CS FOR HOUSE JOINT RESOLUTION NO. 26(FIN) Proposing amendments to the Constitution of the State of Alaska relating to and limiting appropriations from the Alaska permanent fund based on an averaged percent of the fund market value. This was the second hearing for this bill in the Senate Finance Committee. Co-Chair Wilken stated that this Percent of Market Value (POMV) legislation would propose an amendment to the Alaska "Constitution that would limit appropriations from the Permanent Fund to five percent of the average of the market value of the Fund." He stated that CS HJR 26 (FIN), Version 23-LS1006\Z, is accompanied by a Division of Elections' fiscal note. BOB BARTHOLOMEW, Chief Operating Officer, Alaska Permanent Fund Corporation, Department of Revenue, noted that this resolution is the result of approximately six years of effort on the part of the Permanent Fund Board of Trustees to provide a simpler method "to determine how much is available for appropriation from the Permanent Fund." SFC 04 # 109, Side B 08:52 AM Mr. Bartholomew informed the Committee that The Alaska Permanent Fund Board of Trustees supports the Version "Z" committee substitute. AT EASE 8:53 AM / 8:54 AM The bill was HELD in Committee. [Note: HJR 26 was re-addressed later in the meeting.} CS FOR HOUSE JOINT RESOLUTION NO. 26(FIN) Proposing amendments to the Constitution of the State of Alaska relating to and limiting appropriations from the Alaska permanent fund based on an averaged percent of the fund market value. [Note: This bill was heard earlier in the meeting.] Co-Chair Wilken noted that this bill, which is referred to as the Percent of Market Value (POMV) bill, is again before the Committee. He stated that the bill proposes to place an amendment to the Constitution on a Statewide ballot that would, were it approved, limit the appropriation from the Permanent Fund to five percent of the average of the market value of the Fund. He reminded that CS HJR 26(FIN), Version 23-LS1006\Z is before the Committee. BOB BARTHOLOMEW, Chief Operating Officer, Alaska Permanent Fund Corporation, Department of Revenue, shared that the Permanent Fund's Board of Trustees worked for approximately six years to develop this proposal in order to prepare the Fund for the future, both from an investment management perspective as well as "from the perspective of how to make a stable and predictable amount of money available to the Legislature if they desire to appropriate it." He stated that this House of Representatives' legislation is representative of the language proposed by the Board of Trustees. He stated that the bill would establish "a spending limit of five percent of the value of the Permanent Fund on an annual basis." He exampled that were this methodology in effect for the next fiscal year approximately $1.3 billion would be available for appropriation from the Fund. Mr. Bartholomew shared that were the current calculation methodology in affect, and were the Legislature to require additional resources, in excess of $4 billion could be available for appropriation. Mr. Bartholomew stated that this legislation would assure that "the Permanent Fund is invested in long-term assets" with a goal of trying to provide a stable and predictable payout. He pointed out that one of the Board's concerns was to assure, were fiscal concerns to be experienced in the future, that one of the State's largest assets could be as productive as possible to assist in that effort. He stated that inflation proofing has been conducted for 22 years. He stated that this would be inherent to the system, were the spending limit in place. He stated that the goals of limiting spending; protecting the fund against inflation; and granting the Legislature and the public have a predictable payout in the future, would be achieved by this legislation. Senator Bunde stated for the record, that passing this legislation, "while it might be a pre-cursor to some future activity that would use some of the earnings for supporting State services, just passing this does nothing to determine how the funds are spent." Mr. Bartholomew confirmed Senator Bunde's comment to be correct. He stated that, "there's two major public policy issues regarding the Permanent Fund that … are being discussed in the Legislature this year." The first, he noted, is the legislation regarding the Constitutional amendment regarding the Board of Trust's POMV proposal. This proposal, he opined, would serve to identify the method through which to determine what is available and to protect the Fund for the future. He clarified that the POMV proposal would not change how the funds would be used, but would rather specify the amount that could be used. He advised that a separate bill, HB 298, would address how the Permanent Fund's money would be spent. He stressed that these are two separate issues. Senator Bunde responded that the POMV proposal, were it approved, would allow future Legislators to either designate all the earnings calculated by the five-percent methodology, "as dividends or to take all the earnings and put them into funding State services or some combination thereof." Mr. Bartholomew agreed that, "this Constitutional amendment would limit the annual amount available, subject to the Legislature." Senator Hoffman asked regarding the intent of a Board of Trustee's POMV advertisement that had recently appeared in the Anchorage Daily News newspaper. He also asked how the advertisement was financed. Mr. Bartholomew responded that the advertisement was paid for via the Permanent Fund Corporation's operating budget. He stated that the intent of the advertisement was to assist in educating the public regarding the POMV proposal as, he noted, such things as surveys indicate that, "there's still a high level of confusion in the public as to what is the proposal." He stated that due to the fact that "there's a lot of awareness and interest right now" in regards to the Permanent Fund, the Board viewed this "as an opportunity to provide education in as neutral a fashion" as could be done. Therefore, he concluded that the intent was, "in a simple way," to explain the difference between the current process and "the Percent of Market Value (POMV) or endowment approach." Senator Hoffman recalled a previous Finance Committee discussion regarding the Board of Trustees' request for in excess of one million dollars to inform the public about POMV. He stated that the response from the Committee was unfavorable and that the request had been denied. Therefore, he asked why the Board was furthering this endeavor. Mr. Bartholomew responded that "the request for both the authority to do advocacy and for the funding to do the education and outreach on POMV was because of the rule changes that take place" were the legislation passed by the Legislature. He stated that it was understood that, were the POMV proposal approved by the Legislature, the Board's ability to advocate for a Constitutional amendment would be restricted. He stated that, in his discussions with the Board, it was not "linked" that advertisements prior to the Legislative approval of the proposal would be prohibited. Senator Hoffman asked for confirmation that it was not the intent of the Board to get the public to apply pressure on the Legislature to support POMV, by running the advertisement. Mr. Bartholomew assured that the advertisement was not intended to be a tool through which to lobby or influence passage of this legislation. He assured that the Board understands that the issue must be presented in a balanced fashion. He stated that aside from working directly with the Legislature on issues, it would be "inappropriate" for the Board to indirectly lobby the Legislature. Therefore, he continued, the Board viewed the advertisement as an educational tool. Co-Chair Wilken complimented Mr. Bartholomew as being "good soldier and he was glad he worked for the people of Alaska." Senator Olson characterized the response to the advertisement questions as "somewhat confusing, at best, if not "questionable." Senator Dyson referenced the Permanent Fund Corporation's April 2004, "Percent of Market Value talking points" handout [copy on file] and stated that in the subsection titled "how does POMV provide the solution?" it is stated that, "The Fund is invested for a 5-percent real rate of return after inflation." He noted that he had previously asked regarding whether the language in Section 2(b) of the bill on page two, line two, meant that it was "indeed" going to be after inflation. (b) Appropriations from the permanent fund for a fiscal year may not exceed five percent of the average of the market values of the fund on June 30 for the first five of the six fiscal years immediately preceding that fiscal year. Senator Dyson stated that is subsequent conversations, he had been "reminded that the whole thing is a smoothing operation" in that it was a five-year average. He recalled that he had asked whether any language had been considered "that would make it clear that the five percent that we are making available for appropriation is protected against the year that we might have high inflation, and actually, in a given year might be appropriating part of the real value of the corpus." He noted that the response was to the affect "that anything that we did along that line must be carefully worded so that it was over a board period because it would vary from year to year." Therefore, he re-asked whether language could be included to clarify that in any given year, the amount being proposed would "not dip into the principal," as he stated that, in addition to preserving "the value of the principal," the people of the State must be assured that the principal would "be intact." Mr. Bartholomew replied that the issue regarding whether the POMV would allow for the expenditure of the principal or corpus of the Fund, has had a lot of discussion. He stated that it has been determined that there are two methods through which to protect against eroding the Fund. First, he communicated, the concept of the word principal is included in Constitution through the "number that is the sum of all the oil contributions, all the inflation proofing appropriations the Legislature has done, and special appropriations." This number, he specified, currently amounts to $23.5 billion, and "only goes up." He communicated that "the Legislature would not be allowed to appropriate any money that would reduce the Permanent Fund below that level." Mr. Bartholomew shared that an issue raised by the Board, regards those times when there might be short-term extreme downturns in the stock market that might reduce the value of the Fund down towards the principal level. He stated that the Board determined that in those times, "it would not be prudent for the economy" not to distribute a Permanent Fund Dividend to the citizens. Therefore, he continued, the Board proposed an endowment method of not just the principal of the fund, but of the entire fund. Therefore, he stated that in order to respond to the question of how to assure the public that the corpus of the Fund would not be attached, the House of Representatives' legislation before the Committee has adopted a statutory limitation through which the Constitution would allow a five-percent of the total market value to be spent in any one year. Senator Dyson understood that the language specifies market value as opposed to principal. Mr. Bartholomew confirmed, and stated that this would include the entire fund including the principal and the excess earnings. He stated that this currently amounts to $27.5 billion dollars. He stated that it is expected that the total rate of return would be eight-percent, including a three percent inflation factor. Therefore, he stated the real earnings of five-percent, after inflation, would be utilized over time. Mr. Bartholomew stated that in question is how to assure that public that the principal would not be spent. He stated that there is a provision in HB 298-DISTRIBUTIONS OF APPROPS FROM PERM FUND, that, states that every ten-year period would be reviewed by the Corporation to assure that the fund has earned five-percent above inflation. Were this not to occur, he continued, the spending limit would be lowered to the real rate of return. Therefore, he recommended that the expenditure not be viewed on a year to year basis "as there have definitely be years that the Permanent Fund has not make money;" however, he attested, there has never been a ten year period in which the five-percent level was not exceeded. Continuing, he stated that over the 25-year period that the Fund has existed, it has earned six-percent over inflation. He referred the Committee to a PFC graph titled "Rolling 10-year real return - Fiscal year" [copy on file]. He stated that "the Legislature has not spent anywhere near the available funds." Mr. Bartholomew stated that the statutory limitation addresses Senator Dyson's concern. He stated that were a higher rate of protection desired, a Constitutional amendment would be required as opposed to the statutory limitation. Senator Dyson understood that while appropriate inflation proofing could not occur in a year of double-digit inflation; an appropriation of up to five percent of the market value could continue to be made. Doing so, he contended, might result in a net loss of three to five percent of the Funds' market value that year. Mr. Bartholomew replied that while this is correct, what makes this "allowable and prudent" is the fact that the rate of return for fiscal year 2004, for instance, is going to exceed the rate of inflation by ten percent. He stated that adoption of the POMV would limit the expenditures to five percent of the market value, which in this case would have grown in excess of ten percent. This, he attested "would serve to carry that money forward and over time," he stated, it is "believed that the good years would outweigh the bad" years. He stated that limiting the spending in the good years to five percent by retaining those excess earnings via the implementation of a spending limit, would serve to protect the Permanent Fund. Senator B. Stevens pointed out that on the effective date of the amendment that sweeps the Earnings Reserve Account (ERA) into the Principal, as specified in Section 3 of the bill, the ERA would crease to exist. He stated that HB 298 would allow the Legislature to change the distribution of the five percent by a simple majority vote. Therefore, he declared that the concept of the distribution of the earnings "would be at the full discretion of future Legislatures, just as it is now," with the only difference being that the ERA is swept into the principal. Co-Chair Wilken asked whether this legislation would allow for an FY 05 CBR draw. Mr. Bartholomew replied that, as drafted, the POMV program would not allow for an appropriation until July 1, 2005, which would be the beginning of FY 06. Therefore, he concluded the October 2004 Permanent Fund Dividend, which would occur in FY 05, is accounted for in the FY 04 operating budget. He noted, that unless there was a need for other appropriations "as written," that would be no other appropriations from the Permanent Fund until July 1, 2005. At that time, he continued, the appropriation would be limited to five percent, were POMV enacted. Senator Bunde reiterated that there are Alaskans who are concerned that with the adoption of POMR, the Permanent Fund "would go away." He referred to the aforementioned Ten-year look back chart, and stated that while the past few years' stock market performance was dismal, the Fund still made five-percent including the recent years' worst-case scenario. Therefore, he observed that were the POMV in affect for the past ten years, the corpus would not have been used and any appropriation would have been limited to five percent. Mr. Bartholomew responded that this is correct, and were the POMV five-percent spending limitation in place for the entirety of the Fund's history, the expenditures would not have exceeded what the Fund had earned above the rate of inflation. He reiterated the importance of viewing the Fund over a ten-year period verses a year-to-year basis. He noted that HB 298 would provide "guidance to the Legislature" to reduce the five-percent Constitutional spending limit appropriation down to the real earnings level were the average earnings of the Fund to fall below that five-percent level. Senator Bunde stated that the Legislature currently appropriates between three and five million dollars of earnings, on an annual basis, from the Permanent Fund to inflation proof the account. Mr. Bartholomew agreed that the Legislature, on an annual basis, appropriates money from the Fund's earnings account into the protected principal. He stated that under POMV, the earnings would be protected by the five percent limit, but would not subject to a future appropriation. Senator Bunde stated therefore, that were the Constitutional amendment approved, the State would crease to appropriate up to five million dollars of Fund earnings each year. Mr. Bartholomew stated that is correct. He stated that POMV would eliminate the Board's current concerns regarding inflation proofing the Fund when there are other fiscal pressures such as the need to find additional funds to support such things as education and transportation. Senator Bunde pointed out that while "many people say, 'don't' spend the Permanent Fund," they do not understand that the Legislature already spends money to inflation proof the Fund and provide "for the Permanent Fund Dividend itself." He stated that using the POMV method to provide funding for State programs and Dividend checks, "would not change significantly the amount" currently being utilized from the Fund were inflation proofing factored into that amount. Senator Hoffman stated that the Legislature could assess the earnings from the ERA and "spend those dollars with a simple majority today, but we haven't." He attested that the Legislature has not done this, but has rather chosen to take "the more difficult road" of balancing the budget by accessing the CBR, which requires a three-quarter vote of the Legislature, because they are aware that spending the Fund would be perceived by the people as "tapping into… and threatening the Fund." Senator Hoffman continued that were the POMV program adopted, the Legislature could interpret it to state that the people have granted them the authority to spend the five-percent as needed. He stated that the POMV would provide no protection to the Permanent Fund Dividend. He stated the participants of the Conference of Alaskans stated they went one-step above and beyond what they were charged to do by stating that the Permanent Fun should be protected in the Constitution. Therefore, he stressed that consideration of protecting the Permanent Fund be provided were the POMV "management tool" to be adopted. Senator Bunde stated that people could protect their PFD by supporting a person to represent them in the Legislature. Co-Chair Wilken asked for clarification regarding whether the five- percent value of the fund is the value of the fund at a certain point of time over the last five-years, as specified in the bill in Section 2(b). Mr. Bartholomew responded that the applicable rules in this regard as included in statute. He stated that the value of the Permanent Fund would be determined on June 30th of each year as that is the end of each fiscal year. He stated that in order to accommodate the "ups and downs of the financial markets, it's prudent to take an average of the previous five years." Therefore, he stated that this proposal would mandate that, on June 30th, an average of the previous five-years' market value of the Fund, would be determined based upon Generally Accepted Accounting Principals. That value, he continued, would then be multiplied by five-percent in order to determine the amount that would be available. Co-Chair Wilken understood therefore that this would equate to "five June 30's divided by five." Senator Bunde moved to report the bill from Committee with individual recommendations and accompanying fiscal notes. Senator Hoffman stated that his not objecting to the motion does not mean that he supports the proposal. There being no objection, CS HJR 26(FIN) was REPORTED from Committee with $1,500 fiscal note #3, dated January 16, 2004 from the Division of Elections and new zero fiscal note #4, dated April 13, 2004 from the Department of Revenue. RECESS TO THE CALL OF THE CHAIR 10:33 AM / 5:06 PM [NOTE: Due to an audio malfunction, the adjournment of this meeting was not recorded]