8% Total
Long-term projected
3.0% Inflation
5.0% Real return
8.0% Total
(periods ending June 30)
Mr. Storer informed that during the previous ten years, the Fund
experienced a great appreciation in the equity market value due to
an unsustainable bull market. However, he stressed, the Fund also
experienced significant reduction due to the "one of the more
severe down markets in the last 100 years." Despite this, he said,
the Fund's returns were "essentially normalized" and realized a 7.8
percent nominal rate of return. He qualified that inflation was
only 2.5 percent, and therefore the Fund achieved a 5.3 percent
rate of return.
Rolling 10-year real return
[Graph showing annualized real rate of return from 1994
through 2003 varying from below ten percent to above five
percent.]
Mr. Storer explained these calculations are made every year and
compared to the previous ten years. He pointed out the Fund has
achieved earnings of at least five percent every year and
reiterated that the legislatures' discipline to not over-
appropriate in higher earning years has allowed dividends and
inflation-proofing in lower earning years. He predicted that if
this discipline were not exercised during 1999 and 2000, the
earnings would have been overspent and the Fund would currently be
in a deficit. He estimated that a worst-case scenario would result
in a one or two percent rate of return.
Realized income v. market value
[Graph comparing the percent change in value of annual
market value and realized income i.e. the status quo, for
FY 83 though FY 03]
Mr. Storer indicated this graph demonstrates the volatility between
the current formula and the proposed POMV formula. He pointed out
these figures do not represent the amount the Fund earned every
year, but rather "the rate of change in any given year". He
qualified that the significant "spike up" in FY 96 was not actually
an 80 percent rate of return, but rather the realized income
exceeded that of the previous year by over 80 percent. He
reemphasized the POMV method would result in less volatility and
greater predictability.
Why do we need POMV?
For the present
· Ensure the option of an annual payout
· Make payout amounts more stable from year to year
· Make payout method compatible with investment
strategy
For the future
· Prevent overspending in the good years
· Maintain purchasing power for the entire Fund
Mr. Storer stressed this proposal provides the option of payouts by
the legislature, although payouts are not mandatory.
What are Alaskans asking?
· Will this change leave the principal unprotected?
Mr. Storer noted that POMV would essentially remove the term
"principal", although over the long term, this method would ensure
the purchasing power of the Fund.
· How will POMV affect my dividend?
Mr. Storer noted the Trustees' concerns are focused on the value of
the fund and the ability for payouts. However, he noted most
Alaskan's concerns related to the impact on their dividends. He
answered that the dividend formula would not have to be changed,
although the Trustees' support such a change. He recalled the ten
percent chance in any given year that no funds would be available
to pay a dividend under the current dividend formula. He reiterated
that changing the dividend formula to POMV would provide greater
predictability and less volatility.
· Is POMV a raid on the Permanent Fund?
Mr. Storer assured this proposal is not a raid on the Fund, but
rather a limit on how much could be appropriated. He understood
some to disagree this proposal would result in such a raid, but
stressed that the matter would not be raised if the State was not
currently in a "fiscal problems." He stressed these are parallel
issues.
· Why fix the Permanent Fund if it isn't broken?
Mr. Storer opined that the system has been "broken" for some time.
He remarked that the bull market amassed a poor payout program. He
warned that the cost of not changing to a POMV method of managing
the fund would result in lost income and "dislocations to those
expecting dividends." He reiterated that the current payout system
was appropriate for the way the Fund was invested in the 1970s but
is no longer appropriate.
Mr. Storer furthered that investing in equities is not "double
inflation proofing". He explained that the Trustees have invested
the Fund in equities that would increase over time well in excess
of inflation. However, he stated that once a manager sells an
equity stock, such as General Electric, the value is converted to
realized income distributed under the current management system. He
pointed out that if the change were made to a POMV method, this
would not occur.
Senator Bunde questioned the witness' assertion that the formula
used for calculating dividends would not have to be changed if POMV
were adopted. He understood that the current formula is based on
the earnings of the previous five years and the POMV would not
calculate earnings as such.
Mr. Storer explained that the current dividend formula is based on
realized income only. He clarified that management of the Fund
could be converted to POMV and the current dividend calculation
formula could be retained. He stated that if the dividend
calculation became greater than five percent a "wall" would be
encountered. He noted this does not occur often. He emphasized that
in a series of years with strong earnings payouts could be in
excess of five percent, at which time the "fire wall" would be
reached. He advised that the formulas be the same, and that the
current payout formula is in conflict with the POMV formula.
Senator Bunde relayed criticisms that the amount of dividends would
diminish over time under a POMV system. Therefore, he asked if the
current formula used to calculate the amount of dividends would be
more volatile if maintained in conjunction with a POMV method to
calculate the amount of funds available to pay dividends.
Mr. Storer responded that the current formula is very volatile and
emphasized the possibility that no funds would be available to pay
dividends in the event of an extreme bear market.
BOB BARTHOLOMEW, Chief Financial Officer, Alaska Permanent Fund
Corporation, testified that were a POMV adopted and the current
formula for calculating the amount of dividends were maintained,
the dividend payouts would be the same and would remain volatile.
He expressed the challenge for the public is determining how
changes would affect the dividend and how to expend the earnings of
the Fund. He informed that the current formula could be retained,
although this would require the Corporation to maintain two
"separate sets of books" to account the POMV method and the formula
currently used to determine the amount of dividends. He admitted
the managers of the Corporation would prefer not to do this.
Mr. Storer remarked, "The bigger the fund the greater your earnings
compound: ten percent over $20 is smaller than ten percent over $25
billion." Therefore, he stated that any time incremental income is
utilized for purposes such as government services earnings would be
compounded on a slightly smaller fund. He surmised a "small
diminishment" on the value of the dividend would occur, but
emphasized this exists with the current formula as well.
SENATOR RALPH SEEKINS asked if the significant increase of realized
income that occurred in 1996 was a result of Fund management
decisions.
Mr. Storer replied that the Trustees made the decision that
affected the realized income. He described the two components of
investments: active management and passive management, which he
clarified as the index fund. He explained that the Fund was
significantly invested in an index fund designed to replicate the
S&P 500 index, which has "no market timing whatsoever". During the
bull market, he stated that the Trustees discussed
"intergenerational equity" and the concern that the passive
investments would continue to grow to the benefit of future
generations but not for current Alaskans. He relayed that the
Trustees determined to institute a methodology to allow the current
generation to benefit from the bull market as well as future
generations and that some profits should be realized from the
Fund's portfolio. He remarked this action resulted in a larger than
normal dividend for 1996.
Senator Seekins surmised that under the current system, the
Trustees therefore, could manipulate the amount of money taken from
the principal of the Fund by directing the Fund managers what
investments to sell and when to sell them.
Mr. Storer replied that future Trustees could take profits after
"well thought out or other reasons".
Senator Seekins expressed concern with the Trustee's ability to
"play God" in making such determinations that would dramatically
affect dividend payouts. He asked if this ability would exist under
a POMV system of management.
Mr. Storer responded the impacts of such Trustee decisions would
lessen because the POMV method would limit the amount available for
payouts. He added that the most important point of POMV is
inflation proofing. He asserted that POMV is a "positive management
tool", in that asset allocation decisions would be based solely on
maximizing the return on the Fund.
Senator Seekins stated that the current system prohibits the
principal to be spent. He asked if this is correct.
Mr. Storer answered, "principal is a notational number. It's an
accounting number" that identifies contributions from mineral
wealth, inflation proofing and special appropriations. He stated
that the aforementioned Attorney General opinion stated that the
amount available for distribution is the realized income for the
Fund. He exampled a fund with a principal worth $23 billion, and
the value is $21 billion because the stock market went down
dramatically, and realized income is $1 billion. He noted that
under the current formula, $1 billion is available for
distribution, even though the value of the fund is below the
principal.
Senator Seekins applauded Mr. Storer for being a nonpartisan
manager of the Fund. Senator Seekins asked how the witness would
promote the current management method if directed to do so.
Mr. Storer replied he would have "great difficulty". He expressed
that POMV not only modernizes the payout methodology, Generally
Accepted Accounting Principles (GAAP) makes no distinction between
realized income and appreciation. He informed that most endowments
and foundations utilize a POMV payout system. He noted that
currently the Corporation is required to defend why the GAAP does
not apply to the Fund. He furthered that realized income could be
manipulated as well.
Mr. Bartholomew explained the resolution and the changes made in
the Senate State Affairs committee substitute.
Mr. Bartholomew informed that Section 1 of the bill amends Article
IX, Section 15 of the Alaska Constitution to provide for a POMV
method. He pointed out the removal of the term "principal",
stipulating that all the monies would be considered as one fund. He
furthered that currently the Constitution directs that all income
generated from the Fund be deposited into the State general fund,
unless otherwise provided by law. He noted that current statute has
provided that all income would be retained in the earnings reserve
account of the Fund. This resolution, he stated would
constitutionally require that all monies remain in the Permanent
Fund until appropriated.
Mr. Bartholomew addressed the addition of subsection 15(b) to the
Constitution contained in Section 2 of the resolution. He explained
this language implements the POMV and places a spending limit on
the amount that could be withdrawn from the Fund of no more than
five percent of the value of the Fund calculated on a five-year
average. He assured this five-year average would limit the
volatility. He further noted that the language contains a "look-
back" provision requiring the five-year average calculation be made
on the first five of the previous six years. He explained this is
to provide the Legislature, when convening in January of each year,
with calculations based on five completed calendar years. He stated
the Legislature would therefore be aware of the amount available
for appropriation in the upcoming fiscal year.
Mr. Bartholomew said Section 3 of the resolution is technical and
specifies that if this amendment were made to the Constitution, the
balance of the earnings reserve account would be deposited into the
Permanent Fund. He relayed this is to address the legalities of
whether the existing earnings reserve account, with a balance of
"several billion dollars", is actually part of the Permanent Fund
or the general fund.
Mr. Bartholomew summarized that Section 4 of the resolution
provides that the proposed constitutional amendment would be placed
on the ballot of the next general election.
Senator Bunde pointed out not all current Alaskan residents were
present when the Alaska Permanent Fund or the dividend program was
established. He surmised that "revisionist history" was occurring.
He relayed public comments expressing concern that the legislature
"keep their hands off the Permanent Fund", and he attributed this
to over ambitious campaigning by some legislators promising to do
so. He understood earnings of the Fund have been spent. He asked
for affirmation that during the first two years the Fund was in
existence, whether the earnings were deposited into the State
general fund and appropriated for government services.
Mr. Bartholomew answered this is correct and explained that all
earnings were deposited to the general fund and spent for
government services. In 1982, he informed, the legislature adopted
the current statute, which retained the earnings in an earnings
reserve account subject to legislative appropriation.
Senator Bunde stated that approximately one-third of the balance of
the principal is from appropriations from the earnings reserve
account. He surmised that this could technically be considered as
spending of the earnings.
Mr. Bartholomew affirmed the principal of the Fund now is about $23
billion, made up of the three aforementioned components. He stated
that the funds in the earnings reserve account were available for
appropriation and that the legislature has opted to transfer a
portion of those funds and deposit into the principal, making them
no longer available.
Senator Bunde also understood that "tens of millions" of dollars
from the earnings reserve account have been appropriated for hold
harmless provisions to offset reductions in public assistance
benefits that some Alaskans would incur as a result of the
increased income of the dividend.
Mr. Bartholomew replied that currently, of the amount available
annually for expenditure, $35 million is appropriated for non-
dividend activities. He stated that $5 million is utilized to
operate the Permanent Fund Dividend Division, and the remainder is
appropriated to the Department of Corrections and to the Department
of Health and Social Services.
Senator Bunde pointed out that a portion of the earnings of the
Fund have been spent in the past and continue to be appropriated by
the Legislature and therefore a proposal to spend a portion of
earnings for government services is not "sacred ground."
SFC 04 # 39, Side B 02:22 PM
Senator Bunde commented that Mr. Storer expressed he would find it
difficult to "sell" the current formula because it differs from
acceptable accounting practices. However, Senator Bunde remarked
that a "clear majority" of the public is resistant to the POMV
proposal and would oppose it in an election. He expressed concern
about placing such a proposal on the ballot that is predestined to
fail.
Mr. Storer reported that when given an opportunity to explain the
POMV method, listeners support the proposal. He exampled that straw
polls conducted of the conferees at the Conference of Alaskans
first reflected opposition to a POMV plan. However, the plan
received higher support once the conferees understood the method.
He indicated that if the Legislature passed a resolution to amend
the constitution to change to a POMV method, the Corporation would
increase efforts to educate the public.
Senator Bunde reminded of the special election held in September
1999 in which voters rejected a proposal to convert to a form of
POMV for managing the Permanent Fund. He relayed that since that
time, when the subject is addressed, common response is, "What part
of no don't you understand?"
Mr. Storer understood the concerns. He recalled that the
aforementioned advisory vote was "open-ended" and proposed a payout
of 5.8 percent. He attributed many reasons for the opposition of
the ballot proposal. He also realized that a number of years had to
pass before the issue of utilizing the Permanent Fund earnings for
government spending could be reconsidered. He submitted the current
proposal is not a spending plan but rather a spending limit. He
stated the goal is to "memorialize inflation proofing into the
Constitution" to ensure the viability of the Fund. He admitted
obtaining voter approval for the POMV would be a "big hurdle".
Mr. Bartholomew added that the public concerns focus on use of the
earnings of the Fund and not protection of the Fund. He emphasized
the important of being clear on this distinction when discussing
the matter. He noted other proposals address use of the earnings of
the Fund, but were separate issues from the POMV method of managing
the Fund. He told of confusion with "mixed messages" not clearing
identifying the differences.
Senator Dyson understood that under a POMV method, a maximum of
five percent would be available for distribution and that if the
five-year average market value of the fund has only increased four
percent, the amount available for distribution would be limited to
four percent.
Mr. Bartholomew clarified that under the current proposal, the
constitution would specify a five-percent payout limit. He relayed
that discussions of "guard rails" have occurred to further reduce
the percentage available for payout in the event of poor
performance of the Fund. He recommended that if such a method were
instituted, the determination should be based on at least a ten-
year average.
Senator Dyson commented that the ability to payout from the
principal is the basis of criticisms of the POMV proposal.
Mr. Storer emphasized this is one "crux of the issue". He remarked
that the decision makers i.e., the legislature would have the
ability to determine whether payouts of five percent or less that
amount would be made in years when the total market value of the
Fund has failed to increase by at least five percent. He stressed
that the legislature would have the ability to determine what
action is in the best interest of the State. He noted that
currently, the legislature does not have this option.
Senator Dyson reiterated that the argument remains that under the
present law, the legislature is unable to appropriate funds from
the principal of the Fund. He asked whether the proposed
constitutional amendment should include a guarantee against drawing
against the principal.
Mr. Storer advised against tying payouts to performance of the
Fund. He relayed that "discussions" have been held with "some
elected officials," suggesting the adoption of statutory
"guidelines that would give the legislative body the insight to
determine that inflection point" as to whether the entire five
percent should be utilized.
Senator Dyson gave a hypothetical situation in which the Fund has
had four percent growth for several years, and the legislature
chose to appropriate four percent to payout of dividends and no
other purpose. In this scenario, he pointed out, the Fund would not
be inflation proofed, regardless of the actual rate of inflation.
Mr. Bartholomew stressed that worst case scenarios must be used for
comparison. He agreed that under the POMV method, inflation
proofing would not automatically occur; however he pointed out that
in instances of no earnings, inflation proofing would not occur
under the current formula either. He remarked that under the
current system, the legislature has no option to expend funds from
the Fund in years of down markets. He emphasized that in a bad
market, the legislature would have the ability to spend funds under
POMV.
Mr. Bartholomew listed three issues that must be understood by the
public in considering this matter. He stated that the current
formula is "broken" and is not prepared for down markets because
the earnings and the principal have been commingled. He explained
that $5 billion in earnings that should be available to "cushion"
the payout in down years have instead been deposited into the
principal and thus "taken off the table." He opined that the risk
of spending down from the principal during down years under a POMV
method is "far outweighed" by the provisions of the current formula
that allow larger appropriations from the earnings reserve fund in
strong years. He admitted the tradeoff in adopting a POMV
methodology and stated the issue is which method provides the
greatest protection. He relayed that the Trustees' position is that
POMV provides the greatest protection.
Senator Dyson clarified that under POMV there is no earnings
reserve account.
Mr. Bartholomew affirmed.
Senator Olson asked if the POMV is such a valuable management tool,
why the Corporation did not aggressively pursue a change before and
instead wait until the State was in the current fiscal situation.
He remarked that the public is wary of this proposition, partially
due to the timing.
Mr. Storer responded that in 1994 a POMV method of payout was first
proposed. He continued that this option was "defined well before"
the State incurred its current fiscal problems, although it has
taken time for the issue to receive attention. He viewed the
negative comments positively, because it shows that people are
interested in the matter.
Senator Olson asked of instances of funds or endowments
implementing a POMV system that resulted in negative situations in
which the decision to implement POMV was regretted.
Mr. Storer referenced a study reporting that 85 percent of
participants in an association of college and university business
offices utilizes some variant of POMV. He clarified that the
decision to implement POMV was not regretted, rather "they got
caught up in overspending." He told of one university beginning a
large capital project during the bull market, and now must proceed
with the project despite generating less income.
SENATOR BERT STEDMAN clarified the terminology used at this
hearing, notably the implication that a POMV method would modernize
the Permanent Fund. He was under the impression that a form of POMV
has been used by other endowment funds for many years.
Mr. Storer informed that the first fund to adopt a POMV method was
the Ford Foundation in 1968. He said few funds adopted this method
during the 1970s because most were invested conservatively during
that time. However, he noted more funds converted to POMV during
the 1980s and that some universities utilize complex formulas.
Senator Stedman pointed out the this proposal would not therefore
"take the Permanent Fund to the leading edge." He clarified that as
currently structured, the management of the Permanent Fund is
behind methods employed by other endowment funds, such as Harvard.
Mr. Storer remarked that the Alaska Permanent Fund remains one of
the most conservatively managed endowments. He noted that
retirement funds are not managed with a POMV system because of
obligations to retirees. He also stated that unlike other public
funds, the Permanent Fund is limited in how the funds could be
invested.
Senator Stedman reiterated that if POMV were adopted for the
Permanent Fund, the management would still be "no where near
leading edge."
Mr. Storer characterized the management system as "catching up" to
the methods employed for other funds.
Senator Stedman asked if other public entities in Alaska utilize a
POMV methodology.
Mr. Storer gave the University of Alaska Foundation and the
Municipality of Anchorage as examples.
Senator Stedman asked current market value of the principal of the
Permanent Fund.
Mr. Storer responded that the total of contributions, inflation
proofing and special appropriations is approximately $23 billion.
He also stated that if a POMV methodology were in place,
approximately $1.3 billion would be available for payout.
Senator Stedman asked how long during a "normal bear market" it
would take before the market value calculation "dipped into" what
is currently considered the principal of the Fund.
Mr. Storer replied that there is no "normal bear market" due to
many variables and he could not therefore calculate when the
threshold would be reached. He reminded that in March of 2000 the
Fund contained a "cushion" of $8 billion, which was utilized to
inflation proof the Fund and to payout three "substantial"
dividends. He stated that if the entire $8 billion had been paid
out in dividends during one year, no funds would have been
available for the next three or four years for dividends.
Senator Stedman surmised it would take longer to "dip" into the
principal under the current Fund management than under a POMV
management.
Mr. Storer agreed. He furthered that "human behavior" would become
less of a factor under a POMV method and that it would be "easier
to stay the course" in operating the Fund. He reiterated that past
discipline has allowed excess earnings to be "captured" and
deposited into the corpus of the Fund, but he questioned whether
different memberships on the Trustee Board would demonstrate the
same behavior.
SENATOR GRETCHEN GUESS asked why the POMV management system should
be stipulated in the Alaska Constitution rather than State statute.
Mr. Storer responded that the original intent of the Trustees was
to institute the management provisions into the Constitution
because statutes could be changed without voter approval.
Mr. Bartholomew furthered that "near term down markets" could not
be addressed in statute if the excess earnings have been "locked
up." He explained that dividends could not be distributed if this
occurred. He stated that it is necessary to eliminate the earnings
reserve fund and principal and incorporate both into one fund,
which must be done constitutionally.
Senator Guess countered that the earnings of the Permanent Fund are
always available for the legislature to appropriate and are
therefore not "locked up".
Mr. Bartholomew replied that the proposed POMV assures that the
situation of the year 2002, in which the earnings reserve fund was
almost depleted, would not occur. He reported that the earnings
reserve fund balance was almost zero because a dividend was paid
the prior year, stock market earnings reduced and the legislature
"swept" $250 million to the principal of the Fund in 1999. He
informed that if the bear market had continued another three
months, no funds would have been available to pay dividends in
2003. He stated that under the POMV method, this situation would
not have occurred because dividends could have been paid utilizing
the principle of the Fund. He qualified that if the goal is to
always maintain the current "concept of principal", statutory
provision could be enacted to ensure it. He cautioned that the risk
of little to no payout would remain.
Senator Bunde clarified asked if the proposal would place the
current practice of transferring funds from the Permanent Fund to
the State general fund into the Constitution, rather than current
statute.
Mr. Bartholomew affirmed.
SENATOR TOM WAGONER asked if the Legislature passed a resolution to
place a POMV initiative on the ballot, if the intent of the
Corporation is to advertise in support of the POMV method and
educate the public as to its merits. He asked the source of funding
for these efforts.
Mr. Bartholomew told of funding requests before the legislative
finance committees. He noted if these funds were not appropriated,
the Corporation would continue the current practice of accepting
speaking invitations and explaining the issue in those forums.
Senator Wagoner clarified the funding request would appropriate
funds from the Permanent Fund earnings reserve account for the
advertising and education activities.
Senator Bunde ascertained the primary opposition to the POMV
proposal is primarily generated from the "Just Say No"
organization. He recognized concerns with utilizing earnings of the
Fund for State services, but reiterated that these earnings are
already being spent. He asked if the Corporation has considered how
to address this organization.
Mr. Storer relayed that the Corporation has requested to speak to
the "Just Say No" organization and has not received a response. He
expressed interest in speaking to its members, as he said the group
has raised important questions.
SENATOR HOLLIS FRENCH referenced earlier conversations between
himself and Mr. Storer regarding concerns about the long-term
effects of inflation. He predicted the possibility of "entering a
new financial era" similar to the "hyperinflationary times of the
early 1970s". He surmised that if the "best and brightest financial
minds" were asked four years ago whether the federal budget could
revert from a $.5 trillion projected budget surplus to $.5 trillion
budget deficit, these experts would have answered it could not
possibly occur. He was therefore concerned about unforeseen
consequences. He recommended inserting "either the difference
between the rate of return and the rate of inflation" to Section 2
of the resolution on page 2, line 3, amending Article IX, sec. 15
of the Constitution, to read as follows.
(b) To protect the permanent fund from the effects of
inflation and thereby assure that the real value of the
permanent fund will be preserved over the long term,
appropriations from the permanent fund for a fiscal year may
not exceed either the difference between the rate of return
and the rate of inflation, or five percent of the average of
the market values of the fund on June 30 for the first five of
the six fiscal years immediately preceding that fiscal year.
He surmised this would provide assurances for years with lesser
earnings. He asked whether the Trustees have considered a "closing-
off mechanism" that would remove the decision from the legislature
to determine appropriation amounts in the event that earnings were
less than five percent. He expressed concern that the public would
consider the current proposal a guarantee of payout and that the
legislature would have difficulty appropriating a lesser amount.
Mr. Storer informed that two situations of "hyper-inflation"
occurred in the past. He cautioned against "competing complex
formulas."
Mr. Bartholomew emphasized that whether instituted in the
Constitution or in statute, payout calculations should not be made
based on annual earnings. He recommended against a year-to-year
analysis and instead recommended a structure based over a period of
time.
Co-Chair Wilken ordered the bill HELD in Committee.
ADJOURNMENT
Co-Chair Gary Wilken adjourned the meeting at 03:05 PM
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