HOUSE FINANCE COMMITTEE May 1, 2000 10:35 A.M. TAPE HFC 00 - 140, Side 1. CALL TO ORDER Co-Chair Therriault called the House Finance Committee meeting to order at 10:35 A.M. PRESENT Co-Chair Therriault Representative Foster Co-Chair Mulder Representative Grussendorf Representative Austerman Representative Moses Representative Bunde Representative Phillips Representative J. Davies Representative Williams Representative G. Davis ALSO PRESENT Senator John Torgerson; Larry Persily, Deputy Commissioner, Department of Revenue; John Jenks, Chief Investment Officer, Department of Revenue. SUMMARY SB 312 An Act relating to the bond redemption subaccount in the earnings reserve account of the permanent fund; and providing for an effective date. HCS CS SB 312 (FIN) was reported out Committee with a "do pass" recommendation. SENATE BILL NO. 312 am An Act relating to the special subaccount in the budget reserve fund; and providing for an effective date. SENATOR JOHN TORGERSON stated that it was the intent of the Senate Finance Committee to create a subaccount in order to place $400 million dollars to invest in order to obtain a higher yield than current funds remaining in the Capital Budget Reserve (CBR). Senator Torgerson noted that in earlier discussions with the Department of Revenue, it was indicated that the CBR had netted only 1.58% after inflation. He observed that was not very high. He noted that SB 312 initially started out setting up a sub account in the Earnings Reserve Account. The yield in that account is over 10%. It was the intent that the funds would be directed toward the issuance of the repayment of any bonds or debt of the State. He pointed out that language within the proposed committee substitute does not indicate that the funds be used for debt. Senator Torgerson added that the Senate had gone through bonding packages which did not create funding mechanisms for debt reimbursements. He stated that if the money was placed into a sub-account with a higher yield, the Legislature could appropriate that money back into the general fund. Senator Torgerson requested that language be added which would stipulate that the Legislature appropriate for the debt of the State. Co-Chair Therriault referenced Page 2, Section (b), language originally linked to Senate language and the issuance of bonds. He suggested the date was no longer needed. Senator Torgerson explained that in the initial version of the General Obligation (GO) bond package with the 10% earned, that language would be required. He noted that the language would be subject to legislative appropriation every year. He did not see the need for an automatic redeposit, as it would be technically an accounting change, not a legal issue. Co-Chair Therriault advised that the concern was that if this were tied to the repayment of the debt, would there then be an arbitrage problem with the Internal Revenue Service (IRS). Senator Torgerson pointed out that he had "run the language by" the State Bond Council, who then recommended language to amend the Senate version to address that concern. He clarified that in stipulating May, there would be no arbitrage problem or other tax consequences. Senator Torgerson added that if language were added which clarifies that the Legislature "may" appropriate for debt repayment, then the Bond Counsel recommends adding the language: "For other purposes provided by law". That language would clearly stipulate that the Legislature could use the money for anything that they choose to. Representative Austerman inquired how $400 million dollars had been determined. Senator Torgerson explained that the bond package passed from the Senate was for $440 million dollars. The debt reimbursement portion of that is $38 million dollars. He compared it to the amount of return received from the investment of the Permanent Fund. Representative Grussendorf pointed out that the Senate had moved away from the General Obligation (GO) approach. He asked if that would take care of the municipal bonds dealing with harbors and schools. Senator Torgerson stated that the funds could address such concerns. He noted that there is other debt the State pays every year. He interjected that part of the plan was to use a portion of the Tobacco Settlement money to pay for some of the school projects. Senator Torgerson acknowledged that the legislation is a simple accounting mechanism. If the money were aggressively managed, he believed it would be better for the State. He pointed out that an 8% return would place an additional $25 million dollars into the State coffers. Co-Chair Mulder recommended that a sentence be dropped in order to address the arbitrage concern. He believed that the proposed language would raise a red flag. Senator Torgerson disagreed, noting that there is no one indicating that this is an arbitrage problem. He reiterated that the Stated Bond Counsel had recommended language to indicate that it be a dedicated fund. Vice Chair Bunde agreed that a higher return would bring a higher risk to the State. The Department of Revenue recommends that the money not be placed into a higher risk zone but rather remain as it is so that it will be available. He pointed out that they base that suggestion on the expertise of the State hired money managers. He pointed out that the legislation suggests that we ignore that judgement. Senator Torgerson responded that it would depend on the price of oil. He added it is "strange" that the Department would indicate that they do not want to attempt a higher return. Vice Chair Bunde argued that the money should be accessible on a short-term basis and not more aggressively managed. Senator Torgerson observed that the only "downside" would be if the price of oil went down. If the money was obligated in a long-term situation, then there could be an appropriation. Representative J. Davies suggested that the problem is that there could be a substantial risk and penalty. As employees get closer to retirement age, the advice is to move into more conservative investment strategies. The concern rests with the volatility of the market. He reiterated that there could be a "huge" loss. Representative J. Davies noted for the record that if he supports the bill, it would be because there had been long discussions in the Committee regarding the investment horizon of the CBR. He agreed that the House Finance Committee (HFC) has discussed that they would like to see a higher return on that account. If the proposed legislation is a way to single that intent, then it would be appropriate. Representative J. Davies clarified that the passage of the bill would effectively create two pieces of the CBR, a long and short-term investment. It is essential to recognize that there will be a risk if more money should be needed from the CBR. He observed that the Legislature has complete authority to spend the money in any way it wants with a _ vote. The Legislature does not need to specify the purpose. Representative Grussendorf stated that the legislation is a "statutory picket fence". He added that the Legislature would be the ones to determine if the fence is crossed or torn down. The legislation indicates to the Department of Revenue that they have the ability to invest at a higher rate. Representative G. Davis asked the constraints that would be used in order to pull the money out of the CBR account. He reiterated the volatility of the stock market at this time. Representative G. Davis stated that the legislation would be starting a new account. Co-Chair Therriault interjected that it would be a "sub-account", not a new account. Any Legislature would not be able to put constraints on the appropriation powers of the next Legislature unless through a constitutional amendment. The only restraints would be the current _ vote determination. Representative Phillips referenced Page 1, Section 3, and Page 2, Section (b). She asked if that language was acceptable with Senator Torgerson. LARRY PERSILY, DEPUTY COMMISSIONER, DEPARTMENT OF REVNEUE, noted that the Department could invest money with a target of a higher yield. It is important to remember that the higher yield creates a risk that the money would not be available and that we could loose on the investment. Cashing out equities when the market is down could cut into the principle. Mr. Persily recommended that the language in the proposed draft on Page 1, Section 1, should be in statute. The Commissioner of Department of Revenue has the fiduciary obligation established in statute and the bill should give direction in statute. He reiterated that there should not be a conflict between statute and Section 1. Mr. Persily noted that in present time, looking at the spring forecast, the Department determined that November 2004, was the date when the CBR would run dry. As explained in the spring forecast, the State needs about $300 million dollars to be available for a cash flow. If that amount was backed out, and the projected oil prices were over by $2 dollars a barrel, there could be a problem for the Department. Co-Chair Therriault inquired the cushion used by the Department before the CBR was available. Mr. Persily replied that the CBR has been available for the last 10 years. He did not know what was used before that. JOHN JENKS, CHIEF INVESTMENT OFFICIER, DEPARTMENT OF REVENUE, noted that a transition occurred in 1992, when the Statutory Budget Reserve fund was created. The CBR has been the State's "shock absorber". Mr. Jenks pointed out the time horizon and sensitivity in taking an additional more aggressive investment policy. If the State was inclined to believe that they had a long time horizon, they might invest in a policy with 60% stocks and 40% bonds. That would be a balanced long-term investment policy and could make approximately 8.25% gross expected return over a five-year period. He reiterated that would be a gross return and that policy would be substantially riskier than the shorter policy. That policy would have the possibility of about a 4% chance that at the end of five years, you loose money. Ending at 3 years, there is a 9% chance that money would be lost. He emphasized how sensitive the consequences of taking risks are. Mr. Jenks concluded that the critical nature of investing should be for the long term. Representative Austerman inquired the amount of money in the CBR at this time. Mr. Persily replied that there was about $2.6 billion dollars. Representative Austerman asked what the FY00 anticipated draw would be. Mr. Persily replied a little over $300 million dollars. Representative Austerman requested the Department to comment on the recommendation proposed by Senator Torgerson. Mr. Persily responded that it would be a policy call for the Legislature. Mr. Persily noted that the question is if the Department could take the $400 million dollars, place it into a subaccount and then make profitable investment decisions on the long-term horizon. The State Department can do what the Legislature wants; however, there will be a risk. The amount placed into that account would be a policy call. Co-Chair Mulder asked if it would be absolutely necessary to restructure the language. Mr. Persily explained that the money could be set aside. Commissioner Condon has indicated that with the language left in the intent section, it would not relieve him of his fiduciary obligation as it exists in statute. Mr. Persily emphasized that there needs to be language in legislation which clarifies that understanding. Mr. Persily added that if the Legislature decided to pass SB 312 in some form, because the management fees are higher on equities than they are on fixed income, there would be a small fiscal cost attached for the management fees. Mr. Jenks stated that the more aggressive policies have certain types of assets, where there is more reliance on the external managers. There is a small fee associated with the external managers of the equities. Senator Torgerson interjected that $400 million dollars is equivalent to only 2 months operating budget. Co-Chair Therriault stated that before the committee substitute was adopted, he would propose to delete Section Co-Chair Mulder MOVED to ADOPT the changed work draft 1- LS1627\D, Cook, 5/1/00, Cook, 5/1/00, as the version of the legislation before the Committee. There being NO OBJECTION, it was adopted. Representative J. Davies MOVED to AMEND Page 1, Line 8, delete "the" and insert "A", and Page 1, Line 9, insert the sentence from the Intent Section and then delete the remaining portion of Section 1 and renumber appropriately. Co-Chair Therriault asked if it would be appropriate to suggest the language added to Line 9, Page 1, to read: "Money in the sub account shall be invested to yield higher returns than might be feasible to obtain with other money in the budget reserve". Co-Chair Therriault noted that would be Amendment #1. There being NO OBJECTION, the change was made. Co-Chair Therriault MOVED to ADOPT Amendment #2 which would add a sentence which stipulates that the, "Interest earned on the subaccount may be appropriated for debt repayment or any other lawful purpose". He noted that the legal drafters could determine placement of that language. Representative J. Davies OBJECTED. He responded that the Legislature currently has the authority to take that action and that the language should stay as clean as possible. A roll call vote was taken on the motion. IN FAVOR: Foster, Phillips, Mulder, Therriault OPPOSED: Bunde, J. Davies, G. Davis, Grussendorf, Moses, Austerman The MOTION FAILED (4-7). Co-Chair Mulder MOVED to report HCS CS SB 312 (FIN) out of Committee. There being NO OBJECTION, it was so ordered. HCS CS SB 312 (FIN) was reported out of Committee with a "do pass" recommendation. ADJOURNMENT The meeting adjourned at 11:20 A.M. H.F.C. 7 5/01/00