Legislature(1995 - 1996)
03/29/1996 08:08 AM FIN
* first hearing in first committee of referral
= bill was previously heard/scheduled
= bill was previously heard/scheduled
MINUTES SENATE FINANCE COMMITTEE March 29, 1996 8:08 a.m. TAPES SFC-96, #59, Sides 1 and 2 SFC-96, #60, Side 1 SFC-96, #60, Side 2 (575-220) CALL TO ORDER Senator Steve Frank, Co-chairman, convened the meeting at approximately 8:08 a.m. PRESENT In addition to Co-chairmen Frank and Halford, Senators Phillips, Rieger, Sharp, and Zharoff were present. Senator Donley arrived as the meeting was in progress. ALSO ATTENDING: Barbara Ritchie, Deputy Attorney General, Civil Division, Dept. of Law; Laurie Otto, Deputy Attorney General, Criminal Division, Dept. of Law; Vince Usera, Assistant Attorney General, Commercial Section, Dept. of Law; Alison Elgee, Deputy Commissioner, Dept. of Administration; Dick Pegues, Director, Administrative Services Division, Dept. of Law; Nancy Slagle, Director, Budget Review, Office of Management and Budget; Dan Fauske, CEO/Executive Director, Alaska Housing Finance Corporation, Dept. of Revenue; Kevin Brooks, Director, Division of Administrative Services, Dept. of Fish and Game; Nico Bus, Acting Director, Division of Support Services, Dept. of Natural Resources and Dept. of Military & Veterans Affairs; Paul Larson, Deputy Director for Fisheries, Division of Commercial Fisheries Management and Development, Dept. of Fish and Game; John Bitney, Legislative Liaison, Alaska Housing Finance Corporation, Dept. of Revenue; Betty Martin, Comptroller, Treasury Division, Dept. of Revenue; Dean Paddock, Executive Director, Bristol Bay Driftnetters' Association; Jim Kelly, Research and Liaison Officer, Alaska Permanent Fund Corporation, Dept. of Revenue; and aides to committee members and other members of the legislature. ALSO PARTICIPATING VIA TELECONFERENCE FROM KETCHIKAN: Former Representative Oral Freeman. SUMMARY INFORMATION HB 468 - APPROP: SUPPLEMENTAL & OTHERS Discussion regarding requests by the Dept. of Law, Dept. of Natural Resources, Dept. of Military and Veterans Affairs, and AHFC as well as stale dated warrants and ratification of overexpenditures was had with department representatives. The bill was held in committee for continued review at 9:30 a.m., Monday, April 1, 1996. SB 51 - DISPOSITION OF PERMANENT FUND INCOME Discussion was had with Jim Kelly, and former Representative Oral Freeman testified via teleconference from Ketchikan. The bill was held in committee for additional review. SB 152 - GEOGRAPHIC PAY DIFFERENTIALS Discussion and review of a draft CSSB 152 (Fin) (3/29/96) was had with Alison Elgee. CSSB 152 (Fin) was adopted and REPORTED OUT of committee with a zero fiscal note (indicating future savings) from the Office of the Governor, applied to all departments. SB 265 - RECEIPTS OF TEST FISHING OPERATIONS Testimony was provided by Kevin Brooks, Paul Larson, and Dean Paddock. The bill was subsequently held in committee for further review. CS FOR HOUSE BILL NO. 468(FIN) am An Act making supplemental appropriations for the expenses of state government and making and amending appropriations; ratifying certain state expenditures; and providing for an effective date. Co-chairman Frank directed that the FY 96 supplemental budget be brought on for continued committee review. Dept. of Military and Veterans Affairs NICO BUS, Acting Director, Division of Administrative Services, Dept. of Natural Resources, came before committee and advised that he would be representing the Dept. of Military and Veterans Affairs on supplemental items. The $6.5 million for the National Guard and Naval Militia Retirement Program will provide additional solvency to the fund. The program is now funded at 17 percent. Co-chairman Frank inquired concerning the ratio of future savings to up- front moneys placed in the fund. Mr. Bus explained that the Governor requested $2.5 million for FY 97. The department asked the actuary to calculate the impact of the $5.5 million. The result was that for FY 97 the operating budget could be reduced by $850.0. If additional FY 96 funding is provided, the FY 97 operating budget could be further reduced. Co-chairman Frank asked that the department provide numbers "all the way up to full actuarial soundness." NANCY SLAGLE, Director of Budget Review, Office of Management and Budget, explained that projections indicate that a $10 million lump-sum contribution would reduce the FY 97 number to $1.2 million. At the request of Senator Randy Phillips, Mr. Bus provided a history of the program. He explained that a 1988 provision in the National Guard Retirement System allowed for lump-sum payments. Many of the participants request this payment when they retire. The fund was thus drawn down much faster than anticipated. That is the main reason for the present situation. Lump-sum payments are continuing, but the department is working with the division of retirement and benefits to solve the problem and will bring forth recommendations next year. Discussion followed between Senator Rieger and Mr. Bus regarding the target funding ratio for the program. Nancy Slagle advised that adding $5 million to the fund would raise the ratio from the present 17 percent to 53 percent. If $10 million were appropriated, funding would be at 88 percent. In response to questions from Senator Phillips, Mr. Bus voiced his understanding that with the requested $6.5 million in the supplemental plus FY 97 operating budget funding, the program should be stabilized. Mr. Bus explained that the $1.5 million for disaster relief has two elements. The first is $557.0 for floods in the Kenai area. The total cost of the flood exceeded $3 million. The department found most of the needed funding within existing appropriations. The $557.0 request represents the remainder. The second part of the supplemental seeks $1 million for activity between the present time and June 30, 1996. In response to a question from Co-chairman Frank concerning House Finance action, Mrs. Slagle explained that the House funded the $1 million. The Governor included $1.5 million in his original request, for response to emergency needs. Mrs. Slagle voiced concern on behalf of the administration that "We have no other moneys available to respond to disasters through the end of the fiscal year." The department has functioned thus far on outstanding balances from previous disasters. Dept. of Natural Resources NICO BUS again came before committee to speak to the $5,258.6 for fire suppression which he said would fund remaining activity through FY 96. Included is the balance of fixed costs for aviation contracts, suppression, and other efforts. It also includes $750.0 for routine suppression activity (initial attack) as well as $2 million for project fires. Mr. Bus referenced $1.5 million that was to carry over from FY 96 to '97. Due to a fire in June, the funding was used in 1995. The department presently has $9,000.00 remaining. Aviation contracts are due April 1. The department should not technically obligate these $200.0 payments to vendors if there is not sufficient funding. If contracts are cancelled, vendors may commit their aircraft to other uses. Total need for these fixed costs is $2,256.4. That includes aviation, helicopters, tanker craft, fixed wing craft, etc. These are basic commitments the department makes to prepare for the fire season. Discussion of past fire seasons followed. Mr. Bus acknowledged that last year's season was one of the lowest on record. In response to a question from Co-chairman Halford concerning costs for the $236.0 listed as "aviation section," Mr. Bus explained that it relates to in-house expenditures for staff that manages aviation contracts. Mr. Bus advised that he would provide a spread sheet listing individual items of the supplemental request. Discussion followed among the co-chairmen and Mr. Bus concerning whether this effort should be included within fixed operating costs or within the supplemental. Mr. Bus noted that last year the department used a portion of its fixed cost funding for actual fire suppression because funding for suppression was so small. Further discussion followed regarding the nature of aviation and BLM smoke-jumper contracts. In response to a question from Senator Phillips, Mr. Bus said that predictions indicate this is a potentially high fire year, mainly in the interior. Co-chairman Frank asked that Mr. Bus speak to the $1,457.0 in uncollectible federal receivables. Mr. Bus advised that both the department and the Dept. of Law are working with federal agencies to obtain a settlement. Dept. of Law Co-chairman Frank directed that review revert to discussion of Dept. of Law requests. BARBARA RITCHIE, Deputy Attorney General, Civil Division, Dept. of Law, came before committee to speak to Berger v. State. She explained that the situation commenced in 1989 when Roger Berger, dba Frontier Financial Services, began to purchase permanent fund dividends for $325 to $400. In return for the cash, Mr. Berger received an assignment of individual rights to the $873 dividend. The Dept. of Revenue, permanent fund division, began to experience an escalation in the number of assignments. As a result, it took action to adopt a regulation under which it would decline to honor assignments other than those to governmental agencies. Frontier then required individuals who made assignments to complete a change of address form and power of attorney so that the dividend went directly to Frontier and was subsequently signed over by the borrower. The Dept. of Revenue noted circumvention of the new regulation and all parties were notified. In December of 1989, Frontier filed suit challenging the regulation and department refusal to implement the address changes. The superior court determined that the regulation was beyond statutory authority and thus invalid. The statute has since been changed to allow assignment only to a court or governmental agency. In arguing the case, the state raised issues of usury and violation of the small loans act. In December of 1995 the supreme court ruled that the transactions were not loans and returned the case to the superior court for a determination of "what was owed to Mr. Berger." In the meantime, the $873.00 permanent fund dividend was paid to the recipients. Discussion followed regarding advice in the above matter provided by the Dept. of Law to the Dept. of Revenue. VINCE USERA, Assistant Attorney General, Dept. of Law, voiced his understanding that former Assistant Attorneys General, Jeff Bush and Peter Froehlich, advised the Dept. of Revenue that it should not adopt the regulation. Co-chairman Halford voiced his understanding that the department was advised against adoption but did so anyway. He then asked for copies of memos containing Dept. of Law recommendations to the department. Discussion of the failed petition for rehearing before the supreme court followed between Mr. Usera and Senator Rieger. Further discussion followed regarding the stipulated judgment settling the amount versus a superior court trial to determine the amount. Addition discussion occurred regarding the legal standing of those who received both the advance from Mr. Berger and the dividend as well as Dept. of Revenue notification to recipients that the assignments would not be honored by the department. Senator Sharp noted that the $873.00 dividend for 1989, times the number of assignments (2,600), plus interest and attorney fees, does not approximate the requested $3.5 million. It thus appears that the "individual was made more than whole." Mrs. Ritchie noted that statutory interest on the $2.2 million at 10.5 percent for 74 months totaled "almost $1.3 million." Dept. of Public Safety NANCY SLAGLE again came before committee. She explained that the House decided the request for manuals and equipment should be considered within the capital budget. It was thus removed from the supplemental. Dept. of Revenue NANCY SLAGLE advised that the $198.2 request from Alaska Housing Finance Corporation relates to consolidation of leased facilities. Inability to construct a facility for AHFC has necessitated additional lease costs. JOHN BITNEY, Alaska Housing Finance Corporation, came before committee. He explained that the FY 96 budget contained funding for lease payments for six months in anticipation that AHFC would occupy its own facility when leases expired in December. Since the corporation will be remaining in current facilities, the above request is for the remaining six months of this fiscal year as well as a rate increase which incurred. In response to a question from Co-chairman Frank, Mr. Bitney noted that the overall budget was reduced by $2.5 million. He said he had no answer to a question regarding where moneys would be derived if supplemental funding is not provided. Responding to a question from Senator Sharp, Mr. Bitney advised that the rate increased from $1.27 to $1.30 per square foot. Co-chairman Frank asked that Senator Sharp, chairman of the subcommittee on the Dept. of Revenue budget, review the matter and forward a recommendation to committee. Co-chairman Frank inquired concerning the status of space for the corporation. Mr. Bitney acknowledged an RFP for new leases and receipt of six bids. No new leases would be entered before July 1, 1996. The RFP has no relation to the supplemental request. END: SFC-59, Side 1 BEGIN: SFC-59, Side 2 NANCY SLAGLE noted that Sec. 12(b) involves a fund source change between PERS and benefit system receipts. The FY 96 budget inadvertently cut too much out of receipts and brought the total to $19,200.00. The shift will cover costs and ensure that charges are made to proper benefit system accounts. BETTY MARTIN, Comptroller, Division of Treasury, Dept. of Revenue, came before committee. She explained that a portion of the shortage results from the fact that "the SBS accounts went participant directed over the last year . . . ." Management fees for the change were not in the FY 96 budget when it was prepared. The remainder is due to a miscalculation in performance measurement fees. There are two structures for these fees. One is for active management and the other is for passive management. Fees included in the budget reflect passive management when SBS accounts are actively managed. Dept. of Law Discussion next reverted to Sec. 9(c), the $66.6 for a district attorney in Bethel. LAURIE OTTO, Deputy Attorney General, Criminal Division, Dept. of Law, came before committee. She attested to three-person offices for both the public defender and the district attorney in Bethel. Last August, two of the public defenders quit. One of them was hospitalized for a stress-related disease. One of the district attorneys quit, and another actively began asking for transfer to another job. The third described himself as desperate. Ms. Otto said that, when she visited the area and reviewed statistics, she found that staff in Bethel is carrying double and sometimes triple the caseload of other offices. In response to a question from Senator Phillips, seeking the root of the heavy caseload, Ms. Otto attested to a high rate of crime between ages 15 and 30. The Bethel region has "a very large number of people" in that age range. The Bethel office covers all 56 villages in the region. Comments followed by Ms. Otto and committee members regarding the impact of alcohol and prohibitions against alcohol in the area. Ms. Otto noted that Anchorage appears to be the source of much alcohol bootlegged into the region. Over 50 percent of the crime in the DA's office in Bethel comes for the villages. Serious crime in Bethel itself appears to involve local residents. A review of files, indicates that the office is not overcharging criminal actions. It appears that staff undercharges and does not pursue cases it should because of the overload. Staff is routinely working 70 to 80 hours a week and is only paid for 37.5. Ms. Otto said she returned from her review much alarmed by the situation and conveyed her concern to both the Governor and the Attorney General. Further review by staff from the Dept. of Corrections, Dept. of Health and Social Services, and Dept. of Public Safety concluded that an emergency situation exists. There is need for the fourth position requested in the supplemental. A similar position has been requested in the public defender agency. The effect of the fourth attorney is that staff will work six days a week instead of seven. In response to an inquiry from Senator Rieger, Ms. Otto cited sexual assault and domestic violence as the most frequently committed crimes in the area. In the state of Alaska, most crimes are alcohol-related. That is true in the Bethel region among its 30,000 residents. Responding to further questions from Senator Zharoff, Ms. Otto attested to an 82 percent increase in the amount of crime in Bethel while Nome and Dillingham have remained stable. She speculated that much of the increase is due to the fact that Bethel has the highest rate of unemployment, and there is no significant economy. It also has the highest rate of social problems such as child abuse and suicide. The problem is primarily economic. Co-chairman Halford concurred in the foregoing assessment. University of Alaska NANCY SLAGLE spoke to the request for monetary terms for the classified employees association and the Alaska community college federation of teachers for FY 96. The House wished to consider all monetary contracts at one time. Stale Dated Warrants Senator Randy Phillips asked if the state had developed general policies regarding stale dated warrants. NANCY SLAGLE said she was unaware of a time frame after which the state is no longer obligated to pay. The money was owed at some point in time. Statutes require an appropriation to cover warrants that are over two years old. Ratification of Overexpenditures NANCY SLAGLE explained that the administration has reviewed this area of concern. Legislative Audit identified several places where accounting records do not balance expenditures with appropriation levels, for a variety of reasons. Mrs. Slagle referenced audit and management review of the process and noted that the result of that review was furnished to members. The administration will continue to work with agencies to attempt to bring accounting records up to date. The next legislative session has been established as the deadline for cleaning up everything through FY 94. The intent is to clean up accounts on an annual basis and attempt to avoid need for ratifications in the future. Mrs. Slagle noted that much of the $6,877.5 total involves the Dept. of Transportation and Public Facilities. It relates to conversion from the old PBA accounting system to the new system in 1983. Much of the problem resulted from lack of understanding, lack of training, lack of educated staff, etc. Backtracking has been difficult because of lack of documentation in early years. Mrs. Slagle reiterated that much of the problem within DOTPF occurred because moneys were received in a different year than expenditures were made. Collection of revenues was not aligned with expenditures. Co-chairman Frank announced that the committee would again meet at 9:30 a.m., Monday, April 1, 1996, to conclude review of supplemental requests. RECESS - 9:15 A.M. RECONVENE - 9:30 A.M. SENATE BILL NO. 152 An Act relating to geographic differentials for the salaries of certain state employees who are not members of a collective bargaining unit; relating to periodic salary surveys and preparation of an annual pay schedule regarding certain state employees; relating to certain state aid calculations based on geographic differentials for state employee salaries; and providing for an effective date. Co-chairman Halford directed that SB 152 again be brought before committee and referenced a draft committee substitute (0-GS0049\F, Cramer, 3/29/96). ALISON ELGEE, Deputy Commissioner, Dept. of Administration, came before committee and provided the following review of the draft: Secs. 1, 2, and 3 are from the original bill. Sec. 4 was redrafted to include committee amendments to place the Fairbanks area in the 5 percent geographic differential and employees in Washington State at -20. Sec. 4 (b) reflects amendment of the base salary amount from $30.0 to $50.0. Sec. 4(c) allows for premium pay situations for those practicing law or medicine in rural districts 37 through 40. Sec. 5 remains the same as in the earlier version. Secs. 6, 7, 8, and 9 contain technical amendments to reflect the renumbering of the geographic differential section. Sec. 10 contains transition provisions. It has been amended to reflect a hold harmless period in year one, a limited reduction of no more than 5 percent of salary in year two, and full implementation in year three. Ms. Elgee directed attention to a handout (copy on file in the Senate Finance Committee master file for SB 152) and explained that it sets forth figures under both the current and new differential for a $60.0 employee in Fairbanks and an employee at the same pay level in Nome. Senator Randy Phillips questioned the repeal date of July 1, 1998, set forth in Sec. 12, suggesting that it should reflect 1997. Ms. Elgee explained that 1997 would be correct in the event of a one-year hold harmless and no transition. July 1, 1998, allows for the second year of transition per the proposed draft. Discussion followed between Senator Rieger and Ms. Elgee regarding operation of hold harmless provisions. In response to a scenario presented by the Senator, Ms. Elgee said the department would freeze the salary of an employee who is overpaid based on the new differential. Freezing the salary would not preclude award of merit increases or cost- of-living adjustments. Those amounts would be calculated against the revised salary. The employee is frozen at the current salary, or transitioned down to the 5 percent, and the bookkeeping entries are applied against what the new salary would be. At the point that the adjusted salary meets or exceeds the frozen salary, the employee would begin to realize "some benefit from those increases." Senator Sharp referenced Sec. 10(a)(2) and suggested that it would appear to produce a savings, yet none is shown on the fiscal note. Ms. Elgee agreed that there would be savings, in FY 98, as employees turn over or relocate out of their current geographic differential areas. It is impossible to project what those savings might be. The fiscal note represents application of this legislation upon full implementation in FY 99. Senator Sharp MOVED for adoption of the draft CSSB 152 (Finance) as a mark-up vehicle. No objection having been raised, CSSB 152 (Finance) was ADOPTED. Senator Zharoff voiced concern for election districts 5 through 9 and asked how the index and union differential work. Ms. Elgee explained that the index reflects the statutory schedule applied to non-covered employees. It has been in place since 1972. In 1985 an extensive cost-of- living study was conducted. As a result of that study, new cost-of-living indices were adopted through the collective bargaining process with unions. That union differential, in place since 1986, applies to the bulk of unionized employees. Co-chairman Halford asked how many employees fall under the statutory index. Ms. Elgee responded, "I think in the executive branch we're talking about 1,200 people." Co- chairman Halford voiced his understanding that approximately 15 percent of state employees would be directly impacted by the proposed bill. The remainder would be negotiated into the system. Ms. Elgee concurred. She added that not all non-covered employees would be impacted because those in Anchorage and Juneau will see no change since they do not now receive a differential. The bill would affect approximately 93 people in the Fairbanks area. Senator Sharp MOVED for passage of CSSB 152 (Finance) with individual recommendations and accompanying fiscal notes. Senator Zharoff OBJECTED. He said that testimony indicates arbitrary decisions were made in changing the index. He reiterated concern for election districts 5 through 9, saying that he was not comfortable with possible impact. He expressed his belief that employees in those districts would experience reductions because backup information indicates the cost of living in those areas is much higher than what is reflected in the proposed legislation. Co-chairman Halford called for a show of hands on the motion for passage. The motion CARRIED on a vote of 5 to 1, and CSSB 152 (Finance) was REPORTED OUT of committee with a zero fiscal note from the Office of the Governor, covering all departments. Co-chairmen Frank and Halford and Senators Rieger and Sharp signed the committee report with a "do pass" recommendation. Senators Donley and Phillips signed "no recommendation." Senator Zharoff signed "do not pass." SENATE BILL NO. 265 An Act relating to receipts of commercial fisheries test fishing operations; and providing for an effective date. Co-chairman Halford directed that SB 265 be brought on for discussion. Senator Zharoff explained that he introduced the bill to enhance Dept. of Fish and Game ability to successfully manage the changing nature of Alaska's complex fisheries. It will form part of the management scheme to utilize private sector vessels, gear, and expertise to conduct test fisheries. Funds derived from these test fisheries will accrue as designated program receipts. The bill does not impact the legislature's ability to appropriate, but it streamlines the process in conducting test fisheries. A number of test fisheries have been proposed, but the department has not, in the past, had the flexibility nor the resources to follow through. Senator Zharoff asked that department staff speak to the specifics of the program. END: SFC-96, #59, Side 2 BEGIN: SFC-96, #60, Side 1 KEVIN BROOKS, Director, Division of Administrative Services, Dept. of Fish and Game, came before committee. He explained that the bill would reclassify approximately $2.2 million in program receipt authority that would not hereafter roll into departmental caps. As background information, Mr. Brooks noted that test fishery receipts in the current year were part of OMB's classification as designated program receipts because they are based on a contractual relationship. Proceeds from the sale of fish caught during a test fishery are used to pay for the boat chartered to conduct the fishery. Test fisheries have the potential to extend seasons or open new seasons. Attempts to develop the sea urchin fishery in Southeast was cited as an example. These efforts have been hampered because the department cannot ask for additional receipt authority "because it runs up against our caps and shows as an increase to the general fund." OMB took the first step in designating these program receipts. The proposed bill would remove those funds from general fund calculations. It does not cut dollars, it merely reclassifies them. The test fishery receipt program has been part of the department's management program since before statehood. Co-chairman Frank requested a comparison of the current flow of funds versus that contemplated by the proposed bill. Mr. Brooks explained that the department presently receives authority, through the legislative process, to receive and expend approximately $2.2 million in program receipts. That is in the base budget. Under the proposed bill, receipts would continue to flow through the general fund to be requested by the department and appropriated by the legislature. Moneys in excess of expenditures would flow as unrestricted revenue to the general fund. The only change is that the receipts would not roll into department general fund totals. These moneys would show as other funds. Senator Rieger referenced AS 37.05.146, which contains a list of exclusions from what flows through the general fund. It appears that these receipts are merely being added to the list. PAUL LARSON, Deputy Director for Fisheries, Division of Commercial Fisheries, explained that test fishery funds have been used to conduct research throughout the state. He cited use in Prince William Sound to identify pollack resources which had not previously been harvested because the department had no information on abundance. Contract with a local fisherman and sale of pollack caught during the test generated sufficient funds to assess pollack resources and conduct a new fishery in Prince William Sound. Senator Sharp asked if a test fish fund presently exists. Kevin Brooks explained that the proposed bill would not establish a separate fund. Test fishery moneys do not constitute designated funds in the same respect as the fish and game fund. There is currently a test fishery account. Discussion of potential for a sea urchin fishery followed. DEAN PADDOCK, Executive Director, Bristol Bay Driftnetters' Association, came before committee in support of the bill. He concurred in comments that the legislation would streamline department ability to manage. Mr. Paddock advised that he instituted the first state test fishery operation in 1960, based on a borrowed idea from the sockeye commission on the Fraser River. Management biologists need the information obtained through test fishing. Commercial fishermen in Bristol Bay greatly depend on test catches which precede openings. Management of resources in this area would not be as precise without the test fishery. In response to comments concerning the impact of reduced funding on fishery programs, Senator Sharp stressed that the budget for the division of commercial fisheries increased in FY 96 over what it was the previous year. Mr. Paddock attested to increasing complexities associated with effective management. Initial program budgets are not keeping pace with overall demands. Senator Sharp reiterated that while the division did not receive what it requested, it received more than the previous year. Comments followed by Mr. Paddock regarding smolt out- migration on the Egegik River. Senator Zharoff noted a request from Co-chairman Frank that he be allowed a day in which to review the bill. Co- chairman Halford voiced support for the legislation and advised that it would be again taken up at the next bill session. SENATE BILL NO. 51 An Act relating to income of the permanent fund; and providing for an effective date. Co-chairman Halford directed that SB 51 be brought on for discussion. Senator Rieger explained that the bill would introduce the concept of real earnings into management of the state's largest endowment account--the Alaska Permanent Fund. Most endowments operate on a principle where earnings considered usable are those that exceeded inflation in a given year. These moneys are referred to as "real earnings" in contrast to "nominal earnings" which reflect total cash return to a fund compared to what is actually earned in excess of inflation. Given present dynamics and increasing numbers of proposals for potential use of the permanent fund, the focus is on total return, and inflation proofing is an afterthought. Under a "real earnings" concept, inflation proofing becomes the first priority. The remainder of the return is then available for other use. That is how university endowments and most other endowment funds operate. The first fiduciary priority is to protect the principal. That would occur if inflation proofing were automatic. The proposal contained in the legislation is timely because the permanent fund has enjoyed a banner "run up" over the past eighteen months. "Real earnings" based on the new size of the fund are equal to total return under the prior size of the fund. The time is ideal to make the policy change without disruption in what "people see when they look at what the return is and what the legislature sees." JIM KELLY, Director of Communications, Alaska Permanent Fund Corporation, came before committee. He referenced correspondence from the board of trustees indicating that the board had discussed the legislation and did not intend to take a position on the bill. The board is supportive of any changes to existing law which would enhance board ability to protect the principal of the permanent fund. That portion of SB 51 which makes inflation proofing the highest priority represents such a change. Another portion of the bill, making a change in the dividend formula by basing it on "real income" instead of net income, falls outside the scope of the trustees' area of responsibility. The fiscal note for the bill is zero since changes incorporated within the bill would have no operational impact on the corporation. Mr. Kelly explained that inflation proofing provisions were enacted in 1982 at the request of the first board of trustees. For the past fourteen years, each legislature has taken a portion of annual income and appropriated it to principal to protect the fund against inflation. Those appropriations produced a cumulative total of $4.6 billion. That action evidences the legislature's strong, long lasting, and unwavering support for protection of principal. The inflation rate for this year will be 2.82 percent, based on the calendar year change and the consumer price index. Since 1978, inflation has averaged 5.11 percent. The expectation for the next five years is that it will average "somewhere between 3.18 and 3.5 percent. As a percentage of annual net income, inflation proofing has ranged from a high of 55 percent (1991) to a low of 25 percent (1989). This year, with high earnings of over $1 billion, inflation of $400 million amounts to 24 percent. It is projected that inflation proofing in future years will require approximately 44 percent, on average. That is based on assumptions that the fund will be able to earn a realized return "on the order of 7.17 percent, and inflation will average something like 3.18 percent." For total principal of $15 billion, every one percent increase in inflation requires approximately $150 million of net income to be transferred to principal. Mr. Kelly noted that the proposed legislation speaks to "real income" and ensures that nothing but "real income" would be distributed. With the exception of 1990 and 1991, since conception of the fund, nothing but real income has been distributed. The earnings goal of the corporation is to beat inflation and produce real income at a rate of 3 percent. That 3 percent target is likely to be increased to 4 percent at the May 2, 1996, board meeting. The 3 percent target was set when the permanent fund was largely into fixed income investments. Over the years, the fund has become more involved in equity investments which produce a higher rate of return. Investment performance in the 1980s and 1990s has been so good that it has beaten inflation by 5.5 percent in the nearly twenty years the fund has been in existence. Referencing a handout (copy on file in the committee master file for SB 51), Mr. Kelly noted that the trustees are in the process of setting asset allocations for the next year and three-years hence. When this is accomplished, assumptions regarding future earnings will likely change based on capital market assumptions and new asset allocations from the board. Based on the most likely choice to be made by trustees, the total median return (cash plus appreciation) over the next five years is 8.42 percent. If the corporation is unable to gain appreciation because of the market, the least that could be made would be a 4.68 percent median return. The $1.7 billion in income for the current year reflects an 11 percent return. With inflation of 2.8 percent, there has been over 8 percent of real return. Markets go up and down as does inflation. In terms of income available for distribution, if the tradition of protecting principal is maintained (through the proposed bill or not) the state has available the "real income" of the fund. Mr. Kelly reiterated that the goal is 4 percent. On a $15 billion fund that amounts to $600 million a year. As the fund builds to $20 billion, there would be $800 billion of distributable income. Senator Rieger pointed to both the $1.7 billion return and unrealized gains of $2.2 billion. He then directed attention to a tabulation evidencing best and worst case projections of future earnings and explained that it incorporates the $2.2 billion in unrealized gains. One scenario reflects total use of all funding in the earnings reserve and the other reflects no use of those moneys. The Senator noted that in one scenario, transfer to the general fund (even after payment of a $1,000 dividend every year) "hits a billion dollars by the end of the run, per year." In the other case, the dividend grows to "just under $2,000," but no cash is used in the general fund. That results in $23 billion in the earnings reserve account. Real earnings in the future are consistent with total return in the past. The question of inflation proofing and the potential threat to inflation proofing from those who might propose use of earnings beyond what goes into dividends is guarded against by passage of SB 51. Discussion of past year gains and application of the dividend formula followed between Co-chairman Halford and Mr. Kelly. Senator Rieger stressed that the proposed bill does nothing to corporate capital gains. Co-chairman Halford voiced his understanding that the bill would take inflation proofing out of corporate income before the dividend formula is applied. Mr. Kelly concurred. The Co-chairman next noted projections that inflation proofing in the future would require 44 percent of future income and asked what that would do to the formula for dividends. Mr. Kelly responded that of the money made each year, approximately 10.5 percent goes to dividends. For the present year it would amount to a $40 million reduction. Since the dividend is calculated on a five-year basis, that amount would be compounded over time. Transitional provisions in the bill would count four years of net income and one year of real income for the first year. The second year would count three years of net income and two years of inflation proofing reduced net income. The $40 million reduction would thus be $80 million the second year, $120 million the third, $160 the fourth, and $200 million by the end of five years. Co-chairman Halford raised concern regarding dividends and explained that he asked permanent fund staff to provide projections based on the status quo versus the proposed bill. He then directed attention to tabulations (copies on file in the master file) and noted that the bill would reduce the constant value of the dividend to $606.00 in 2001 versus a real value of $1,002 in that same year. The reduction would occur under the proposed bill because the pool of funds for the dividend would be reduced by removal of inflation proofing moneys before the dividend is calculated. Mr. Kelly concurred. Co-chairman Halford reiterated that the real value of the dividend is reduced by $400 in "just five years." He acknowledged concern in some sectors that the dividend would grow to "some huge amount." He then pointed to the graph he distributed and noted that "the dividend never gets to $1,200, in real dollars, before 2006 . . . ." Senator Randy Phillips concurred in need for protection of the permanent fund. He suggested that the fundamental issue is protection of the fund versus protection of the dividend. Co-chairman Halford noted that the permanent fund dividend protects the principal in the eyes of the public. Senator Sharp voiced his understanding that the proposed bill would not require greater amounts for inflation proofing than those presently provided. Senator Phillips reiterated that the question should be how best to protect the fund. Senator Rieger's proposal would inflation proof first and pay dividends later. The question is, "Do we protect the dividends, or do we protect the permanent fund itself." Co-chairman Halford noted that the legislature could change the priority for dividends versus inflation proofing without changing the dividend formula. The proposed bill applies the existing formula after inflation proofing is removed. That has the effect of "reducing the dividends pretty drastically over time." The Co-chairman noted that the original debate on priority of dividends versus inflation proofing was "almost a draw in advocates and supporters of the permanent fund." The question of priority is different from the taking of inflation proofing before dividends are calculated. Co-chairman Halford advised that he did not have as strong a feeling about priorities are he does about the reallocation resulting from the proposed bill. Senator Phillips voiced agreement with protection of permanent fund principal. The question is how that might best be done. END: SFC-96, #60, Side 1 BEGIN: SFC-96, #60, Side 2 Co-chairman Frank voiced support for use of "real income" versus nominal income. He further spoke to the mitigating effect of five-year averaging of dividends and inquired regarding the impact of increasing the percentage from 21 to 25 percent. Senator Rieger noted that the increase would represent a policy call for the legislature. He noted that the corporation currently pays out 55 percent in dividends rather than 50 percent as perceived by the public. Senator Phillips asked that Mr. Kelly apply provisions of the proposed bill to both past dividends and principal amounts. Mr. Kelly advised that it would have had no effect on the principal. He agreed to apply it to dividends from inception in 1982 to the present time. Co-chairman Halford reiterated that projections indicate that, over time, 44 percent of income would be required for inflation proofing. If 44 percent is taken out of the formula before the calculation is made, the dividend is reduced by that same 44 percent. Senator Phillips again asked which of the two--inflation proofing or dividends--would be the most effective in protecting the principal of the fund. Co-chairman Halford voiced his belief that both protect the fund. They are not in conflict. The dividend and inflation proofing can be paid. Over the history of the fund, there has continually been a surplus. The legislature has deposited that surplus into principal. That surplus could be used for other activities. FORMER REPRESENTATIVE ORAL FREEMAN next spoke via teleconference from Ketchikan. He attested to the fact that the permanent fund is working exactly as it was intended to. There is no reason nor rationale for "tinkering or messing with it when it's working great." The general public is highly suspicious of changes in the fund. Mr. Freeman referenced similar discussion of inflation proofing in the late 1980s. At that time, he advised, he posed questions regarding what would happen in a situation where inflation equals earnings. If inflation proofing is the first priority, all earnings would be used for that purpose. The general public would soon question need for a fund that produces no benefit for its people. Mr. Freeman stressed that the dividend is the life insurance policy for the permanent fund. When the fund loses the confidence, backing, and support of the general public, the permanent fund will disappear. He suggested that the proposed bill is not worth the effort put into it. In response to a hypothetical situation posed by Senator Rieger, Mr. Freeman stressed that the second half of the earnings of the permanent fund has taken care of inflation since 1982 and has produced an excess of $2.2 billion. He voiced his belief that the fund would be undamaged if inflation proofing was short in a particular year since the history of the fund indicates that would not happen year after year. Co-chairman Halford remarked that moneys are traditionally maintained in the earnings reserve account to cover a shortfall in any particular year. Mr. Freeman concurred. Co-chairman Halford noted that Senator Rieger had prepared an update based on nominal dollars using current income numbers and requested that projections also be prepared based on real dollars. Senator Zharoff asked if, at some point, inflation proofing consumes all of the earnings. Senator Rieger responded, "There's always a hypothetical like that." He then explained that people have noted that half is going to dividends and are wondering what is happening with the other half. Proposals are offered with increasing frequency concerning what to do with the other half. Some of them will eventually garner enough support to pass. When that happens, 100 percent of the nominal earnings of the permanent fund will be spoken for. The loser will be inflation proofing. SB 51 reflects truth in advertising of what the permanent fund is really achieving. At the present time, the fund pays out half of the inflation component as a dividend. That misleads the public into thinking that "this was only half of the performance of the fund that is being paid." The proposed change is timely because of fund performance. The proposed bill could be effected without impacting "the amount that is put on the table." Senator Zharoff noted that the other half is not being spent. It "rolls right into the corpus of the fund." Co-chairman Halford voiced his belief that the public understands that half the income is used for dividends while the other half provides inflation proofing. He acknowledged an advocacy that believes that some of the income should go through government and "get spent through government." He suggested that the combined effects of the proposed bill would result in inflation proofing, a reduction in the dividend formula, and a building account that would be used to fund some governmental service. The public should ultimately decide what services it wishes to buy. Senator Sharp concurred. He suggested that inflation proofing first and applying the dividend to half of the remainder would cause the public to question the purpose for the remaining half. Co-chairman Halford suggested that the bill be held in committee for updated projections. He said it could possibly be heard again in the coming week. ADJOURNMENT The meeting was adjourned at approximately 11:00 a.m.