Legislature(2015 - 2016)SENATE FINANCE 532
04/04/2016 05:00 PM Senate FINANCE
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| Audio | Topic |
|---|---|
| Start | |
| SB114 || SB128 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | TELECONFERENCED | ||
| += | SB 114 | TELECONFERENCED | |
| += | SB 128 | TELECONFERENCED | |
| + | TELECONFERENCED |
SENATE FINANCE COMMITTEE
April 4, 2016
5:04 p.m.
5:04:56 PM
CALL TO ORDER
Co-Chair MacKinnon called the Senate Finance Committee
meeting to order at 5:04 p.m.
MEMBERS PRESENT
Senator Anna MacKinnon, Co-Chair
Senator Pete Kelly, Co-Chair
Senator Peter Micciche, Vice-Chair
Senator Mike Dunleavy
Senator Lyman Hoffman
Senator Donny Olson
MEMBERS ABSENT
Senator Click Bishop
ALSO PRESENT
Randall Hoffbeck, Commissioner, Department of Revenue;
Martin Baily, Economist, McKinsey and Company, Senior
Fellow, Brookings Institution; Craig Richards, Attorney
General, Department of Law.
SUMMARY
SB 114 PERM FUND: EARNINGS, DEPOSITS, ACCOUNTS
SB 114 was HEARD and HELD in committee for
further consideration.
SB 128 PERM. FUND:DEPOSITS;DIVIDEND;EARNINGS
SB 128 was HEARD and HELD in committee for
further consideration.
SENATE BILL NO. 114
"An Act relating to deposits into the dividend fund;
and relating to the Alaska permanent fund."
SENATE BILL NO. 128
"An Act relating to the Alaska permanent fund;
relating to appropriations to the dividend fund;
relating to income of the Alaska permanent fund;
relating to the earnings reserve account; relating to
the Alaska permanent fund dividend; making conforming
amendments; and providing for an effective date."
5:05:11 PM
RANDALL HOFFBECK, COMMISSIONER, DEPARTMENT OF REVENUE,
referred to the Permanent Fund Protection Act that was
established earlier in the year. He shared that McKinsey
and Company was contracted to do the analysis. He remarked
that they were a leader in nonprofit, business, and
government consulting. He shared that, over the recent five
years, McKinsey had supported more than 300 public finance
projects in 35 countries. They were a lead advisor to
institutional investors, including sovereign wealth funds
and U.S. state pension funds. He shared that McKinsey had
advised other petrol rich states that had considered
adopting fixed dividend models for their sovereign wealth
funds.
Co-Chair MacKinnon noted that the presentation was
available on the State of Alaska website.
5:09:23 PM
MARTIN BAILY, ECONOMIST, MCKINSEY AND COMPANY; SENIOR
FELLOW, BROOKINGS INSTITUTION, discussed the presentation
"Ensuring a sound fiscal future," authored by McKinsey and
Company (copy on file). He turned to slide 1:
The Alaska Department of Revenue has sought an
objective assessment of the financial model it built
to evaluate an annual draw from the Earnings Reserve
of the Permanent Fund, as outlined in the Alaska
Permanent Fund Protection Act. The fact-based
assessment of the financial model included in this
document was conducted by McKinsey and Company, Inc.
with support from expert Martin Baily.
Mr. Bailey discussed slide 2, "Context for this effort":
The APFPA proposal would re-route oil revenues to the
APFC to help stabilize State spending
The Alaska Permanent Fund Protection Act (APFPA)
calls for directing a steady annual amount to the
General Fund to mitigate the impact of oil price
volatility on year-to-year budgeting.
Specifically, the proposal recommends that:
50 percent of oil royalty revenues and 100
percent of production tax revenues flow to
the Alaska Permanent Fund Corporation (APFC)
for investment
A fixed annual draw of $3.3B (adjusted for
inflation beginning in 2020) from the APFC
to the General Fund to fund State
expenditures; the amount would be
methodically revisited every 4 years to
ensure continued Fund sustainability
Dividend payments be paid out of the
remaining 50 percent of oil royalties
The APFPA seeks to improve budget stability
Given a rising budget deficit and declining oil
production revenues, the APFPA seeks to:
Protect and grow the State's sovereign
wealth to maximize long-term returns,
acknowledging the rising importance of
investment income in funding its budget
Delink public spending from volatile
commodity prices and stabilize the budget by
establishing a disciplined, formulaic
approach to drawing from the State's wealth
State modeling proposes that a $3.3B draw should be
sustainable
The Department of Revenue (DOR) has undertaken an
extensive exercise to assess in a financial model
what amount of annual draw will be sustainable
(i.e., what draw amount can the State expect with
greater than 50 percent confidence to maintain
the starting asset's real value over time without
depleting the Earnings Reserve)
Given the Earnings Reserve's current size and the
$3B proposed transfer from the Constitutional
Budget Reserve, the State can plan with 100
percent confidence to draw $3.3B annually for at
least 4 years (at which point the draw amount
will be reviewed)
The cumulative confidence level of being able to
draw $3.3B annually falls to 95 percent over 10
years and to 69 percent through 2040. Revisiting
the draw on a 4-year cadence will lend additional
confidence (e.g., this safeguard has not been
factored in to modeling)
The State sought an independent review of this model's
rigor
The State sought an independent evaluation of (i)
the soundness of the model's methodology and (ii)
critical assumptions underlying the model (most
notably those related to expected oil revenues
and investment returns)
Mr. Baily addressed slide 3, "Overview of conclusions":
The DOR model is sound in its methodology
The model tests whether a $3.3B annual draw will
be sustainable
Monte Carlo simulations, to estimate confidence
levels for (i) future oil prices and (ii)
investment returns, as well as deterministic
analysis to establish a base case scenario for
oil production
model's logic is generally robust in testing the
likely impact of a $3.3B draw, based on a review
of the model's structure, logic, conceptual
soundness, and process for future updates
The assumptions that underlie the model are reasonable
Key assumptions on future crude oil selling
price, oil production, and investment returns
(total and statutory) were obtained from
credible, objective sources
These assumptions are all within the range
of reasonableness Assumptions on oil production
and price are reasonable and, taken together,
somewhat more conservative than most
Investment returns assumptions are
reasonable, though were considered optimistic for
the near-term by some members of the APFC
investment staff and were higher than those
projected by APFC's strategic partners (third-
party asset managers)
Certain institutional investor best practices could
help improve this plan's long-term sustainability
The State of Alaska could further strengthen
the long-term viability of the APFC and the
sustainability of its contributions to the
General Fund by leveraging best practice
learnings from other SWFs and investors, e.g.:
Clear savings-and-spending rules and capital
planning
Regular communication between investor and
sponsor
Formal and informal investment education
opportunities for government officials and board
members
Board governance processes with appropriate
composition, appointment expertise and roles
Well-designed strategy tied to Fund
obligations and long-term investing
5:14:30 PM
Co-Chair MacKinnon asked members to hold their questions to
the end of the presentation.
Mr. Baily continued to discuss slide 3.
Mr. Baily moved to slide 4, "Contents":
· Scope of the review
· Summary of the APFPA proposal
· Review of DOR model
Mr. Baily spoke to slide 5, "The scope of this assessment":
Overview
The Department of Revenue is seeking an objective
assessment of its financial model which analyzes a
$3.3B fixed annual draw from the Earnings Reserve of
the Permanent Fund to finance General Fund spending
In scope:
Detailed review and vetting of the DOR financial
model's methodology and construction, including
appropriateness of use of Monte Carlo analysis
Assessment of the reasonableness of key baseline
assumptions (oil price, oil production,
investment returns) affecting the sustainable
draw
Perspective on best practices of other SWFs which
inform consideration of the proposed model
Not in scope:
Holistic evaluation of the proposed budget or
budget deficit
Perspectives relating to current or future tax
regimes (e.g., Petroleum Value model)
Assessment of the Permanent Fund's mandate or its
investment management processes
Macroeconomic study of future market fundamentals
Recommendations for alternative funding models
Mr. Baily turned to slide 6, "SWFs benefit from
establishing a clear set of disciplined saving and spending
rules to invest for the long-term":
Establishes a clear set of disciplined saving and
spending rules as well as a predefined capital plan
Singapore's SWF, GIC, has developed a proprietary
internal model projecting 20-year sub-asset class
level returns
Government of Singapore is allowed to spend 50
percent of the annualized 20-year expected
returns giving Government flexibility on a year-
by-year basis on how much to draw, but capping
outflows at a low enough level to grow the corpus
The National Fund of Kazakhstan had previously
suffered from discretionary draws from the
corpus. Under 2010 reforms annual draw is fixed
at $8 billion for use both to reduce budget
deficits and for economic development. Government
can adjust the annual draw by 15 percent (as it
did in 2013)
If the balance of the National Fund falls below
20 percent of Kazakh GDP in a given fiscal year
the Government must reduce the annual draw until
the balance has returned to 20 percent of GDP
Norway has a bipartisan balanced budget consensus
which limits government non-oil deficits to 4
percentage points. This prevents the government
from drawing down the corpus of Norway's
Government Pension Fund Global unless Norges Bank
Investment Management beats the long-run expected
investment returns of 4 percent
Temporary increases in withdrawals are allowed
under only limited circumstances, but requires a
specific parliamentary resolution
5:19:07 PM
Mr. Baily discussed slide 7, "The DOR model was built to
establish and test the sustainability of a fixed annual
draw from the Earnings Reserve":
What are the major inflows into the Fund?
Production tax revenues
Royalty revenues
Investment returns
What are the most important drivers of future inflows?
Oil production
Oil price
Investment returns (total statutory)
What is the projected spendable output based on cash
flow projections?
Sustainable draw amount must ensure:
less than 50 percent confidence that real
value of starting assets is preserved over
time
Earnings Reserve durability (confidence that
the annual draw can be taken from ER)
Mr. Baily looked at slide 8, "The DOR conducted advanced
probabilistic ("Monte Carlo") modeling to better understand
the Fund's ability to sustain the draw." which showed three
graphs for a high-level description of the DOR modeling
process":
Step 1
Understand the critical revenue drivers of the
model - in terms of restricted and unrestricted
revenue sources
Step 2
Build a probabilistic model of expected oil price
and investment returns fluctuations
Step 3
Understand impact on revenue flows into the Fund
and Earnings Reserve available for the annual
draw
Mr. Baily spoke to slide 9, "Over 4 weeks, a detailed
review of the most critical elements of the DOR's modeling
methodology and assumptions was conducted":
SWF Model
Assumptions and Methodology
The existing DOR sovereign wealth fund model
was reviewed along 2 dimensions: methodology
and assumptions
Oil revenues (oil price and
production); Investment returns (total
and statutory net income); Structure of
model; Logic and conceptual soundness;
Process
Key elements of the model were
prioritized and pressure-tested
using industry experts, third-
party projections and proprietary
modelling assessment framework
5:24:12 PM
Mr. Baily displayed slide 11, "The DOR model implies a 69
percent cumulative confidence that a $3.3B annual draw can
be made from the Earnings Reserve each year through 2040":
Earnings Reserve acts as a buffer to short-term
investment return and oil revenue volatility
$10B starting balance means near 100 percent
confidence of being able to draw $3.3B per year for
first four years even with negative investment returns
APFC has only had negative total investment returns
four times in the past 30 years
Effects of cumulative volatility and declining oil
production reduce confidence over time - but even in
2040 cumulative confidence that a $3.3B annual draw
can be made from Earnings Reserve is 69 percent
(confidence would be even higher if adjusted for
periodic review)
Co-Chair Kelly asked if the model on slide 11 assumed the
$3 billion draw on the CBR, but asserted that most
legislators did not believe that was politically possible.
He wondered whether future slides would show the
probability for removing the draw.
Mr. Baily clarified that the model was run on the
assumption that the $3 billion was brought into the
earnings reserve, starting at $10 billion. He stated that
the model was not run the lower level of $7 billion. He
felt that, had the model been run at $7 billion, the draw
would need to be lowered and there may not be the same
level of confidence to have enough money in the earnings
reserve going forward. He remarked that there was
opportunity in the periodic review, so there could be
adjustments at that time.
Vice-Chair Micciche asked how the single significant
failure affect the future cumulative confidence.
Mr. Baily replied that one would be able to see a
significant failure. He felt that there was enough money in
the earnings reserve, so one could anticipate a necessary
adjustment. He remarked that there would need to be a new
run on the model to assess the confidence under the new
situation.
5:29:46 PM
Vice-Chair Micciche thought it would be interesting to view
slide 11 without the CBR infusion.
Co-Chair MacKinnon stated that the committee had the data
and it had been distributed the previous week.
Vice-Chair Micciche did not remember a cumulative
confidence level slide.
Co-Chair MacKinnon wondered if Commissioner Hoffbeck could
provide that information. Commissioner Hoffbeck agreed to
provide that information.
Co-Chair MacKinnon asked if the committee could get the
information as soon as possible. Commissioner Hoffbeck
stated that he would provide that information in a couple
of days.
Mr. Baily discussed slide 12, "The DOR model predicts that
the Permanent Fund will be $96B in 2040 with an
interquartile range of $34B and $196B":
Permanent Fund balance will grow or shrink in any
given year because of volatility in investment returns
and oil revenues
DOR goal is to maintain the real value of starting
assets by seeing the median balance grow with
inflation of 2.25 percent
Modelled output meets this threshold, predicting
median balances rising to ~$96B in 2040 (nominal
value)
Given expected volatility, 2040 ending balance is
predicted to be between $34B and $196B with a 50
percent confidence level (the threshold set by DOR)
Mr. Baily moved to slide 14, "Review of the DOR model
indicates that the assumptions and methodology underlying
Fund projections are sound":
Conclusions from the review
· The DOR modeling assumptions and methodology are
reasonable
o Key assumptions on future oil price, oil
production, and investment returns (total
and statutory) were obtained from objective
sources and are within the range of
reasonableness
o The methodological approach taken, including
use of Monte Carlo simulations, is
reasonable, and the model logic is generally
robust in testing the likely impact of a
$3.3B draw
Future iterations of the model could benefit from
the following changes: Build functionality to
account for second-order relationships (e.g.,
year-on-year correlation between variables1 and
the impact on production of reaching certain
breakeven prices for crude2)
Establish consistent process and ownership for model
construction and sources
Assumptions may be periodically revisited based on
changes to Fund strategy and investment management,
or changes to the tax regime affecting Fund inflows
5:34:05 PM
Mr. Baily discussed slide 15, "The review considered the
modeling methodology and assumptions behind critical
drivers of inflows to the Fund":
Crude selling price
Explanation of DOR approach
DOR has employed a Monte Carlo analysis
using ERG crude oil price projections to
determine the likelihood of price evolution
in the future based on a survey of expert
forecasts
How approach was assessed
Comparison of projections with multiple
third-party objective sources (e.g.,
Woodmac, Rystad)
Production volume
Explanation of DOR approach
DOR has employed a deterministic analysis
using ERG oil production projections - this
approach takes a fairly conservative
approach (e.g., approach reflects the
uncertainty of future production projects)
How approach was assessed
Comparison of projections with multiple
third-party sources
Total return rate and Statutory net income rate
Explanation of DOR approach
DOR has relied on Monte Carlo analysis based
on projections from Callan Associates (the
third-party financial consultant that the
Permanent Fund has used for 20+ years) to
estimate the likelihood of future Fund
performance based on current Fund strategy
How approach was assessed
Comparison of projections with historic
performance and third-party projections
Interviews with Permanent Fund investors to
understand view of projections and potential
for change to future fund performance
Mr. Baily displayed slide 16, "Two types of analysis are
used in the DOR model: "probabilistic" and "deterministic"
analysis":
Deterministic
Explanation
Describes the outcome of some scenario given
appropriate inputs (in this case, based on the
average or median value and the degree to which
that value varies over time)
When is it best used
When projections are based on an assumed trend
given variance from that trend within certain
standard deviation (e.g., use of a conservative
baseline case for oil production)
Probabilistic "Monte Carlo"
Explanation
Monte Carlo analysis is a modeling technique that
runs multiple trials and gives a distribution of
potential outcomes. Running a Monte Carlo model
creates a probability distribution that indicates
the likelihood that an outcome will occur
When is it best used
When attempting to project highly volatile and
less predictable drivers where the impact of
"randomness" is important to understanding risk
(e.g., oil price, investment returns)
Mr. Baily moved to slide 17, "Model methodology is robust,
with some potential opportunities for future improvement":
Structure
Check for errors
Explanation:
No major mechanical errors found
Potential steps to improve model:
None
Dependencies on other models
Explanation:
Petroleum Model model sub-optimally
structured
Oil production projections are not linked to
price projections
Potential steps to improve model:
Consider full audit of Petroleum Model
(particularly in light of tax / royalty
regime)
Wire model to account for price/production
relationship in future model iterations
Single use of source
Explanation:
Sources consistently used with exception of
some oil price inputs (e.g., median used in
Petroleum Model vs. probabilistic price used
in SWF model)
Potential steps to improve model:
Validate Petroleum Model for consistency in
oil pricing (e.g., using probabilistic model
vs. median)
Logic and conceptual soundness
Calculation of inputs
Explanation:
Underlying data sources are objective (e.g.,
Callan)
Does not account for impact of unrealized
returns on Earnings Reserve balance)
Potential steps to improve model:
Consider impact unrealized returns that are
apportioned to Earnings Reserve on the funds
available for spend
Deterministic vs. probabilistic
Explanation:
Current use of Monte Carlo methods is
defensible given behavior of oil price and
investment returns
Potential steps to improve model:
None
Probabilistic methodology
Explanation:
Pert distribution of oil price (i.e., 3
points) is sufficient but highly sensitive
to accuracy of underlying inputs to the
distribution (P10, P50, P90)
Does not account for year-on-year
correlations in oil prices (e.g., "gamblers
dilemma")
Potential steps to improve model:
Consider exploring more sophisticated
probabilistic methodology (e.g., revisit
accuracy of Delphi-style method used in PERT
distribution)
Account for year-on-year correlations in
probabilistic analysis
Process
Repeatable and consistent process
Explanation:
Informal construction process (partly driven
by ongoing iterative policy process)
Governance procedures to ensure systematic
auditing/updating not yet developed
Potential steps to improve model:
For future sustainable draw re-visitations,
create set of rules / guidelines for
timeline / triggers of update and develop
design principles to guide construction
Ownership
Explanation:
Unclear future ownership (partly driven by
unclear end use of model)
Potential steps to improve model:
For future sustainable draw re-visitations,
articulate clear owner(s) with auditing /
updating rights
5:39:02 PM
Mr. Baily turned to slide 18, "Each of the modeling
methodology used by the DOR model to project critical fund
inflow drivers is technically sound":
Crude selling price
Description of DOR model methodology:
Use of probabilistic analysis (PERT distribution)
based on P10=$31/bbl, P50=$56/bbl, P90=$87/bbl
Rationale for methodology:
Probabilistic analysis accounts for volatility
Distribution method leverages preexisting DOR/ERG
crude oil price projections
Production volume
Description of DOR model methodology:
Use of deterministic analysis based on
conservative base case (e.g., assuming no new
project-driven increase in production)
Rationale for methodology:
Not much volatility in the projections and hence
no need for probabilistic analysis
Total return rate
Description of DOR model methodology:
Use of probabilistic analysis (normal
distribution) based on 6.9 percent mean rate of
return and 13.9 percent standard deviation
Rationale for methodology:
Objective and transparent methodology
Distribution method based on mean reversion
methodology used by Callan
Statutory net income rate
Description of DOR model methodology:
Use of probabilistic analysis (PERT distribution)
based on based on P10=3.7 percent, P50=6.01
percent, P90=8.14 percent
Rationale for methodology:
Probabilistic analysis accounts for volatility
Distribution based on data available from Callan
statutory model (P10/50/90 distribution)
Mr. Baily spoke to slide 19, "Based on the recommendations
that came out of the model review, a series of actions were
executed":
Improvement identified:
Build Earnings Reserve sufficiency test into the
master model (versus using separate models to
test Fund balance and ER sufficiency)
Adapt fully objective, repeatable source for
investment returns (versus prior use of blended
projected and historic returns rates)
Update standard deviation of returns assumption
to match Fund returns projections
Use most technically correct formulas and @Risk
functions (e.g., calculation for geometric mean,
@Risk and risk target function cross check)
Changes made to model
Expanded model to include ER sufficiency analysis
Changed source from a 50 percent historic/50 percent
projected return to a 10 year deterministic projection
from 3rd party (Callan)
Changed standard deviation from use of Power Cost
Equalization Fund deviation to deviation matched to
returns source (Callan)
Executed tactical improvements (e.g., updated the
formula to calculate geometric mean, revised at risk
function to calculate cumulative confidence)
Mr. Baily discussed slide 20, "Assumptions appear generally
reasonable; returns projections are perhaps aggressive in
the near term":
Crude oil price
Assumption
10th percentile @ $31/bbl
Median @ $56/bbl
90th percentile @ $87/bbl
Source
Annual expert conference held by DOR/ERG1
Explanation
Roughly in-line with third-party estimates,
albeit conservative
Objective use of DOR/ERG projections
Crude production
Assumption
Declining from 500k bbl/day in 2017 to 112k
in 2040
Source
Survey of O and G companies (with likelihood
adjustments)
Explanation
In line with or below third-party estimates
in short term; below 3rd parties in long-
term due to AK LNG exclusion
Objective use of DOR/ERG projections
Total returns
Assumption
Mean 6.9 percent
Standard deviation 13.9 percent
Source
Callan deterministic model (Dec 2015)
Explanation
In line with other available projections
(e.g., 6.4 percent historic returns, 7.45
percent alternative probabilistic
projection)
Statutory net returns
Assumption
10th percentile at 3.7 percent
Median @ 6.01 percent
90th percentile @ 8.14 percent
Source
Callan probabilistic model (Dec 2015)
Explanation
Only viable estimate available (e.g., no
other multi-year projections available)
5:44:58 PM
Mr. Baily turned to slide 21, "Future iterations of the
model could account more rigorously for future trends and
second-order relationships":
Future shifts in fund target or mandate
Description
SWF proposal requires Permanent Fund to
manage toward fixed stream of liabilities
(i.e. like a pension fund)
Likely to entails shift in strategy and
potentially returns projections
Observations on impact
Investment earnings are single largest
driver of success of SWF (vs. O and G taxes
and royalties)
Even small percent changes in earnings
therefore imply significant changes to fund
value and sustainability
Future shifts in fund allocation strategies
Description
Permanent Fund will likely change investment
strategies in due course
SWF proposal considers possibility of
bringing more investment in-house
Observations on impact
Changes in investment strategy for a given
asset class will alter risk/return
distributions
Investing in-house will reduce fees
Liquidity constrains
Description
Clearer liability stream will allow for more
appropriate level of liquidity
Liability driven investing may introduce
greater leverage to portfolio
Observations on impact
Reduced levels of liquidity and/or higher
leverage may exacerbate risk on extremes of
market return distribution
New tax proposals
Description
Current proposal would amend the tax credit
system and directly impact O and G revenues
going to the State
Observations on impact
O and G revenues are a relatively small
percent of revenue in SWF model
Short-term impact, however, could be
significant to ensure stability of fund
Senator Dunleavy referred to slide 20, and asked about the
phrase in the title of the slide, "returns projections are
perhaps aggressive in the near term."
Mr. Baily replied that there was uncertainty in markets. He
stated that 6.9 percent real return was a fairly high
return. He felt that 6.9 percent was achievable, and did
not feel that it was aggressive over the time period of the
model. He remarked that markets were fairly weak at the end
of 2015, and slightly weak into 2016. He stressed that many
of those markets were reversed.
5:49:51 PM
Vice-Chair Micciche referred to slide 3, and noted that
investment assumptions were reasonable. He remarked that
some members of the Alaska Permanent Fund Corporation
investment staff felt that those numbers were considered
optimistic. They believed that the numbers were higher than
the projected numbers from the strategic partner's third
party asset managers. He wondered whether local fund
managers had experience with that particular asset
allocation, and whether they had a higher expertise.
Mr. Baily wondered whether the question was related to
whether the people who were running the portfolio knew more
than McKinsey.
Vice-Chair Micciche indicated in the affirmative.
Mr. Baily did not have a straight answer to the question.
Vice-Chair Micciche wondered what would happen to the model
in the outlier years.
Mr. Baily stated that the model was surprisingly robust.
Co-Chair Kelly referred to slide 21, he noted that oil and
gas revenue were a relatively small percentage of revenue.
He remarked that tax proposal bent the production curve,
and stressed that production was not a small portion of the
permanent fund. He wondered if the royalties were also
included.
Mr. Baily replied that the royalties and taxes were
considered in the evaluation.
5:54:44 PM
Vice-Chair Micciche did not believe that the guarantee of
robust markets. He queried the effects of a drawn out
correction. He remarked that the choice was between a
likely POMV, and the robust success of a fixed draw. He
wondered what would occur to a fixed draw model with an
extension.
Mr. Baily replied that there would be a periodic review,
and deferred to Commissioner Hoffbeck.
Commissioner Hoffbeck explained that the four year periodic
review was in place due to the off chance of low oil prices
and low market returns.
Vice-Chair Micciche asked why the state would not remain in
'adjustment mode.'
Mr. Baily stressed that McKinsey was taxed with evaluating
the fund. The advantage of the DOR proposal was that it was
similar in essence to other countries. He thought there was
enough robustness in the funds that. He thought the goal in
the budget process was to find something that was robust in
normal circumstances.
5:59:55 PM
AT EASE
6:01:51 PM
RECONVENED
Commissioner Hoffbeck commented that using a multi-year
average with the POMV, resulting in robust returns followed
by low market returns for multiple years. He shared that
there would be a review and adjustment. He remarked that,
although the POMV was more dynamic, a sustained period of
low oil returns could "bust" the earnings reserve.
Co-Chair MacKinnon asked to look at slide 3, and asked
about the target "Certain institutional investor best
practices could help improve this plan's long-term
sustainability." She wondered whether the variables were
run between the rates of returns versus the national
averages.
Mr. Baily replied in the negative. He explained that it was
related to the idea of gaining a clear ownership of the
model. The focus was more around the practice of building
and preserving the model.
Co-Chair MacKinnon referred to the associated bullet point,
"The State of Alaska could further strengthen the long-term
viability of the APFC and the sustainability of its
contributions to the General Fund by leveraging best
practice learnings from other SWFs and investors," and
wondered whether there would be additional training on the
models.
Mr. Baily replied in the affirmative.
Co-Chair MacKinnon wondered if Mr. Baily saw a weakness in
some practices at the PFC.
Mr. Baily did not say it was a weakness.
6:05:45 PM
Co-Chair MacKinnon referred to slide 5, and the items
listed as "Not in scope." She wondered whether those were
in the scope of the evaluation.
Commissioner Hoffbeck replied that they were not in the
scope of the evaluation.
Co-Chair MacKinnon wondered whether the items not in the
scope conducted by the administration.
Commissioner Hoffbeck replied that they were conducted by
the administration.
Co-Chair MacKinnon wondered whether there was a holistic
evaluation of the budget and budget deficit.
Commissioner Hoffbeck replied in the affirmative.
Co-Chair MacKinnon referred to slide 6, and referred to the
non-oil deficits to 4 percentage points. She wondered
whether there was consideration of the limit on the deficit
on non-oil deficits.
CRAIG RICHARDS, ATTORNEY GENERAL, DEPARTMENT OF LAW,
replied that it was taken into account in the sense that
there was a realization that they could not follow Norway's
rules-based system. He explained that Norway's system saved
all the petroleum revenues, and largely budgeted off of
broad-based taxation.
Co-Chair MacKinnon thought it was an interesting to trigger
to apply to manage the volatility on the other side.
Co-Chair MacKinnon referred to the Singapore model on slide
6, and wondered if there was an examination of a 20-year
prospective look at annualizing expected returns to
establish a draw versus annuity.
Attorney General Richards stated that he did not exactly
look at the Singapore model, but the model was close to the
efforts. He explained that they took the expected
annualized 24-year returns of the Permanent Fund, and
calculated a draw amount that equated to maintaining the
real value of the fund after inflation.
6:11:48 PM
Co-Chair MacKinnon assumed the testifiers were considering
an asset allocation change. She remarked that the earnings
reserve was currently fairing at a 5 to 6 percent interest
rate; but the CBR was at 2 percent because of liquidity.
She queried the sensitivity to drawing down the actual
earning opportunity inside the earnings reserve with the
current formula. She stressed that there would not be as
much cash available to generate earnings, because it would
suddenly be a liquid asset.
Commissioner Hoffbeck stated that there would need to be
some level of liquidity in order to make the draw. He
remarked that the liquidity could be managed. He stressed
that there would be no other change in allocation.
Attorney General Richards stressed that the allocations
would continue to change. He remarked that the Permanent
Fund was not considered a static fund.
Co-Chair MacKinnon asked if Commissioner Hoffbeck had
forecast a lower rate of return due to the liquidity in the
earnings reserve.
Commissioner Hoffbeck replied in the negative.
Attorney General Richards answered in the negative. He
thought there would be some impact but did not know the
exact impact.
Co-Chair MacKinnon asked if the directive of the CBR should
be changed if there would be a reduction of the rate in the
earnings reserve. She remarked that current state statute
mandated that the funds should be liquid in order to be
utilized.
Commissioner Hoffbeck agreed. He explained that there would
be reinvestments in the subaccount, should the earnings
reserve be used as a primary funding source.
Co-Chair MacKinnon asked if Commissioner Hoffbeck believed
that the reinvestment could be done without statutory
change.
Commissioner Hoffbeck replied that the funds that were not
projected as necessary could have a longer allocation.
6:16:09 PM
Co-Chair MacKinnon referred to slide 7, and asked
Commissioner Hoffbeck if oil production was up or down in
the current year.
Commissioner Hoffbeck replied that oil production was up,
forecast to be up the following year, and drop off in the
third year.
Co-Chair MacKinnon pointed out that the model presumed that
it was down for multiple years.
Commissioner Hoffbeck stated that the forecast during the
time of the model showed a decline moving forward.
Co-Chair MacKinnon thought it was important to recognize
that oil production was currently up and forecast as up,
due to the policies adopted by the legislature.
Commissioner Hoffbeck agreed, and stated that there were
multiple reasons for increased oil production.
Co-Chair MacKinnon looked to slide 9, and referred to the
statement "The existing DOR sovereign wealth fund model was
reviewed along 2 dimensions: methodology and assumptions."
She wondered whether other sovereign wealth funds used
other dimensions to examine their models.
Mr. Baily replied that the assumptions and methodologies
would be the two principles.
Co-Chair MacKinnon wondered whether the oil revenues and
production were weighted in the model.
Mr. Baily replied that it was illustrative, and not meant
to be weighted.
Co-Chair MacKinnon remarked that there was concern about
the lack of change in the probabilistic models because of
the variables based on the different forecasts. Co-Chair
MacKinnon wondered whether the per barrel charge and time
were the considered axes.
Mr. Baily answered in the affirmative.
Co-Chair MacKinnon wondered if there was an inclusion of $9
to $150.
Mr. Baily replied that PERT distribution was used, with the
high of $96, middle $56, and low of $36.
Co-Chair MacKinnon wondered whether a wider spread would
result in a problem because of the wide path on dollar
value. He wondered whether the model could break.
Mr. Baily replied in the affirmative, and depended on the
probability of the very high price.
Co-Chair MacKinnon asked if the data was based on Callan
data.
Mr. Baily replied that the price of oil was based on third
party estimators in Callan's own energy practice.
6:21:46 PM
Co-Chair MacKinnon referred to slide 11, "$10B starting
balance means near 100 percent confidence of being able to
draw $3.3B per year for first four years even with negative
investment returns." She wondered whether the state could
experience negative returns for multiple years.
Mr. Baily stated that if there was a whole sequence of very
large negative returns. He furthered that McKinsey had done
an assessment.
Attorney General Richards pointed out that McKinsey had not
worked on the POMV. He pointed out that bad probability
events on the front would increase decreasing the earnings
reserve.
Vice-Chair Micciche noticed that slide 6 listed three
sovereign wealth funds, and wondered if the rules of the
funds were public.
Mr. Baily stated that there had been extensive studies of
sovereign wealth funds.
Vice-Chair Micciche referred to slide 12, and thought that
if the CBR insertion was unsuccessful that there would be a
different result. He wondered whether they were weighted
toward the negative potential balance.
Mr. Baily replied that the computer ran through the
different draws and told the median, resulting in the
estimates of the probability distributions.
6:26:58 PM
Vice-Chair Micciche wondered why the black dot was not in
between the 75 and 25 percentile; and the median at $115
billion.
Mr. Baily stated that the model was not linear.
Vice-Chair Micciche thought the graph was strangely
consistent through 2040.
Mr. Baily thought the advantage of the model was that it
forced one to be systematic about assumptions, and was a
powerful tool. He thought it was not necessarily the most
obvious result.
Co-Chair MacKinnon asked if Mr. Baily could speak to the
earnings reserve account in reference to the graph on slide
12.
Mr. Baily replied that he did not know what would be in the
earnings reserve at that that point.
Commissioner Hoffbeck thanked the committee for the
opportunity to bring McKinsey to discuss the model.
Mr. Baily thought the project proved useful when
considering the budget options.
SB 114 was HEARD and HELD in committee for further
consideration.
SB 128 was HEARD and HELD in committee for further
consideration.
Co-Chair MacKinnon discussed the schedule for the week.
6:31:15 PM
AT EASE
6:31:22 PM
RECONVENED
Co-Chair MacKinnon discussed housekeeping.
ADJOURNMENT
6:31:38 PM
The meeting was adjourned at 6:31 p.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| SB 128 - Ensuring a Sound Fiscal Future - McKinsey Presentation 040416.pdf |
SFIN 4/4/2016 5:00:00 PM |
SB 128 |