Legislature(2003 - 2004)

10/30/2003 07:07 PM JUD

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
                    ALASKA STATE LEGISLATURE                                                                                  
              SENATE JUDICIARY STANDING COMMITTEE                                                                             
                         ANCHORAGE LIO                                                                                          
                        October 30, 2003                                                                                        
                           7:07 p.m.                                                                                            
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Senator Ralph Seekins, Chair                                                                                                    
Senator Scott Ogan, Vice Chair                                                                                                  
Senator Hollis French                                                                                                           
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
Senator Gene Therriault                                                                                                         
Senator Johnny Ellis                                                                                                            
                                                                                                                                
OTHER LEGISLATORS PRESENT                                                                                                     
                                                                                                                              
Senator John Cowdery                                                                                                            
Representative Mike Hawker                                                                                                      
                                                                                                                                
COMMITTEE CALENDAR                                                                                                            
                                                                                                                                
SENATE JOINT RESOLUTION NO. 18                                                                                                  
Proposing amendments to  the Constitution of the  State of Alaska                                                               
relating to  limiting appropriations from  and inflation-proofing                                                               
the Alaska  permanent fund  by establishing  a percent  of market                                                               
value spending limit.                                                                                                           
     HEARD AND HELD                                                                                                             
                                                                                                                                
SENATE JOINT RESOLUTION NO. 19                                                                                                  
Proposing amendments to  the Constitution of the  State of Alaska                                                               
relating to the Alaska permanent fund.                                                                                          
     HEARD AND HELD                                                                                                             
                                                                                                                                
PREVIOUS ACTION                                                                                                               
                                                                                                                                
SJR 18  - See State Affairs  minutes dated 5/1/03 and  5/6/03 and                                                               
     Judiciary minutes dated 5/15/03, 6/26/03, 10/28/03, and                                                                    
     10/29/03                                                                                                                   
SJR 19  - See State  Affairs minutes dated 5/13/03  and Judiciary                                                               
     minutes dated 5/17/03, 6/26/03, 10/28/03, and 10/29/03                                                                     
                                                                                                                                
WITNESS REGISTER                                                                                                              
                                                                                                                                
John Kiernan                                                                                                                    
No address provided                                                                                                             
POSITION STATEMENT: Testified on SJR 18 and SJR 19                                                                            
                                                                                                                                
Sharman Haley                                                                                                                   
No address provided                                                                                                             
POSITION STATEMENT: Posed questions on POMV                                                                                   
                                                                                                                                
ACTION NARRATIVE                                                                                                              
                                                                                                                                
TAPE 03-59, SIDE A                                                                                                            
                                                                                                                              
        SJR 18-CONST. AM: PF APPROPS/INFLATION-PROOFING                                                                     
            SJR 19-CONST. AM: PERMANENT FUND INCOME                                                                         
                                                                                                                              
CHAIR  RALPH   SEEKINS  called  the  Senate   Judiciary  Standing                                                             
Committee  meeting  to  order  at  7:07  p.m.  Judiciary  members                                                               
present were  Senators French, Ogan and  Seekins. Senator Cowdery                                                               
and Representative Hawker were also present.                                                                                    
                                                                                                                                
He  recognized  John  Kiernan  who was  present  to  testify  and                                                               
informed him that  Mr. Bob Storer from the  Alaska Permanent Fund                                                               
Corporation  would  give an  overview  of  the POMV  (Percent  of                                                               
Market Value).                                                                                                                  
                                                                                                                                
BOB STORER from  the Alaska Corporation (APFC)  Board of Trustees                                                               
explained that  both SJR 18  and HJR 26 propose  a constitutional                                                               
amendment,  which they  refer  to as  "the  5 percent  solution."                                                               
Multiple boards  have determined that  this is a superior  way of                                                               
insuring that all generations benefit  equally from the permanent                                                               
fund.                                                                                                                           
                                                                                                                                
He  referred  to  the  slides  on  page  two  of  the  PowerPoint                                                               
presentation to show the four  year change in the realized income                                                               
account and  the reserved account,  which includes  principal and                                                               
unrealized gains. He pointed out  that the principal is protected                                                               
in the constitution  and cannot be touched without a  vote of the                                                               
people. In contrast, realized income,  which is actualized profit                                                               
from the sale  of an asset and interest from  bonds and dividends                                                               
income, may be appropriated.                                                                                                    
                                                                                                                                
He explained  POMV is a formula  that limits the spending  of the                                                               
fund and  is based on  the total market  value of the  fund. They                                                               
suggest  setting  a percentage  that  is  based on  the  expected                                                               
difference between  the total investment  return and the  rate of                                                               
inflation. The Legislature has always  appropriated the impact of                                                               
inflation into  the fund principal  and the payout is  the excess                                                               
return. The  board maintains  there is  a superior  method, which                                                               
would be  to limit  the amount  that can  be appropriated  in any                                                               
given time  to the real  or excess earnings  of the fund  and the                                                               
affects of inflation would remain in the fund.                                                                                  
                                                                                                                                
Historically,  inflation has  been  three percent  and over  time                                                               
they believe they are able to  earn about eight percent so a five                                                               
percent appropriation is reasonable  and what they are suggesting                                                               
for appropriation. Justification for this  change may be found in                                                               
looking at data from the last  ten years because it shows returns                                                               
during the  bull market as  well as  the recent results  when the                                                               
market  performed poorly.  Over the  previous wildly  fluctuating                                                               
ten year  period, the fund  earned 7.8 percent and  inflation was                                                               
just  2.5 percent,  which  made  it possible  to  achieve a  real                                                               
return of  5.3 percent.  Looking forward,  they believe  they can                                                               
continue to do the same.                                                                                                        
                                                                                                                                
He  then  referred to  the  slide  showing the  asset  allocation                                                               
shift. In the  late 1970s and early 1980s, the  fund was invested                                                               
exclusively  in  fixed income  instruments  and  most income  was                                                               
realized from  cash flow. As  the fund matured,  emphasis shifted                                                               
from  income producing  assets to  asset appreciation  to produce                                                               
income.  Recognizing  contemporary   investment  standards,  they                                                               
believe a  superior methodology would  be to limit the  payout of                                                               
the total market value of the  fund, which would also capture the                                                               
appreciation of equities.                                                                                                       
                                                                                                                                
POMV would provide for a  permissible legislative payout from the                                                               
permanent  fund in  each year  of five  percent of  market value,                                                               
averaged over  a five  year period.  Under the  current scenario,                                                               
actual earned income  from the fund is  available for legislative                                                               
appropriation. The Board of Trustees  supports a solution that is                                                               
up  to five  percent  of  market value.  They  believe that  will                                                               
conserve  the  fund  for  future  generations  and  maintain  the                                                               
ability to pay out monies for current generations.                                                                              
                                                                                                                                
POMV  protects the  fund by  eliminating the  distinction between                                                               
principal and  earnings. With  regard to  the concern  that there                                                               
could  be an  invasion of  principal,  he pointed  out that  four                                                               
years ago  about 25 percent of  the fund was earnings  that could                                                               
have  been appropriated.  If that  amount had  been appropriated,                                                               
there would  have been nothing  available for payout.  This limit                                                               
imposes discipline  so there wouldn't  be overspending in  a bull                                                               
market,  which   he  believes  to  be   critically  important  in                                                               
protecting principal.                                                                                                           
                                                                                                                                
He explained the chart on  current formula payouts for 1998, 2000                                                               
and 2003 takes the total realized  income for the last five years                                                               
multiplies it  by .21  percent and divides  by two.  Applying the                                                               
current formula out to 2005  and using a mid-case scenario, there                                                               
would be less  available for the dividend and not  enough to meet                                                               
inflation proofing.                                                                                                             
                                                                                                                                
In  comparison, the  POMV simply  takes the  market value  of the                                                               
fund at  the end of five  years, average the five  years and take                                                               
five percent.  He referred  to the  chart to  show that  there is                                                               
less volatility using this formula.                                                                                             
                                                                                                                                
He  then  explained  the chart  showing  realized  income  versus                                                               
market value. In  1996, realized income increased  by 80 percent,                                                               
but it dropped  by that same amount in 2001  and 2002 showing the                                                               
volatility in  the current formula. Predictability  and stability                                                               
of  payout is  important  and the  current  formula shows  higher                                                               
volatility.  He emphasized  this  by reminding  members that  the                                                               
board repeatedly warned  of the possibility of  no payout earlier                                                               
in the year.                                                                                                                    
                                                                                                                                
People sometimes ask  which method would have  the greater payout                                                               
over time and  they say that ultimately, it's the  same, but POMV                                                               
smoothes  the  payouts  to  higher   lows  and  lower  highs.  In                                                               
addition,   POMV  eliminates   any   question   that  the   asset                                                               
allocations  are   based  on   anything  other   than  investment                                                               
management  decisions. Under  the  current  method, actions  will                                                               
affect the dividend.                                                                                                            
                                                                                                                                
JOHN  KIERNAN  testified as  a  private  citizen and  noted  that                                                               
several  years  ago  83  percent   of  the  Alaskans  that  voted                                                               
indicated  they did  not want  the dividend  touched and  now the                                                               
Legislature is going after the permanent fund itself. He said:                                                                  
                                                                                                                                
     When we  have BP  taking 65 percent  of the  profits of                                                                    
     oil,   the   federal   government   gets   35   percent                                                                    
     corporation tax,  Alaska gets about 3  percent and with                                                                    
     what  the  federal  government  gets  it  makes  up  35                                                                    
     percent and  then the other  65 percent of  the profits                                                                    
     go to  BP - of  oil. And oil is  the big money  in this                                                                    
     state.  We  fought  the  war of  1776....  to  get  the                                                                    
     British out  of America,  but they're taking  our money                                                                    
     in oil  money out of  here, to  London. So okay,  I can                                                                    
     invest  in BP  and share  some of  that profit,  that's                                                                    
     great, but I understand from  a letter I've gotten hold                                                                    
     of... that  says 'At statehood  a major portion  of our                                                                    
     private property  mineral rights were  negotiated away.                                                                    
     We  property  owners were  told  that  the state  would                                                                    
     manage our  mineral rights for  the benefit of  all. We                                                                    
     would receive  a dividend, much  like a  stock dividend                                                                    
     to  compensate  us for  the  loss  of this  significant                                                                    
     right.' She  then says, 'Hands off  my dividend!' among                                                                    
     other  things.   She  says,  'Now   unrestrained  state                                                                    
     spending  threatens  the  dividend  and  the  proposed,                                                                    
     highly promoted, POMV is not  the answer. Alaska spends                                                                    
     more  than  twice  as  much  as  any  other  state  per                                                                    
     person." If that be the  case, you guys know more about                                                                    
     that than  I do and I  can only take from  what she has                                                                    
     written here  and this was  in the Alaska  Digest Email                                                                    
     News on  10/23/03, which  was just a  few days  ago. If                                                                    
     that is the  case, then the state  has committed itself                                                                    
     to taking  care of  those mineral  rights and  paying a                                                                    
     dividend to the public. Okay,  we have a permanent fund                                                                    
     that  does  that, but  what  the  public are  concerned                                                                    
     about is that  they said no, don't  touch the dividend,                                                                    
     but  now  they're  looking  at  going  after  the  fund                                                                    
     itself. Five  percent of the  fund sounds okay,  but if                                                                    
     the fund is not earning money  at all. If we hit a real                                                                    
     depression, and  do we still  continue to pay  out five                                                                    
     percent  of  the  fund  even  in  a  really  depressing                                                                    
     situation? That  would cause the  fund to  disappear if                                                                    
     the  depression  lasted  a  long  time.  I  agree  five                                                                    
     percent, five into 100 is  20 years, but okay, in rough                                                                    
     calculations  it  would take  a  long  time for  it  to                                                                    
     disappear.                                                                                                                 
                                                                                                                                
     Okay, then I read another  problem. Why is Alaska being                                                                    
     ripped off?  Most oil exporting  countries go  to great                                                                    
     lengths to  keep their tax policies  secret. However, a                                                                    
     great deal  of information about OPEC  member Nigeria's                                                                    
     oil tax policy can be  found at a certain email address                                                                    
     which  I've got  written down  here. Doing  business in                                                                    
     Nigeria, when you reach the  page, do a word search and                                                                    
     find petroleum profits  tax is payable at  the tax rate                                                                    
     of 85  percent for all  companies. And 85  percent rate                                                                    
     is the norm  for all OPEC countries....  [They] all pay                                                                    
     those  taxes. A  complete  list of  companies that  pay                                                                    
     those taxes can  be found at another  email address. If                                                                    
     85 percent does not  stop major oil company involvement                                                                    
     in  Nigeria, what  is our  Governor or  our Legislature                                                                    
     doing about  our pitiful, miniscule  tax rates  here in                                                                    
     Alaska?  Why are  we giving  away our  resource wealth,                                                                    
     but  are   attempting  to   raid  the   permanent  fund                                                                    
     dividend.                                                                                                                  
                                                                                                                                
     It's not a  bad solution to our  financial dilemma, but                                                                    
     it's not  going to  help the  people, this  taking away                                                                    
     the permanent  fund from the people.  The oil companies                                                                    
     should be paying more in  taxes than just three percent                                                                    
     to Alaska  and five  percent to the  federal government                                                                    
     and  then  walking  away with  65  percent.  That's  my                                                                    
     thinking.                                                                                                                  
                                                                                                                                
     I hear you in that you  say that the five percent would                                                                    
     be  a steady  form of  income. And  then how  expensive                                                                    
     would be another matter, but  it would be a steady form                                                                    
     of income and  even in bad times it would  take it over                                                                    
     20  years for  the  fund to  be  wiped out  completely.                                                                    
     Usually  bad times  only  last about  a  year and  then                                                                    
     we're  back to  the good  times  again. So  I see  your                                                                    
     point, it's possibly  a good thing to do.  But you have                                                                    
     to sell it to the people  and yes, that 83 percent said                                                                    
     no, don't touch  the dividend so you've got  to sell it                                                                    
     to the people.                                                                                                             
                                                                                                                                
     I  would  say  that  if   the  people  saw  that  their                                                                    
     dividends were  going to  continue and  if all  the oil                                                                    
     revenue was put into the  fund for investment, not just                                                                    
     put into  state coffers  for spending,  but all  of the                                                                    
     oil revenue and all of  the revenue from everywhere was                                                                    
     put into the  fund for investment and  then only payout                                                                    
     five percent, you might convince  some people then. But                                                                    
     [not] to just take five percent  of the fund and add it                                                                    
     to the general fund.                                                                                                       
                                                                                                                                
SENATOR COWDERY noted that when he homesteaded in 1954 it was                                                                   
clear that he didn't have any subsurface rights and he had no                                                                   
problem with that.                                                                                                              
                                                                                                                                
He recalled that the first lease sale was about $900 million and                                                                
royalty rates were set at about 12.5 percent. He asked Mr.                                                                      
Kiernan how he would change the formula.                                                                                        
                                                                                                                                
MR. KIERNAN asked about the length of the leases.                                                                               
                                                                                                                                
CHAIR SEEKINS said, "In perpetuity."                                                                                            
                                                                                                                                
MR. KIERNAN expressed surprise.                                                                                                 
                                                                                                                                
CHAIR SEEKINS explained that if a company leases a piece of                                                                     
property for oil extraction, they pay a royalty and harvest the                                                                 
resource until it  is not longer there. Their  profit comes after                                                               
they  have  paid royalties.  He  pointed  out the  company  isn't                                                               
paying just  three percent;  they've already  paid at  least 12.5                                                               
percent in royalties.                                                                                                           
                                                                                                                                
SENATOR COWDERY  added that the  royalty on some fields  has been                                                               
as high as 50 percent.                                                                                                          
                                                                                                                                
CHAIR  SEEKINS  stated  there  was   no  agreement  at  statehood                                                               
regarding sacrificing subsurface mineral rights for a dividend.                                                                 
                                                                                                                                
MR. KIERNAN acknowledged that his  source might be incorrect then                                                               
asked about mineral rights on leasehold property.                                                                               
                                                                                                                                
CHAIR SEEKINS  said the  agreement has already  been made  and it                                                               
can't be altered.                                                                                                               
                                                                                                                                
REPRESENTATIVE HAWKER noted  that Section 6 of  the Statehood Act                                                               
gave all of the fundamental  resource wealth to Alaska. The first                                                               
line clearly  delineates the  purpose for  which that  wealth was                                                               
given, which was to develop Alaska's community infrastructure.                                                                  
                                                                                                                                
CHAIR SEEKINS added that the  federal government held that wealth                                                               
in trust for the people of the future state.                                                                                    
                                                                                                                                
SENATOR OGAN suggested returning the discussion to the POMV.                                                                    
                                                                                                                                
CHIAR SEEKINS agreed.                                                                                                           
                                                                                                                                
SENATOR COWDERY said  an agreement is an agreement  and the state                                                               
signed  the agreement.  People  were very  pleased  when the  oil                                                               
companies arrived.                                                                                                              
                                                                                                                                
SENATOR FRENCH  referred to  the third bullet  point on  the POMV                                                               
solution  and noted  that protecting  the fund  by constitutional                                                               
inflation proofing is there by implication only.                                                                                
                                                                                                                                
MR. STORER agreed it was there by implication.                                                                                  
                                                                                                                                
SENATOR FRENCH  said that if there  were a year where  the return                                                               
on  the fund  was five  percent  and the  Legislature decided  to                                                               
spend  the five  percent  then there  wouldn't  be any  inflation                                                               
proofing that year.                                                                                                             
                                                                                                                                
MR. STORER  said they use  the term "over  time" to say  that you                                                               
will succeed  in earning  a five year  return over  inflation. He                                                               
said, "You're correct,  it is implied; the  residual remains with                                                               
the fund."                                                                                                                      
                                                                                                                                
They did a  study on rolling tenures and found  there was never a                                                               
ten year period in which less  than five percent was earned. This                                                               
includes the  recent three year  bear market. Looking  at shorter                                                               
time horizons there  is no question there have  been periods when                                                               
that goal wasn't achieved, but  with the long-term discipline you                                                               
will achieve the goal he said.                                                                                                  
                                                                                                                                
SENATOR FRENCH  asked what it  is about the current  structure of                                                               
the  fund   that  jeopardizes  future  generations   receiving  a                                                               
dividend.                                                                                                                       
                                                                                                                                
MR. STORER  replied that's  a good question  because to  date the                                                               
Legislature has appropriated for  inflation proofing and at times                                                               
they  have   appropriated  additional  revenue   into  principal.                                                               
However, there is no way to  predict whether or not that would be                                                               
the  case with  future Legislatures.  Currently statute  requires                                                               
the  dividend  come  first followed  by  inflation  proofing.  By                                                               
memorializing this  in the constitution,  it has a  more powerful                                                               
effect  on  inflation  proofing  and if  they  are  correct,  the                                                               
purchasing  power will  be maintained  and all  generations would                                                               
benefit equally.                                                                                                                
                                                                                                                                
SENATOR FRENCH  said that since the  fund moved away from  a bond                                                               
strategy into  equities it  seems less  likely that  the dividend                                                               
payout would  be too  much under the  current structure.  He used                                                               
Microsoft  stock as  an example.  It pays  no dividends,  but the                                                               
value of the stock has  risen considerably. If the permanent fund                                                               
were to  have a  lot of this  stock, the size  of the  fund would                                                               
increase, but there  wouldn't be any realized  earnings until the                                                               
stock  was   sold.  Under  current   methodology,  none   of  the                                                               
appreciation would  be available  for distribution as  a dividend                                                               
or  inflation proofing  or any  other  use unless  the stock  was                                                               
sold.                                                                                                                           
                                                                                                                                
MR. STORER said,                                                                                                                
     "You brought up an excellent point and it goes back to                                                                     
     another point I touched on briefly....                                                                                     
                                                                                                                                
TAPE 03-59, SIDE B                                                                                                            
7:52 p.m.                                                                                                                     
                                                                                                                              
     ...is almost given away, it's  one half of a percent is                                                                    
     what we  pay for the  management of that. And  there is                                                                    
     virtually  no turn  over unless  a stock  enters or  is                                                                    
     removed from the dividend. So  what happens is, on that                                                                    
     portfolio, you  get a dividend, but  there is virtually                                                                    
     no change  and so what  would happen in  that portfolio                                                                    
     absent   activity,  would   be   it  would   appreciate                                                                    
     theoretically.  Your Microsoft  keeps appreciating  and                                                                    
     there  are only  paper profits,  yet the  value of  the                                                                    
     fund is increasing rather  dramatically. The other half                                                                    
     of  the portfolio  -  we use  active  managers. We  use                                                                    
     active managers  to diversify the  risk and  you expect                                                                    
     them  to add  some incremental  value above  the index.                                                                    
     Otherwise  why would  you do  that? Those  managers are                                                                    
     active  all  the  time  and   in  fact  when  they  buy                                                                    
     Microsoft  their discipline  actually is  different....                                                                    
     Many of  them own it,  but they  tend to own  a limited                                                                    
     amount  in the  portfolio.  When  that Microsoft  stock                                                                    
     goes up, and you've got  five percent of the portfolio,                                                                    
     they sell. So now you've  got only three percent of the                                                                    
     portfolio. So they're selling the profits.                                                                                 
                                                                                                                                
     The  other decision  that they  make is  they may  like                                                                    
     Intel  better than  Microsoft  for  whatever reason  so                                                                    
     they  may sell  all  the Microsoft  because they  think                                                                    
     they can earn  more in Intel. The  problem becomes that                                                                    
     we have  a balance. What  if -  I know one  state whose                                                                    
     domestic portfolio  is exclusively passive. If  we did,                                                                    
     there would be virtually  no dividend whatsoever unless                                                                    
     you made non-investment  arbitrary decisions to harvest                                                                    
     the profits. Which brings the  second question. What do                                                                    
     you  do  with  the  money? So,  there  are  potentially                                                                    
     arbitrary  and non-investment  decisions that  can come                                                                    
     out  of these  kinds of  things. That's  the beauty  of                                                                    
     limiting to the value of  the market value of the fund.                                                                    
     That way  you're capturing  some of  that appreciation,                                                                    
     but no  more than would  be in excess of  inflation. So                                                                    
     it  eliminates the  ambiguity other  than  it's a  pure                                                                    
     investment decision.                                                                                                       
                                                                                                                                
CHAIR  SEEKINS  referred to  the  chart  showing realized  income                                                               
versus market  value and  asked if  the change  in value  in 1996                                                               
resulted  from  a management  decision  or  a Board  of  Trustees                                                               
decision because they wanted to increase the dividend payout.                                                                   
                                                                                                                                
MR. STORER  advised he didn't  participate in  those discussions,                                                               
but he  believes the  debate stemmed from  fact that  assets were                                                               
increasing dramatically in  the raging bull market  and there was                                                               
concern  that  future generations  would  benefit  from the  bull                                                               
market more than  the current generation. At that  time the board                                                               
made  the decision  to  take profits  in  the passive  portfolio,                                                               
which had the effect of increasing the dividend.                                                                                
                                                                                                                                
CHAIR SEEKINS  stated this decision was  made without legislative                                                               
consultation for the purpose of increasing the dividend.                                                                        
                                                                                                                                
MR. STORER replied  the payout would be the  same ultimately, but                                                               
there was an arbitrary decision with regard to when.                                                                            
                                                                                                                                
SENATOR FRENCH asked if this was the permanent fund.                                                                            
                                                                                                                                
MR.  STORER said  it was.  He pointed  to the  spike in  1996 and                                                               
advised  that was  during the  bull  market so  there was  profit                                                               
taking, but there was also a  specific decision made by the Board                                                               
of Trustees to take profits in the passive portfolio.                                                                           
                                                                                                                                
SENATOR  COWDERY  questioned  how  close we  came  to  having  no                                                               
dividend.                                                                                                                       
                                                                                                                                
MR. STORER said that according to  their studies, there was a ten                                                               
percent  chance  there  would  be no  dividend  in  2003.  Things                                                               
changed in  the last quarter of  the fiscal year and  they earned                                                               
about  ten percent.  "But if  that  was the  first quarter  there                                                               
would have  been about a  ten percent probability of  no dividend                                                               
under the existing formula."                                                                                                    
                                                                                                                                
SENATOR COWDERY questioned, "On the  existing formulas, if it had                                                               
stayed  that  way  for  two  or three  more  quarters  before  it                                                               
turned?"                                                                                                                        
                                                                                                                                
MR. STORER  quipped, "Another executive director  would be making                                                               
this presentation."                                                                                                             
                                                                                                                                
SENATOR  COWDERY asked  if the  fund  plummeted $4  or 5  billion                                                               
during the slump.                                                                                                               
                                                                                                                                
MR. STORER  said it  wasn't that  much, but  it was  dramatic. At                                                               
fiscal  year  end, the  earnings  reserve  was $1.6  billion  and                                                               
around mid July   [2002] that money  was gone. By July  24 it was                                                               
back up, but the volatility lasted  for about a six month period.                                                               
That year, [2002]  the fund had the worst quarter  in the history                                                               
of the  fund. That quarter was  -7.5 percent, but for  the fiscal                                                               
year the  fund earned about  5.5 percent. During the  latter part                                                               
of that  calendar year, the value  of the fund was  less than the                                                               
principal  about  three  times.   That  includes  the  unrealized                                                               
losses.                                                                                                                         
                                                                                                                                
SENATOR COWDERY asked  if it was correct that  the dividend would                                                               
have been  about the same  if the POMV  had been in  place during                                                               
that time.                                                                                                                      
                                                                                                                                
MR. STORER  said that  was probably accurate.  The irony  is that                                                               
for the next two years the  dividend will probably continue to go                                                               
down under POMV.                                                                                                                
                                                                                                                                
CHAIR SEEKINS asked about inflation  proofing in POMV. He said he                                                               
understands  it's   inherent  to  the  strategy,   but  it's  not                                                               
constitutionally guaranteed.                                                                                                    
                                                                                                                                
MR. STORER agreed and added  there is no constitutional guarantee                                                               
inflation proofing would be exercised in any given year.                                                                        
                                                                                                                                
CHAIR SEEKINS said, "When it  came to cutting funds for education                                                               
or cutting  inflation proofing, the Legislature  can decide which                                                               
of those they are going to do."                                                                                                 
                                                                                                                                
MR.  STORER  replied  the   same  fundamental  debates  regarding                                                               
inflation proofing could exist in the future.                                                                                   
                                                                                                                                
CHAIR SEEKINS asked about the  invasion of principal question. He                                                               
remarked that he understands very  well how influential the Board                                                               
of  Trustees can  be in  determining whether  or not  there is  a                                                               
dividend  and how  large it  might be  because they  are able  to                                                               
instruct management  to sell or  not sell. If it  was politically                                                               
expedient to make  sure that there was money for  a dividend, the                                                               
trustees  could  conceivably  cherry  pick the  fund  to  produce                                                               
realized  income so  funds could  be  available for  distribution                                                               
even though the principal of the fund was decreased.                                                                            
                                                                                                                                
MR. STORER replied that fact exists every year.                                                                                 
                                                                                                                                
CHAIR SEEKINS said,  "Even today there is  no real constitutional                                                               
provision  that protects  the principal  from  invasion based  on                                                               
different creative strategies."                                                                                                 
                                                                                                                                
MR.  STORER  agreed.  In  investment   management  there  are  an                                                               
increasing number of ways to get from A to B.                                                                                   
                                                                                                                                
CHAIR  SEEKINS  asked whether  the  POMV  strategy would  provide                                                               
better, worse or neutral protection of fund principal.                                                                          
MR. STORER  opined it would  unequivocally make  every investment                                                               
decision a pure investment management decision.                                                                                 
                                                                                                                                
SHARMAN HALEY,  an economist,  asked why  the projections  to the                                                               
end of  the decade  comparing the current  formula with  the POMV                                                               
under the  50 50 scenario  shows that in  the short run  the POMV                                                               
dividend is  higher, but by  the end  of the decade,  the current                                                               
formula shows a  higher dividend. She questioned  why they aren't                                                               
more comparable.                                                                                                                
                                                                                                                                
CHAIR  SEEKINS   advised  the   50  50   formula  is   not  under                                                               
consideration under the bill.                                                                                                   
                                                                                                                                
MR. STORER  said the 50 50  formula is an example  they have used                                                               
and the answer goes to the stability of payout issue.                                                                           
                                                                                                                                
     "Whereas there's  less volatility in market  value, you                                                                    
     get this constant  that's going to go  up like that....                                                                    
     So over  the next  few years,  the moving  average, the                                                                    
     amount  that's  available   will,  under  the  existing                                                                    
     formula, will  continue to drop. What  happens and what                                                                    
     you  see are  extrapolations of  the median  case only.                                                                    
     What happens is  that as the normalized  payout goes up                                                                    
     then  you  will  see  more  profits  generated  in  the                                                                    
     realized income  that compensates.  We overshot  in the                                                                    
     bull    market   and    we're   undershooting    rather                                                                    
     significantly  so we  go  back out.  In  the out  years                                                                    
     you'll see it  go above a bit and what  I think is that                                                                    
     ultimately they smooth out and compress a bit.                                                                             
                                                                                                                                
     There  is an  arbitrary issue  in our  projections that                                                                    
     you  can  appreciate.  We   have  to  predict  realized                                                                    
     income. Which means we're  predicting two things. We're                                                                    
     predicting   markets  and   we're  predicting   manager                                                                    
     behavior  to  those  markets.  So  we  take  historical                                                                    
     turnover rates  in our  realized assumptions,  but they                                                                    
     are arbitrary decisions.                                                                                                   
                                                                                                                                
CHAIR SEEKINS  emphasized that in  considering POMV,  they aren't                                                               
considering any  change in the  way distributions  are allocated.                                                               
It is just a proposal for  determining how much is available from                                                               
the fund for distribution on an annual basis.                                                                                   
                                                                                                                                
MR. STORER  added that people do  care a lot about  the amount of                                                               
the  dividend and  there is  a  fiscal issue.  They are  parallel                                                               
issues,  but they  exist even  without  the POMV.  He said  their                                                               
point isn't the spending issue; it's the management of the fund.                                                                
                                                                                                                                
CHAIR SEEKINS said  his point is to insulate from  market and, in                                                               
particular,  political  volatility.  He pointed  out  that  board                                                               
members serve at the pleasure  of the governor and legislators do                                                               
not confirm  the board. When  he was  removed from the  board, he                                                               
received a letter from the  governor stating he was being removed                                                               
because it  was doubtful  that he would  invest according  to the                                                               
governor's  political philosophy.  He  opined it  is a  dangerous                                                               
situation  to   invest  according   to  a   governor's  political                                                               
philosophy  and it  shouldn't be  a  possibility. In  considering                                                               
POMV, that is a valuable consideration.                                                                                         
                                                                                                                                
Considering POMV by  itself, it is an upgrade.  The chart showing                                                               
how  asset  allocation  has  changed   makes  it  clear  that  an                                                               
allocation  and distribution  upgrade is  in order.  The proposed                                                               
formula is used by 85 percent of  the major funds so it's not new                                                               
or untried.  He stated  his personal position  is that,  "I would                                                               
trust that the decision being made on  how much to take out on an                                                               
annual basis, in case of a  major depression would better be made                                                               
by  the 60  members of  the  Legislature than  the six  political                                                               
appointees on  the Board of  Trustees -  having been one  and now                                                               
being on the other."                                                                                                            
                                                                                                                                
CHAIR  SEEKINS announced  he would  hold a  committee meeting  on                                                               
this subject  during the first  week of the upcoming  session. If                                                               
additional meetings  are needed in  different areas of  the state                                                               
he will hold them.                                                                                                              
                                                                                                                                
There being  no further  business to  come before  the committee,                                                               
Chair Seekins adjourned the meeting at 8:20 p.m.                                                                                

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