Legislature(2009 - 2010)SENATE FINANCE 532

02/06/2009 09:00 AM Senate FINANCE


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09:06:09 AM Start
09:06:15 AM Presentation:
09:50:26 AM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ Presentation: TELECONFERENCED
State Budget Reserves/Savings Accounts
and Sweep Mechanics
Bills Previously Heard/Scheduled
                    SENATE FINANCE COMMITTEE                                                                                    
                        February 6, 2009                                                                                        
                           9:06 a.m.                                                                                            
                                                                                                                                
9:06:09 AM                                                                                                                    
                                                                                                                                
CALL TO ORDER                                                                                                                 
                                                                                                                                
Co-Chair Stedman  called the Senate Finance  Committee meeting to                                                               
order at 9:06 a.m.                                                                                                              
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Senator Lyman Hoffman, Co-Chair                                                                                                 
Senator Bert Stedman, Co-Chair                                                                                                  
Senator Charlie Huggins, Vice-Chair                                                                                             
Senator Johnny Ellis                                                                                                            
Senator Kim Elton                                                                                                               
Senator Donny Olson                                                                                                             
Senator Joe Thomas                                                                                                              
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
None                                                                                                                            
                                                                                                                                
ALSO PRESENT                                                                                                                  
                                                                                                                                
Kim  Garnero,  Director,  Division   of  Finance,  Department  of                                                               
Administration; Kevin Brooks,  Deputy Commissioner, Department of                                                               
Administration;   David  Teal,   Director,  Legislative   Finance                                                               
Division.                                                                                                                       
                                                                                                                                
SUMMARY                                                                                                                       
                                                                                                                                
^Presentation:                                                                                                                
State Budget Reserves/Savings Accounts and Sweep Mechanics                                                                    
                                                                                                                                
9:06:15 AM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman observed  the importance  of understanding  how                                                               
sweep  mechanics  work and  how  the  state's account  books  are                                                               
closed.  He  acknowledged  the  importance  of  the  relationship                                                               
between the  state's general fund  and the  Constitutional Budget                                                               
Reserve  Account  (CBR),  which  is  the  state's  main  fallback                                                               
account to  cover any  shortfalls. A 3quarter  vote is  needed to                                                               
access the CBR.  He noted that the state's cash  reserve would be                                                               
reviewed over the next months.                                                                                                  
                                                                                                                                
9:09:20 AM                                                                                                                    
                                                                                                                                
KIM  GARNERO,  DIRECTOR,  DIVISION   OF  FINANCE,  DEPARTMENT  OF                                                               
ADMINISTRATION,   explained   the   sweep  process.   The   sweep                                                               
calculation  requires  substantial,   quality  time  with  annual                                                               
auditors. She emphasized the need  to understand the general fund                                                               
from an accounting viewpoint. The  fund structure of the state of                                                               
Alaska   is   determined   by   generally   accepted   accounting                                                               
principles,  which   is  reflected   in  the   audited  financial                                                               
statements  contained  in   the  Comprehensive  Annual  Financial                                                               
Report.                                                                                                                         
                                                                                                                                
Ms.  Garnero explained  that  accountants identify  the  overall                                                                
general fund  as fund 11000 in  AKSAS, the statewide  accounting                                                                
system. Fund  11000 is comprised of  all the sub-funds, most  of                                                                
which  were established  by  the legislature.  Fund  11000 also                                                                 
includes the  lower level,  primary general  fund designated as                                                                 
11100 in  the accounting system; primary  general fund is  still                                                                
very  large, and  accounts for  the  majority of  the  financial                                                                
activity  of the  state  of  Alaska. Most  funding  sources  are                                                                
revenue  streams  into  this  general  fund,  including  federal                                                                
funds, program receipts, and receipt supported services.                                                                        
                                                                                                                                
9:12:56 AM                                                                                                                    
                                                                                                                                
Ms.  Garnero  defined  the  reverse   sweep  as  an  appropriated                                                               
transfer that  restores the  balances of  the sub-funds  to repay                                                               
amounts previously  borrowed or  drawn. The  reverse sweep  is an                                                               
appropriated transfer that restores the balance of the sub-                                                                     
funds.  The sweep  is  done as  the last  step  in preparing  the                                                               
Comprehensive Annual  Financial Report; the reverse  sweep occurs                                                               
in early December, but the  available balance is calculated as of                                                               
June 30 of the previous fiscal year.                                                                                            
                                                                                                                                
Ms. Garnero informed that the sweep is required under the  Alaska                                                               
State Constitution  to repay previous  borrowing every year  with                                                               
the  general fund  available  balance.  Under the  terms  of  the                                                               
constitution, anything spent from  the CBR must be repaid by  the                                                               
general  fund.  The  reverse sweep,  on  the  other  hand,  is  a                                                               
legislative  appropriation from  the  CBR,  and it  adds  to the                                                                
repayment requirement.                                                                                                          
                                                                                                                                
Ms.  Garnero clarified  that  the  "available for  appropriation"                                                               
calculation is the key to the  sweep. The first step of the sweep                                                               
moves all  available funds up  to the overall general  fund (fund                                                               
11000).  Encumbered  amounts  and   amounts  for  continuing  and                                                               
specific  appropriations of  the subsequent  year are  set aside.                                                               
One  of two  criteria is  used to  determine which  sub-funds are                                                               
excluded from the sweep requirement:                                                                                            
                                                                                                                                
   1. If it meets the definition of "available for appropriation"                                                               
     as determined by the Supreme Court of Alaska; or                                                                           
   2. If it is legally restricted to a specific purpose by an                                                                   
     outside entity.                                                                                                            
                                                                                                                                
Ms.  Garnero noted  that  if a  sub-fund  meets either  of  these                                                               
criteria, the available balance is not swept. The balance in  the                                                               
primary general fund 11100  is available for sweep, and in  years                                                               
of reverse sweep appropriation language, this is the only  amount                                                               
retained  in the  subsequent  fiscal  year as  repayment  of  CBR                                                               
borrowing.                                                                                                                      
                                                                                                                                
Ms. Garnero  provided a brief  review of the state's  recent cash                                                               
flow borrowing.  She referred to  a spreadsheet contained  on the                                                               
department's webpage, which starts  with the available balance of                                                               
the CBR  at the beginning of  the fiscal year. She  observed that                                                               
from FY02 to  FY05, borrowing occurred during the  fiscal year to                                                               
address cash flow  needs of the general fund.  This borrowing was                                                               
authorized  by  appropriation  language and  followed  a  process                                                               
established in an interagency  memorandum of understanding (MOU).                                                               
In  FY02 and  FY03, there  was  net cash-flow  borrowing at  June                                                               
30th. In  FY04 and  FY05, the  state was able  to repay  the cash                                                               
flow borrowing  by June 30th. The  additional (deficit borrowing)                                                               
or repayment was  the based on the  available balance calculation                                                               
in  the  primary  general  fund  11100. In  FY02  to  FY05,  more                                                               
borrowing was required  to bring a negative  available balance in                                                               
the general fund up to zero.                                                                                                    
                                                                                                                                
Ms. Garnero  explained that in  FY06 the general  fund available                                                                
balance was  appropriated to the  Public Education Fund,  and in                                                                
FY07, it  was appropriated  to the  Alaska Capital  Income Fund,                                                                
both of which are sub-funds of the general fund.                                                                                
                                                                                                                                
Ms. Garnero concluded that in FY08, the general fund had an                                                                     
available balance to repay previous CBR borrowing, and $582                                                                     
million was transferred for this purpose.                                                                                       
                                                                                                                                
9:16:26 AM                                                                                                                    
                                                                                                                                
Ms. Garnero  elucidated that the  designated fund balance  is the                                                               
oil and  gas production tax  revenues budgeted in the  next year.                                                               
There  is an  annual direct  appropriation  from the  CBR to  the                                                               
Treasury Division to pay management fees.                                                                                       
                                                                                                                                
Ms. Garnero summarized  that the ending available  balance of the                                                               
CBR increased about  $5 billion during FY08. This  was the result                                                               
of $3 billion  appropriated to the CBR, $1 billion  net sweep and                                                               
reverse sweep,  $582 million  additional general  fund repayment,                                                               
and the operating income of $416 million.                                                                                       
                                                                                                                                
Ms. Garnero provided members with a description of each sub-                                                                    
fund of the general fund, indicating whether or not it is                                                                       
swept, and if so, how much was swept in FY08 (copy on file).                                                                    
                                                                                                                                
Ms. Garnero  drew attention to  sub-funds; the CBR itself  is a                                                                 
sub-fund of  the general fund.  The CBR  is not swept  to repay                                                                 
itself.  However,  the  Budget   Reserve  Fund  established  in                                                                 
statute  is a  sweepable  sub-fund, as  is  the Alaska  Capital                                                                 
Income  Fund.  She explained  that  any  fund established  with                                                                 
language  that allows  a  specific  appropriation is  sweepable                                                                 
because  if  it   can  be  appropriated  for  "X"   it  can  be                                                                 
appropriated for anything.                                                                                                      
                                                                                                                                
Ms. Garnero explained  that language that establishes the fund                                                                  
"as spendable without further appropriation" meets the Supreme                                                                  
Court definition  to exclude from  sweep. The Public Education                                                                  
Fund and  Permanent Fund  Dividend Fund are  examples of funds                                                                  
that are excluded from the sweep.                                                                                               
                                                                                                                                
9:19:27 AM                                                                                                                    
                                                                                                                                
In  response  to  a  question by  Senator  Stedman,  Ms.  Garnero                                                               
clarified  that  the  reverse  sweep   has  reduced  the  CBR  by                                                               
$1,466,159. Another  billion dollars  was transferred to  the CBR                                                               
based on an  appropriation from the legislature  from the general                                                               
fund. There has been a year  to date current net loss in earnings                                                               
of $65 million.  The current balance of the CBR  is close to $6.8                                                               
billion. Co-Chair  Stedman concluded  that market values  need to                                                               
be watched in discussions of appropriations from the CBR.                                                                       
                                                                                                                                
9:21:17 AM                                                                                                                    
                                                                                                                                
Senator  Olson asked  if sweeps  ever occur  at other  times. Ms.                                                               
Garnero  noted  that  transfers  are  not  appropriated  [by  the                                                               
legislature] or authorized under the constitution.                                                                              
                                                                                                                                
In  response  to  a  question   by  Senator  Elton,  Ms.  Garnero                                                               
explained that the reverse sweep  reinstates the cash to the sub-                                                               
                st                                                                                                              
funds on  July 1.  She  acknowledged that state revenues  flow in                                                               
more  slowly   at  the   beginning  of   the  fiscal   year  than                                                               
expenditures because of  large payments that are due  in July and                                                               
August. A lot of the cash  flow borrowing occurs at the beginning                                                               
of  the fiscal  year  and repayment  begins at  the  end [of  the                                                               
fiscal year].                                                                                                                   
                                                                                                                                
9:23:44 AM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman stated  that the  hearing  is not  an issue  of                                                               
solvency or  liquidity of the  state, but  an attempt to  look at                                                               
the next five years.                                                                                                            
                                                                                                                                
DAVID TEAL,  DIRECTOR, LEGISLATIVE  FINANCE DIVISION,  provided a                                                               
model to demonstrate the sweep  process [members reviewed a excel                                                               
spreadsheet, which Mr. Teal  manipulated via overhead projector].                                                               
He  referred  to  investment  returns and  the  "burn  rate."  He                                                               
observed that  oil prices are  currently down,  creating deficits                                                               
instead of  surpluses. Given the  deficit, the question  is: "How                                                               
fast are we  burning through our reserves?" He  observed that the                                                               
state  is doing  okay  if  the reserve  balances  grow, but  that                                                               
action may need to be taken if the reserve balances decline.                                                                    
                                                                                                                                
9:28:03 AM                                                                                                                    
                                                                                                                                
Mr. Teal  explained that the model  uses a simple growth  rate as                                                               
demonstrated  in the  spreadsheet  provided to  members (copy  on                                                               
file). Oil  prices are  averaged over  the year,  which is  not a                                                               
good way to discern revenue.   He emphasized that it is important                                                               
to watch the trends.                                                                                                            
                                                                                                                                
Co-Chair Stedman  observed that  a growth rate  of 3  percent was                                                               
used, which  could be higher or  lower. The model draws  from the                                                               
CBR first  and then  from the Statutory  Budget Reserve  Fund. He                                                               
stressed that  these factors  were used as  a starting  point and                                                               
that   there  would   be  opportunity   for  further   discussion                                                               
[regarding the priority of funds].                                                                                              
                                                                                                                                
Mr.  Teal   observed  that  the  model   reviews  several  funds:                                                               
Constitutional  Budget  Reserve  Fund, Statutory  Budget  Reserve                                                               
Fund, Alaska  Housing Finance Corporation (AHFC)  Capital Savings                                                               
Account,  Public  Education  Fund, and  Permanent  Fund  Earnings                                                               
(realized only).                                                                                                                
                                                                                                                                
Senator Eton asked how the  Permanent Fund Earnings were plotted.                                                               
Mr.  Teal explained  that only  realized earnings  were used.  He                                                               
noted  that there  are substantial  unrealized losses,  but until                                                               
the  losses  are realized  the  cash  is  still in  the  account.                                                               
Additional  losses  could  occur  if money  is  pulled  from  the                                                               
account. He  noted that the legislature  has historically avoided                                                               
withdrawing from this account.                                                                                                  
                                                                                                                                
9:32:12 AM                                                                                                                    
                                                                                                                                
Mr. Teal  explained that he  began with  a 3 percent  growth rate                                                               
and oil at  $75 per barrel since the budget  breaks. He explained                                                               
that $75 per barrel oil  is the approximate breakeven price where                                                               
reserves  are essentially  flat.  In his  scenario, reserves  are                                                               
fairly flat. The  revenue picture looks better if  oil prices are                                                               
higher. He  observed that a  3 percent [rate of  inflation] looks                                                               
better "if you want to hold a flat budget."                                                                                     
                                                                                                                                
Mr. Teal observed that the  budget picture would improve if there                                                               
were a  five percent operating  reduction, which may  be possible                                                               
but  has not  been successfully  done by  the legislature  in the                                                               
past.                                                                                                                           
                                                                                                                                
Co-Chair Stedman  observed that  a little less  than half  of the                                                               
operating budget  is formula driven, which  cannot be controlled.                                                               
He stressed that  it is a challenge to keep  the operating budget                                                               
flat  and virtually  impossible to  decline it  at 4  percent per                                                               
year compounded.  He felt  that 3 percent  growth is  a realistic                                                               
range. Mr. Teal concurred.                                                                                                      
                                                                                                                                
Mr. Teal looked  at a model in  which oil prices drop  to $65 per                                                               
barrel. Reserve balances  would fall and the CBR  would be almost                                                               
gone by 2014. By 2015,  the CBR, Statutory Budget Reserve Account                                                               
and  the AHFC  Savings Account  would all  be depleted.  The only                                                               
funds left  would be the  Public Education Fund and  the Earnings                                                               
Reserve Account.  The CBR would  be depleted  by 2012 at  $55 per                                                               
barrel oil.  There would be  no reserves by  2014 if oil  were at                                                               
$55 per barrel.                                                                                                                 
                                                                                                                                
9:36:55 AM                                                                                                                    
                                                                                                                                
In  response  to  a  question   by  Co-Chair  Stedman,  Mr.  Teal                                                               
explained  the difference  between the  use of  January 2009  and                                                               
FY09. He followed  the sweep process from 2006,  which began with                                                               
a CBR  balance of $2.2 billion.  He demonstrated that at  the end                                                               
of January 2009  the CBR balance was $6.8 billion.  At the end of                                                               
FY09 [June 30,  2009] there would be a deficit  of $1.36 billion,                                                               
which would end the year with $5.4 billion in the CBR.                                                                          
                                                                                                                                
9:40:04 AM                                                                                                                    
                                                                                                                                
Co-Chair Stedman  asked Mr.  Teal to  review growth  factors. Mr.                                                               
Teal observed  that the permanent  fund and retirement  funds use                                                               
estimates of  8 percent  for their earnings  because they  have a                                                               
long  time horizon.  The division  used a  4 percent  estimate to                                                               
reflect the shorter time horizon.  As oil prices have fallen, the                                                               
investment  horizon  is shortened,  due  to  the need  to  access                                                               
reserves. The numbers will change  slightly depending on interest                                                               
rate assumptions. He  felt that 4 percent is  a reasonable return                                                               
on the CBR given the potential cash needs.                                                                                      
                                                                                                                                
Co-Chair  Stedman observed  that the  CBR could  be exhausted  in                                                               
three to eight years.                                                                                                           
                                                                                                                                
Mr. Teal explained  that the CBR is split in  to two accounts: an                                                               
aggressive  portfolio and  one  that is  not  as aggressive.  The                                                               
division looks at the CBR  as one account. Co-Chair Stedman noted                                                               
that there would be further  discussions on the investment of the                                                               
CBR.                                                                                                                            
                                                                                                                                
9:44:10 AM                                                                                                                    
                                                                                                                                
Mr.  Teal reviewed  the Statutory  Reserve Fund.  The legislature                                                               
appropriated  money to  the fund  and has  never withdrawn  funds                                                               
from  the  account;  the  interest  earned is  not  kept  in  the                                                               
account. A billion dollar deposit  was made with no earnings; the                                                               
earnings or losses are credited  to the general fund. He observed                                                               
that because  there is no  interest on the  fund there can  be no                                                               
loss.                                                                                                                           
                                                                                                                                
Co-Chair Stedman observed that there  is a question of whether or                                                               
not the  fund could incur losses.  Mr. Teal agreed that  it was a                                                               
question  for   the  Department  of  Revenue   or  Department  of                                                               
Administration.                                                                                                                 
                                                                                                                                
Mr. Teal  noted that the  AHFC Capital  Fund was also  a one-time                                                               
deposit  with  no withdrawals  until  2010.  The governor's  2010                                                               
budget request appropriates the  funds. He observed that Co-Chair                                                               
Stedman asked  that the funds  be withdrawn from the  model since                                                               
they are general  funds and the desire was to  address the access                                                               
to reserves.  The assumption is that  the governor's expenditures                                                               
of $238 million would not occur.                                                                                                
                                                                                                                                
Mr.  Teal  observed  that  the  Public  Education  Fund  is  more                                                               
complicated because  there is an  inflow and outflow  every year.                                                               
The fund  does not earn  interest or sustain losses.  The balance                                                               
is  $1.1 billion.  The model  assumes that  the Public  Education                                                               
Fund remains  at this level  until conditions require the  use of                                                               
the reserves.  Any increase  in education  funding is  built into                                                               
the 103 percent rate that goes to expenditures overall.                                                                         
                                                                                                                                
Co-Chair  Hoffman asked  if there  were provisions  for increases                                                               
regarding  intensive  needs  and area-cost  differentials,  which                                                               
would affect the bottom line of the fund.                                                                                       
                                                                                                                                
9:47:28 AM                                                                                                                    
                                                                                                                                
Mr. Teal  acknowledged that there  were changes to  the education                                                               
formula that  would increase  costs. He  explained that  the 2010                                                               
increase  to  education was  about  $50  million. The  fund  will                                                               
receive the increase  for another couple of years  because of the                                                               
increase  in the  base student  allocation, intensive  needs, and                                                               
the  geographical differential.  The [FY]  2010 operating  budget                                                               
shows an increase of approximately  2.7 percent including the $50                                                               
million  dollars  [to the  Public  Education  Fund]. He  noted  a                                                               
better model  could be  designed based  on each  agency's growth,                                                               
but [for simplicity] the division based  its model on a 3 percent                                                               
[growth rate].                                                                                                                  
                                                                                                                                
Co-Chair Stedman suggested that  the Legislative Finance Division                                                               
could add to the model.                                                                                                         
                                                                                                                                
Mr.  Teal  reviewed  the Permanent  Fund  Earnings  Reserve.  The                                                               
division  relies on  public statements  for their  information on                                                               
this fund.  The fund  contained $1.4  billion in  FY06. Dividends                                                               
and inflation  proofing are paid  out and earnings are  paid into                                                               
the fund. The fund gained earnings  through FY08, with a total of                                                               
$5  billion in  reserves. The  December 2008  statement showed  a                                                               
loss of $407 million dollars.  He estimated that the reserve loss                                                               
is greater, but much of the loss is unrealized.                                                                                 
                                                                                                                                
9:50:26 AM                                                                                                                    
                                                                                                                                
Co-Chair Hoffman noted  that the losses in the  CBR were reported                                                               
through  the first  week of  February at  $765 million.  Mr. Teal                                                               
calculated the losses at $789 million  but noted that they may be                                                               
using different assumptions than the Department of Revenue.                                                                     
                                                                                                                                
Mr.  Teal  concluded  with  the  fact that  at  $40  per  barrel,                                                               
reserves would be gone by 2012.                                                                                                 
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
The meeting was adjourned at 9:52 AM.                                                                                           
                                                                                                                                
                                                                                                                                

Document Name Date/Time Subjects
2 4 09 Savings Accounts Cash Flow and Balances.pdf SFIN 2/6/2009 9:00:00 AM
2 6 09 Savings Spreadsheet.pdf SFIN 2/6/2009 9:00:00 AM
General Fund subfund sweep list for Senate Finance.doc SFIN 2/6/2009 9:00:00 AM
Mechanics of Sweep overview & CBRF spreadsheet.pdf SFIN 2/6/2009 9:00:00 AM