SENATE BILL NO. 21 "An Act relating to appropriations from the income of the Alaska permanent fund; relating to the calculation of permanent fund dividends; and providing for an effective date." 9:46:24 AM SENATOR BERT STEDMAN, SPONSOR, introduced himself and stated he would be presenting a bill he was very proud of. He asked for the committee's support. He thought the committee would observe that there had been no other bill on the topic of the Permanent Fund with the same unique aspects. He relayed that he would be giving a short presentation, after which he would invite Legislative Finance Division (LFD) staff to display some different data inputs to further illustrate the provisions of the bill. He stated that the bill had a basic structure and was a starting point. He emphasized that the bill was not an all- inclusive solution, and did not endeavor to solve the fiscal gap. Senator Stedman thought that members could recognize that forecasts were not correct and with luck could provide direction and magnitude. He referenced the pension obligations of the state, and the recession of 2008-2009 as examples. He noted that the focus of the bill was much shorter; and was a different way of approaching the fiscal issue at hand, rather than looking at filling the deficit as quickly as possible. Senator Stedman remarked that the state was very fortunate to have a large savings account in the Permanent Fund. He thought that it was important to take affirmative action to protect the fund for future generations. He stated that the approach of the bill considered what the Permanent Fund could reasonably do to aid in the problem of the deficit, and how to eliminate the structural deficit. 9:50:13 AM Senator Stedman discussed the presentation, "SB 21 (2017) "'GUARD and GROW' THE ALASKA PERMANENT FUND," (copy on file). He showed slide 2: Issue: Structuring the Permanent Fund to Guard It from Being Raided. Opportunity: Build a New Fiscal Framework • Continues the Proper Management of the Fund, • Provides a Fair Dividend, • Allows for Transfers Back to Principle of Fund, and • Limits Use For Public Services. Senator Stedman commented that the Permanent Fund was a sensitive subject; and thought the risk to the fund lie with the legislature that had the power of appropriation to destroy, hinder, protect or build the fund. He commented onthe cartoon depicted on the slide, which depicted the legislature as a wolf that would devour the earnings capability and erode the purchasing power of the fund (or not). He commented on the successful track record of the Permanent Fund, and posited that the bill would leave the important pieces intact. Senator Stedman noted that the people of the state owned the subsurface rights, unlike other states. He made a special note that there were multiple generations represented at the table. He emphasized that future Alaskans had just as much right to the Permanent Fund as people already in the state. 9:54:15 AM Senator Stedman stated that the bill would allow fair dividends to the owners of the resource. The bill would also allow (in the case of additional income) back to the Permanent Fund for future growth, to be added back to the dividend, or used for public services. He thought everyone recognized that it was not possible to solve the fiscal problem without the help of the Permanent Fund. He thought that looking forward to increased oil production, the state would be in the position to add money back to help the Permanent Fund grow at a faster rate. Senator Stedman discussed slide 3, "CURRENT PRINCIPLES FOR THE PERMANENT FUND": · A "Permanent" Savings Account: The fund should conserve part of the state's revenue from resources to benefit all generations. AS 37.13.020(1) · The Fund's Principle Should Be Protected While Prudently Invested The fund should be managed to protect the principal while maximizing total return. AS 37.13.020(2) · The Fund's Purchasing Power Over Time Should Be Preserved While Maximizing Return AS 37.13.120(a) Senator Steadman discussed the history of the Permanent Fund. He cautioned against discussing the concept of an "average dividend," which was contingent upon the size of the fund. Senator Stedman showed slide 4, "CURRENT PRINCIPLES WORK - 8.66% ANNUALIZED RETURNS FOR LAST 32.5 YEARS ($734,000 IN 1977 TO $57,304,500,000 2/21/17)," which showed a bar graph entitled 'Fund's Long-Term Investment Performance." He reiterated that the bill would not solve the state's entire fiscal problem. He thought the safety of the fund should come before solving the state's fiscal problem. 9:58:04 AM Senator Stedman showed slide 5, "SB 21 (2017) PROTECTS THE PERMANENT FUND UNDER CURRENT PRINCIPLES: INVEST PRUDENTLY, PROVIDES A FAIR DIVIDEND, ALLOWS FOR REINVESTMENT, AND LIMITS THE AMOUNT FOR GOVERNMENT!": · Sets up a 4.5% payout based on a rolling 5 year average. (Uses first 5 of the last 6 fiscal years) · Splits the 4.5% payout and sets a minimum 2.25% allocation for dividends · The remaining 2.25% of the payout can be allocated towards increased dividends, returned to the permanent fund for investment, or to the general fund for state services. · Sets a maximum of 2.25% on the amount of the payout that can be used for government services. Senator Stedman reiterated that the bill was not a holy grail of bill solutions, and was targeted to protect the Permanent Fund. He discussed the closures of pulp mills and saw mills in Sitka, Wrangell, and Ketchikan. He recounted that at the time of the closure Sitka had a fund that was all bonds. In the late 1980s he had a discussion with the administrator in city hall about converting the fund to a balanced approach of stocks and bonds with a POMV. The community had converted the fund to a POMV with a payout rate of 6 percent, and the configuration had been running for over 20 years. He drew parallels between the generations of Sitkans that had an interest in Sitka's fund and the many generations of Alaskans who deserved benefits from the Permanent Fund. He stated that the city was considering lowering the payout rate of the fund. Senator Stedman continued discussing the fund of the city of Sitka, which had experienced a slight erosion of purchasing power over the previous two decades. He thought the bill was not dissimilar to how the community of Sitka had dealt with its fiscal impact. He stated that the bill was set with a 4.5 percent payout and had a smoothing mechanism much like the other bills of the same topic. He thought it was wrong to set the payout by considering the size of the deficit rather than what could be borne by the fund portfolio. He hoped to engage in discussion about the 4.5 percent rate of payout and examine stress points. He considered that a 6 percent payout would erode future purchasing power over time. 10:03:15 AM Senator von Imhof looked at slide 5, and addressed the last bullet point, which showed a maximum of 2.25 percent for the amount the payout could be used for government services. She noted that the bullet above showed there was flexibility for the 2.25 percent portion that could be used for dividends, returning to the fund, or for state services. She wondered how to reconcile the extra flexibility with the language in the bill that had a maximum payout for government services. Senator stated that the 4.5 percent payout was split with one half for dividends (for the owners of the asset); and the state had the ability to use one half of the payout rate to help with the state's fiscal situation. He explained that if there were strong fiscal returns, the remaining 2.25 percent could be used in the ways illustrated on the slide. He argued that the best course of action would be to put the funds back to the corpus of the fund for future generations. Sentator Stedman thought that if there was less than a 50 percent split to the public, it would erode public support. He thought going above 50 percent for the dividend would be a fiscal strain. He observed that taking the entire 4.5 percent of the draw would solve the fiscal problem, but would create a political problem. If the entire payout went to dividends, the state would not be able to fix the deficit. He thought a balance was necessary, and noted that the bill was not prescriptive with regard to dispersal of the payout. He thought it was important to give policy- makers the ability to make the necessary decisions to increase the dividend or route the funds back to the Permanent Fund. He thought that the provision, in combination with a spending limit that had been discussed, was an attractive solution to help control government. 10:06:55 AM Senator Stedman showed slide 6, "SB 21 (2017) - PROJECTED 4.5% DRAW, DIVIDEND AMOUNTS, AND OTHER FUNDS," which showed a table. He pointed out that the dividend amount for 2018 would be roughly $1700 (for approximately 650,000 dividends) under the proposed plan in the bill. He thought some might consider it to be an excessively large dividend; and reminded that the size of the dividend was dependent upon the size of the Permanent Fund. He thought flexibility would be needed from the public to solve the fiscal crisis. He wanted to see the payout set at 50/50, which could be adjusted up or down if the need arose. In using the two combinations, in conjunction with spending restraints and possible revenue enhancements, it was possible to eliminate the structural deficit without hindering the earnings capability of the Permanent Fund in perpetuity. 10:09:23 AM Senator Stedman turned to slide 7, "SB 21 (2017) - SAFEGUARDS THE FUND SO IT CAN GROW AND LAST FOR GENERATIONS": · SB 21 (2017) is not intended to fill the entire fiscal gap. It's primary focus is guarding the permanent fund so it can grow for future generations while keeping downward pressure on government spending. · Other pieces that address the fiscal gap, like budget reductions, efficiencies, and revenue enhancements may be bolted onto the fiscal framework in the near future. Senator Stedman reiterated that SB 21 was straightforward and simple. He commented that the bill had taken two months to draft, as earlier versions had been too complicated. He thought that the public would be in support if the changes to the Permanent Fund were transparent. He commented that the primary goal of the bill was to protect the Permanent Fund for future generations of Alaskans. He thought it was possible for the current generation to address the problems. Senator Stedman thought the politics of the bill might beg the question as to why there was a statutory change rather than a constitutional amendment. He thought the bill would show that the POMV worked, and enshrine it in the constitution with a requirement for public support. He did not think there was sufficient time for a constitutional amendment. He asked the committee to look at the statutory framework for a POMV, and work with the levers to payout the dividend split for two years, ending with a 50-50 split. He wanted to confine the ERA and require the legislature to deal with the issue of the deficit. 10:13:38 AM Co-Chair Hoffman thought the people of Alaska were looking toward the legislature to come up with financial solutions to address the deficit. He stated that SB 70 accomplished the task in the out years. He thought the dilemma was how to address the deficit, while Senator Stedman was addressing how to protect the Permanent Fund and the dividend. He thought the dividend was protected by SB 70. He thought that Senator Stedman asserted there could be some form of SB 70 for ten years, during which the dividend would be static. He wondered if Senator Stedman had considered how such a change might work towards a fiscal solution. Senator Stedman commented that the members in the Senate did not always agree. He did not necessarily agree that it was fair to the people of Alaska to use the average to conclude a dividend rate. He thought the dividend outflow should be tied to the size of the fund. 10:16:51 AM Senator Stedman addressed Co-Chair Hoffman's question regarding freezing the dividend for ten years. He noted that there would be five different legislative groups over the period of time being discussed, with varied agendas and opinions. His thought that the problem could be fixed at a more rapid rate. He thought the focus should be on solutions for the next three to five years. He commented on the unpredictability of fiscal projections, and used the example of the state retirement system. Co-Chair MacKinnon asked if the legislature had statutorily contributed about $24 billion of additional funds to the Permanent Fund. Senator Stedman was not aware of the precise amount that had been contributed, but he knew that from time to time the legislature had appropriated earnings reserves to protect the corpus of the Permanent Fund. He emphasized that he would be shocked if the legislature let the ERA continually grow. He had seen projections in which the ERA was $20 billion to $30 billion. Co-Chair MacKinnon stated that the legislature had contributed $17 billion and inflation proofing. Co-Chair MacKinnon asked if Senator Stedman was prepared to give an overview of the bill. Senator Stedman stated that there was only one paragraph in the bill. Co-Chair MacKinnon observed that the bill was three pages. 10:19:58 AM Senator Stedman read from the Sectional Analysis (copy on file): SECTION 1 Deletes language from AS 37.13.140 related to income available for distribution. SECTION 2 Deletes references in AS 37.13.145(d) to AS 37.13.145(b) and (c), which are repealed by section 5. SECTION 3 Adds a new subsection to AS 37.13.145 that authorizes the legislature use 4.5% of the average fiscal-year- end market value of the balance of the fund for the first five of the last six fiscal years, including any unrealized gains and losses. The legislature must allocate a minimum of 2.25% for dividends. The other 2.25% of the payout can be appropriated towards increased dividends, reinvested into the Permanent Fund, or to the General Fund for public services. A maximum of 2.25% can be used for public services. SECTION 4 Makes conforming amendment to AS 43.23.025(a) to change a reference from AS 37.13.145(b) to AS 37.13.145(e)(1). SECTION 5 Repeals AS 37.13.145(b) and AS 37.13.145(c). SECTION 6 Provides an effective date of July 1, 2017. Senator Stedman added that the bill was structurally so basic that implementation would necessitate additions for several items. 10:21:53 AM AT EASE 10:23:46 AM RECONVENED Senator Stedman wanted to review interactive scenarios with the assistance of LFD to illustrate the dynamics of SB 21. He wanted to change variables and discuss deficit issues. He addressed the spreadsheet "LFD Fiscal Model," which was previously used in committee to discuss SB 70 [copy on file under Senate Finance meeting 2/27/17]. Co-Chair MacKinnon commented that the committee had previously modelled and tested fiscal plans through an interactive graph from LFD. When reviewing different bills and fiscal models, the committee first considered the Undesignated General Fund (UGF). She referred to Designated General Funds (DGF), and used the example of University receipts and tuition, which were designated to go back to the University. The committee would not want to hamper the University from being able to take care of itself through revenues of its own. She used the example the Department of Fish and Game's designated funds that went toward managing resources. She discussed federal funds and perceived budget growth. She relayed that the state had used limited UGF dollars to leverage as many federal dollars as possible to fight the recession. 10:26:22 AM Co-Chair MacKinnon detailed that the previous year's capital budget had approximately $115 million to $117 million used to leverage approximately $1 billion in federal funds to invest across the state to care for ports, roads, and airports. She looked at the graph on the top left of the fiscal model and pointed out that the blue represented projected revenue from FY 16 to FY 26, and the green represented anticipated draws from state savings. She noted that the orange color on the graph denoted a CBR draw, or a Statutory Budget Reserve (SBR) draw. She specified that there was approximately $288 million remaining in the SBR. The red on the chart represented unanticipated draws. If the ERA was depleted (where the current dividend calculation was from) the dividend would be at risk. She communicated that when the committee considered the dividend it had to consider it in balance with funding services provided to communities. Co-Chair MacKinnon recalled that the Senate Labor and Commerce Committee had reviewed economic research that alledged one in three dollars in local spending came from the state. She observed that under SB 21, state reserves were moving in a downward pattern. She reiterated that Senator Stedman's plan was not to close the fiscal gap but rather protect the corpus of the Permanent Fund and the dividend. She noted that there were two additional graphs on the model pertaining to the Permanent Fund, and there was a table depicting payout dollars as well as fund growth. In the middle of the fiscal model there was a table of scenarios and assumptions being considered. She reviewed the assumptions considered by the provisions of SB 21. 10:29:42 AM Senator Stedman directed attention to the graph on the upper left, "UGF Revenue/Budget," and thought it demonstrated that the state would be using the ERA, which he thought was indicative of a structural deficit. He reviewed the lower left-hand graph "Budget Reserves," and observed the diminishment of the SBR and the CBR. He argued that the Permanent Fund could produce revenues of 4.5 percent annually, which would not solve the fiscal problem. He thought additional measures were needed. Senator Stedman changed variable assumptions on the fiscal model, including a POMV payout of 4.75 percent, and observed that with the structural deficit appeared again in 2023. He discussed different payout rates and considered the lower right-hand graph, which showed the payout for dividends. He thought there would need to be discussion with the public. He considered the fiscal model with a combination of $300 million in reductions and tax changes; and observed the CBR extending to 2025. He thought it was important to continually work so that the structural deficit would not re-appear in the future. Senator Stedman emphasized that the Permanent FUnd could aid in getting out of the budget deficit. He thought that if the public gave the legislature some flexibility, it could be done with minimum disruption. He thought it was possible to do more revenue enhancements, but that it would necessitate political discussion. He considered options such as flattening the dividend for four years or six years. He stressed that the Permanent Fund should not be subordinate to the budget deficit. 10:34:59 AM Senator von Imhof referred to the rate of Permanent Fund investment return. She pointed out that there were two funds (the ERA and the corpus of the fund), which had been invested in the same manner. She thought it was arguable that if the state started taking predictable draws from the ERA, its investment mix would need to be reviewed. She observed that the CBR growth earnings were 2.89 percent, and reminded that the CBR had to be kept relatively liquid to enable access to the funds. She thought it was arguable that the ERA as well had to be kept more liquid. She thought increased liquidity would not enable the ERA to reach the proposed 6.95 percent rate of return. She asked if the sponsor could look at the fiscal model with a 6.25 percent rate of return for the Permanent Fund. Senator Stedman thought Senator von Imhof had made a good point. He remarked at the diminishment of the CBR. He noted that the model did not take into account a constitutional amendment for a POMV, and a shutdown of the ERA. He reminded that the fiscal model was not all-encompassing, but would provide an idea of magnitude when considering some of the fiscal provisions being proposed. He added that the bill would not require a structural change to the permanent fund, but would try to keep the legislature out of the ERA so that the Permanent Fund would not have to diminish its risk tolerances. 10:37:40 AM Senator von Imhof observed that with the change to the fiscal model, it was possible to see the CBR maintain its value over time, even when the Permanent Fund returns were slightly less. Senator Micciche asked if the model was flat. ALEXEI PAINTER, ANALYST, LEGISLATIVE FINANCE DIVISION, explained that the model currently showed a flat budget, but could be changed to show other scenarios. Senator Micciche commented that all the changes made to the fiscal model moved the bill closer to SB 70 and SB 26. He discussed modelling various assumptions for SB 70, and the effect on the state reserves. He thought all the proposed plans ensured the health of the corpus of the Permanent Fund. He pointed out that some plans preserved savings in perpetuity. He considered that SB 70 (as opposed to SB 21) allowed response time if there was a dramatic increase or decrease in the price of oil in accordance with the fall revenue forecast. He was uncomfortable with the amount of reserves, and thought that SB 21 did not have a structural comprehensive solution that provided a level of comfort; and thought the state would quickly need to look at either dramatic cuts or new revenue measures. He wondered how the sponsor felt about the health of the state's reserves. 10:42:19 AM Senator Stedman strongly disagreed with Senator Micciche, and thought the other plans put too much reliance and pressure on the Permanent Fund. He noted that SB 70 would take $4.9 billion from the ERA. He discussed other bills and provisions to take funds from the ERA. He thought it was unsustainable to rely overmuch on the portfolio. He thought the Permanent Fund should be isolated before the legislature dealt with other fiscal issues. He was concerned that the easiest of all the legislative options would be to loot the Permanent Fund. He thought there was a management problem when 9 percent of the fund was taken out in one year. He agreed that SB 21 left more work to do in the future. He was adamantly opposed to taking out billions from the Permanent Fund just because the legislature could not make hard decisions as a group. Senator Micciche pointed out that experts from the Permanent Fund had testified in committee to ensure that the payout of 5.25 percent did not compromise the corpus or health of the fund. He agreed that it was not acceptable to risk the corpus of the fund, but thought that experts had concurred that an effective draw rate of 4.56 percent draw rate the following year was extremely unlikely to find a failure rate over time. He thought Senator Stedman might be more conservative in his analysis. Senator Stedman commented that the current year's dividend in combination with draws from the ERA was significant. He informed that the 4.5 percent in the bill was coincidentally at the same rate that Callan and Associates had considered a reasonable draw rate. He urged members to look at the numbers and consider what was sustainable for the Permanent Fund. He thought there was a better solution that included action to isolate the Permanent Fund. He stated that he would support SB 21 as a draft for the committee to consider changes. SB 21 was HEARD and HELD in committee for further consideration. Co-Chair MacKinnon discussed the agenda for later in the day.