SB 23-APPROP:SUPP. PAYMENTS OF PRIOR YEARS' PFD  SB 24-PFD SUPPLEMENTAL PAYMENTS  4:42:30 PM CHAIR SHOWER announced the consideration of SB 23 and SB 24, both sponsored by the Senate Rules Committee at the request of the governor. He noted that the committee members should have a report [February 16, 2019, letter to the committee from Commissioner Tangeman] that has some information relating to the permanent fund and the dividend. He said the committee was looking for a refresher on these bills before looking at the new information. He wanted the committee members familiar with the bills again because he wanted amendments to be submitted over the next week so they could get public testimony and move the bills out of committee. 4:44:01 PM BRUCE TANGEMAN, Commissioner, Department of Revenue (DOR), Anchorage, Alaska, introduced himself. BILL MILKS, Assistant Attorney General, Department of Law (DOL), Juneau, Alaska, introduced himself and said he was available to answer questions ED KING, Chief Economist, Office of Management and Budget (OMB), Juneau, Alaska, introduced himself and offered to answer questions. 4:44:26 PM COMMISSIONER TANGEMAN said SB 23 and SB 24 are being referred to as the Backpay PFD bills. The purpose is to make whole the dividend amounts from Fiscal Year (FY) 16, 17, and 18. The governor's bill proposes to pay out those amounts over the next three years. The governor views it as a three-year issue with a three-year solution. Instead of drawing the full amount down from the earnings reserve to pay back the amount, which DOR estimates to be $1.9 to $2 billion total, the proposal is to pay the full amount out over the next three years. COMMISSIONER TANGEMAN said the simple mechanics are that if someone received a dividend in FY16 and qualifies in FY19, $1,061 would be added to that person's dividend. If someone received a dividend in FY17 and qualifies in FY21, $1,289 would be added to that person's dividend. If someone received a dividend in FY18 and qualifies in FY22, $1,328 would be added to that person's dividend. The justification is that while dividends were not paid out in full over the past three years, the balance of those dividend amounts sat in the earnings reserve. That account saw a ten percent return one year and 12 percent another, so some healthy revenue was earned from the money that did sit there. Governor Dunleavy believes that money is owed to the citizens of Alaska who qualified for a dividend. Allowing it to also sit in the earnings reserve for the next three years is an opportunity to earn more revenue to defer the total cost of about $2 billion. COMMISSIONER TANGEMAN said there were several questions at the last presentation that he could walk through. He asked how the committee wanted to proceed. CHAIR SHOWER asked for the 30,000 feet view of the new information. The purpose was to get the members up to speed and review the latest numbers and any changes. COMMISSIONER TANGEMAN deferred to Mr. King. 4:47:19 PM ED KING, Chief Economist, Office of Management and Budget (OMB), said one of the first questions was how the mechanics in the changes of the fund would play out. He put together a transactional report [on page 1] showing the transfers out of the earnings reserve and the transfers into the earnings reserve as earnings are realized. The left-hand column is the status quo without SB 23 passing. The right-hand column shows the financial impacts of SB 23. He was trying to illustrate that although $2 billion will be drawn out of the account, in addition to the Percent of Market Value (POMV), income also goes into the fund. He was addressing the issue of whether there is enough money in the account to fund both general fund obligations and this proposed payback. CHAIR SHOWER said he wanted to make this crystal clear because the committee went around and around with this the last time it was brought up. This would be akin to having $20,000 in an account. Adding $4,100 brings it up to $24,100. Taking the money out for the dividend brings the account back to a little under $20,000. There was a lot of confusion because they are not just taking several billion out [of the fund]. They would not be at $16 billion or, in his example, with $16,000 in the account. The account is close to where it started because income is added and subtracted. It is close to a wash. He asked if that was an accurate description. MR. KING answered yes. CHAIR SHOWER said he wanted to keep from going as far down the spin as last time. MR. KING said the question continues on page 2 with regard to how the account balances would change over time. He's shown in a stacked bar chart the three different parts of the fund, the principal account, the earnings reserve account (which is a holding account for the earnings), and the unrealized account. That is appreciation on assets that are held by the fund, but not sold yet. The money can't be spent; it's like equity in a house. That equity doesn't sit in a checking account until someone sells the house. It shows that in either case, with or without this bill, the fund is projected to grow and remain healthy. It should not be confused with the fact, as shown on the next page, that the ERA balance is projected to decline. It should not be confused with the idea that the entire fund is in jeopardy. 4:50:31 PM SENATOR REINBOLD said it is hard for her to imagine that there is going to be growth. A lot of these are risky investments. She doesn't want a Pollyanna view, but this chart is "you are going to have your cake and eat it too" thinking. COMMISSIONER TANGEMAN said that is a good, healthy concern to have. Both the dividend calculation and POMV calculation is a five-year average. DOR used a five-year average to absorb corrections in the market. While they are not projecting a correction in the market, the assumptions by the Permanent Fund account for things like that. It is part of the Alaska Permanent Fund Corporation's estimated 6.555 percent return. There will be market corrections. That is why they are using a five-year average for both the POMV and permanent fund dividend. 4:51:46 PM CHAIR SHOWER said that on page 3, the red bar, which represents SB 23 passing, shows the ERA balance declining over time. He asked why they showed the blue bar, which represents SB 23 not passing, also going down. He thought they should be seeing an increase if SB 23 does not pass. 4:52:08 PM MR. KING said he put the other charts on page 2 to show there is a difference between the entire fund balance vs. just the ERA balance. The way that the mechanisms currently work, with POMV and inflation proofing and the Permanent Fund projections, there isn't enough earnings to satisfy all the requirements. The ERA balance is declining, even with the status quo because the principal account is growing. The money is not evaporating. It is migrating to the other account. The reason why the red bar declines more quickly is because when there is a smaller asset base, there are smaller earnings; the inflation proofing balance does not change because the principal account is the principal account, regardless, and the inflation proofing requirement doesn't change, but the POMV number does. The entire balance of the account changes with those dynamics. CHAIR SHOWER asked, when talking about the difference between the ERA to the principal balance, how that is reinvested or how that ends up back in. He asked him to describe for the folks back home why he sees that blue bar increasing. He said you did a good job explaining the Earnings Reserve Account itself and he'd like the same thing for the process with the permanent fund principal, the corpus itself. MR. KING responded that the principal account of the fund is protected by the constitution. It receives deposits of 25 percent or more of all royalties the state collects. All the earnings on that principal account flow into a holding account called the earnings reserve. When the legislature decides it wants to protect some of those earnings, they move the money into the principal account in order to protect that money from future appropriations. The statute requires a transfer of that kind to account for inflation proofing. The principal account increases because of royalties and inflation proofing. Historically, when the Earnings Reserve Account has had additional funds in it, the legislatures of the past have done special appropriations to move that money. 4:54:42 PM SENATOR MICCICHE said he heard what Mr. King is saying about assuming a 6.55 percent total return and a 6.4 percent statutory return. He asked if he injected a 2008 into his modeling, which would take some time to recover from, especially in the earnings reserve, where they had that down very close to zero, uncomfortably close to zero. He said he doesn't see that in here. MR. KING replied that it is not in here because it is portraying the average return used by the Permanent Fund Corporation to demonstrate the fund. As DOR does their Monte Carlo simulations, they look at different iterations that include these corrections. A 2008-type correction happens once every ten years or so. Then there are years of 20 percent growth. When there is volatility of negative 18 percent in one year and plus 22 percent in another year, the fund is saying in its projection, that over time it results in a 6.5 percent return. He said he'd show those iterations in Finance to show how that volatility plays out. In some situations, the permanent fund only grows with inflation and in other situations, the fund grows to over $100 billion. They don't know which world they will be living in, so they have to make a guess and play to those average. SENATOR MICCICHE said he understands and looks forward to seeing those. He has an investment account and over 40 years has seen the worst of the worst and the best of the best. Every committee that deals with SB 23 and SB 24 becomes a finance committee. Normally the committee is policy related, but it's very difficult in this case. He asked Mr. King if he could provide these charts with more granularity. CHAIR SHOWER asked him to break the charts down for the next meeting. 4:57:33 PM SENATOR REINBOLD echoed Senator Micciche's comments about the need for more granular data. She said Mr. King said this is the average return the corporation is using and she wants to know if statistically, it is based on what happened in the past, including 2008. He said they will have to guess and play to averages and she wants to know what formula he is using to guess. MR. KING replied that the corporation uses what it calls a geometric mean. It is the average of all future projected returns. The fund uses a consultant to generate those returns. The history of the fund, including the 2008 correction and the bad years in the early 2000s, is overwhelmed by the really good year. Last year's return was 10.74 percent. Some years have had a return of 22 percent. The average return of the 40-year fund history is over 9 percent. The fund is looking forward to a 6.5 percent return. The corporation is providing a number that is more conservative than the historic performance would suggest, but it probably has good reasons for doing that. MR. KING said that because of the way that interest works, a 10 percent return and a 10 percent loss are not equivalent because of the way compounding works. The arithmetic mean is also important. The corporation's 6.5 percent geometric mean works out to about a 7.65 percent arithmetic mean. When they are running simulations, they are ending up with situations with better returns that more closely relate to historic performance, with some occasional corrections. The standard deviation the corporation is using is quite wide. They are trying to pin down whether that distribution makes the most sense for running the scenarios. CHAIR SHOWER asked that since they were running out of time, was there anything else to highlight. 5:00:38 PM MR. KING replied that they appreciate that there are risks associated with the fund balance, whether they take this additional draw or not. It is an important conversation. He would like to highlight that the governor's opinion is that the money that he is talking about repaying to the people should not be in the fund at all. That is an important conversation to have at a later date. MR. KING pointed out that the bill needs a correction for the FY22 number. Where it reads 1,328, it should be 1,388. He thanked Legislative Finance for identifying that. SENATOR MICCICHE said he is looking at the reality at how they are paying bills today and how he is expecting that they will pay the bills at the end of the session. He asked if it would be helpful if he plugged in some assumptions, so they don't have to model on a wide band. If they would like to meet, he thought they could model a few specific numbers and see how that looks over time. They cannot assume what the legislature could do. He is worried about that because it would create stress on the earning reserve and potentially the corpus itself. If they got together, he might be able to help DOR streamline their work on modeling stress testing. SENATOR REINBOLD said she wanted to reiterate the need for better granular data. These charts are not working for her. They need to be historically accurate and include the POMV, including the unstructured draw with SB 23 and how they are modeling those projections. This is a sensitive issue. The people are listening. The populist view is pay them all back, everyone wants their money. They cannot get it wrong. However, it must be a permanent fund for future generations. She asked DOR to provide the committee with good data because this, along with the crime legislation, is being watched closely. 5:03:40 PM CHAIR SHOWER held SB 23 and SB 24 in committee.