Legislature(2017 - 2018)HOUSE FINANCE 519
02/08/2018 01:30 PM House FINANCE
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| Audio | Topic |
|---|---|
| Start | |
| HB142 | |
| HB213 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | HB 213 | TELECONFERENCED | |
| += | HB 142 | TELECONFERENCED | |
| + | TELECONFERENCED |
HOUSE BILL NO. 213
"An Act relating to the investment, appropriation, and
administration of the public school trust fund."
1:56:33 PM
Co-Chair Foster indicated that the committee last heard
HB 213 on January 30, 2018 at which time a committee
substitute, version R, was adopted, and public testimony
was taken. His office had received one amendment for the
bill. He asked the bill sponsor and his staff to come to
the table.
1:57:22 PM
REPRESENTATIVE JUSTIN PARISH, SPONSOR, spoke to the benefit
of the bill. The bill was a way of bringing additional
revenue to the State of Alaska through better management of
one of the state's large investment funds. The state would
be able to continue to achieve the mission of the trust -
to maintain its inflation-adjusted value and do better at
spinning off money to support public education. He had no
fundamental objections to the amendment being offered.
Representative Wilson wanted to better understand how much
money the state was making on the account based on the way
it was currently being managed, versus the amount the state
would make if it was managed in the way it was proposed in
the bill.
Representative Parish referred to a Department of Revenue
(DOR) spreadsheet "DOR 10-Year 'What if' Payout" (copy on
file). He pointed to the 3rd and 4th lines below the table
under "Notes." The status quo endowment returned a little
under 6 percent (the projection). He deferred to Mr.
Barnhill to explain further.
1:59:51 PM
MIKE BARNHILL, DEPUTY COMMISSIONER, DEPARTMENT OF REVENUE,
sent a letter to the committee, dated February 3, 2018
(copy on file). Attached to the letter were the rates of
return for the Public School Trust as of December 31, 2017.
The 1-year return was 13.79 percent; the 3-year return was
6.74 percent; the 5-year return was 7.36 percent; and the
10-year return was 6.23 percent. He would be happy to
review them to give members the historical sense of the
performance of the fund.
Mr. Barnhill continued that the primary intent of the bill,
from the department's perspective, was not to generate more
income for public schools. It was to convert the trust fund
from an old-style principle-and-income trust fund to a
modern style endowment fund. In making the change, the
purpose would evolve from protecting the principle to
protecting the inflation-adjusted value of the fund over
time. The old principle and income fund did a fine job of
protecting the inflation-adjusted value. However, he
thought the endowment approach did it more precisely. Once
the fund was converted to an endowment style trust fund,
DOR would feel comfortable changing the asset allocation.
Mr. Barnhill reported that currently DOR had roughly 55
percent invested in equities and 45 percent invested in
fixed income. He explained that because it was under the
principle and income style of accounting, the department
weighted it more heavily to fixed income in order to
generate more cash. Under the statute for the trust fund,
only cash could be expended. Once the fund was converted to
an endowment fund, the department would weight it more
heavily to equities - approximately 70 percent equities, 30
percent fixed income. The fund could be invested more
aggressively, and over time, the fund was expected to
generate more income. The reason for changing to an
endowment fund was two-fold. First, the department wanted
to protect the inflation-adjusted value of the fund over
time so that the real value of the fund would not change.
Secondly, the department wanted to prudently maximize
income to current beneficiaries. It would maintain the
fairness of the trust by providing the same benefit over
various periods of time. He referred to the concept as
"intergenerational equity."
2:02:59 PM
Representative Wilson was concerned with spending the
principle. She understood that rules disallowing dipping
into the fund were no longer in place. She wondered why
4.75 for a Percent of Market Value (POMV) was chosen rather
than 4 percent or 4.25 which would lessen the chance of
eating into the principle. Mr. Barnhill thought a review of
Amendment 1 might help answer the representative's
question. He referred to page 2 of the amendment.
Representative Guttenberg suggested that the amendment be
moved. Representative Wilson preferred to hear Mr.
Barnhill's explanation first.
Mr. Barnhill continued with his explanation. He referred to
page 2 of Amendment 1, lines 7-8. He highlighted that words
"not more than" were inserted before 4.75. Currently, the
bill read: "4.75 can be appropriated of the 5-year average
market value of the fund." He explained that by inserting
the words "not more than" it would give the department the
ability to correct its course. He suggested there might be
investment environments in which, in an effort to maintain
the inflation-adjusted value and to maximize income to
current beneficiaries, the department would want to
appropriate less that 4.75 percent. For example, the
department might recommend 4.5 percent for one year and the
wording would allow for the adjustment. From an investment
management perspective, the department was trying to
maintain the inflation-adjusted value over successive
periods of time.
Mr. Barnhill pointed to Amendment 1, page 2, lines 10-12
which eliminated the distinction between principle and
income. He acknowledged Representative Wilson's concern was
fair. In every transition from a principle and income trust
to an endowment trust, the question was always raised about
being able to protect the principle of a fund. The concern
was the principle being invaded and spent in a down market
when the trust was under water. He explained that what
modern trust law permitted trustees of endowments to do was
spend the endowment when it was under water. The notion was
about trying to balance competing concerns - protecting the
inflation-adjusted value and meeting the needs of current
beneficiaries. He reiterated that in substantial down
markets modern trust law permitted expenditures from an
underwater trust. However, the expectation was that
management would do everything possible to return the value
to the inflation-adjusted value. He clarified that the
department included the course correction language of "not
more than 4.75 percent" so that the trust administrators
could make the recommendation to appropriate something less
than 4.75 percent when the trust was underwater. He added
that the benefit to having the "not more" language was the
analysis would be made annually and would allow for course
correction.
2:07:08 PM
Representative Wilson appreciated Mr. Barnhill's comments.
She asked for further clarification regarding the 4.75
number, which she thought was a number used in general
practice. She queried the use of language that stipulated
not using any of the principle. She wanted to ensure the
health of the fund.
Mr. Barnhill thought her concern was fair. The department
called her concern, "The blow through concern." The
question was whether the department would make a
recommendation or whether the legislature would blow
through the principle. He could not offer a guarantee that
the principle would not be spent. He spoke about the
"Prudent Expenditure Rule." He explained that the experts
in trust law married a prudent expenditure rule with the
prudent investment rule. The idea was that the department
would be subjecting an expenditure to a prudency evaluation
and the fiduciary standard of care, the highest standard
under law. The department's hope was that if the
legislature embraced the endowment approach, when the
department made a recommendation to spend less than 4.75
percent and provided justifying analysis, the legislature
would respect its recommendations. He relayed that the
department would provide the factors used in its evaluation
to support spending less. He noted that if an analysis was
done pursuant to a fiduciary standard of care, the
department would be rigorous in its analysis and give the
legislature its best guess as to the prudent way to spend
from the trust.
2:10:15 PM
Vice-Chair Gara MOVED to ADOPT Amendment 1 (copy on file):
Page 1, lines 4 - 10:
Delete all material and insert:
"* Section 1. AS 3 7.10.07 1(d) is amended to
read:
(d) In exercising investment, custodial, or
depository powers or duties under this section,
the fiduciary or the fiduciary's designee is
liable for a breach of a duty that is assigned or
delegated under this section, or under AS
14.40.255, 14.40.280{c), 14.40.400(b), AS
37.10.070, AS37.14.160 [AS 37.14.l lO(c),
37.14.160], or 37.14.170. However, the fiduciary
or the designee is not liable for a breach of a
duty that has been delegated to another person if
the delegation is prudent under the applicable
standard of prudence set out in statute or if the
duty is assigned by law to another person, except
to the extent that the fiduciary or designee
(1) knowingly participates in, or knowingly
undertakes to conceal, an act or omission of
another person knowing that the act or omission
is a breach of that person's duties under this
chapter;
(2) by failure to comply with this section
in the administration of
specific responsibilities, enables another person
to commit a breach of duty; or
(3) has knowledge of a breach of duty by
another person, unless the fiduciary or designee
makes reasonable efforts under the circumstances
to remedy the breach."
Page 2, lines 3 - 4:
Delete "in separate principal and income accounts
for"
Insert "into [IN SEPARATE PRINCIPAL AND INCOME
ACCOUNTS FOR]"
Page 2, lines 5 - 6:
Delete "that distinguish between the principal
and income of the fund"
Insert "[THAT DISTINGUISH BETWEEN THE PRINCIPAL
AND INCOME OF THE FUND]1"
Page 2, line 13, following "appropriate":
Delete "AS 37.14.140 is"
Insert 11AS 37.14.110(c) and 37.14.140 are"
Representative Wilson OBJECTED for discussion.
Vice-Chair Gara spoke to the amendment. He mentioned that
he and Representative Pruitt had expressed concerns and
thought an amendment was needed for the bill. He explained
that without the amendment, if the stock market performed
poorly the fund would not generate revenue. The current
trust would spin off $25 million. The legislature would
have to come up with $25 million from another source. He
furthered that if the next year was another bad year, there
would be no money again. The prudent expenditure rule
stated that trusts were managed for the long-term. In other
words, the principle would be fully maintained over the
long-term. The point of the Public School Trust was to spin
off a consistent amount of money in a careful way.
Vice-Chair Gara spoke to the flexibility of a modern
endowment model. He also noted that the bill in its current
form tried to balance generating income while protecting
the principle. Based on a 5-year look-back and after about
10 years 2.5 percent of the principle would disappear. The
sponsor of the bill originally had a 10-year look-back
which limited revenue too much. The changes in the
amendment would facilitate spinning off roughly $8 million
in revenue and allowed the department to invest more
prudently to generate better returns over the long-term. He
thought it was a safe way of producing more revenue from
the trust fund which was the sponsor's intent along with
protecting the principle over the long-term. He invited Mr.
Barnhill to comment.
Mr. Barnhill responded that the amendment was fine. He
noted that in looking at the chart containing the various
adding methodologies ["What if Payouts] that with the 5-
year average POMV, the inflation-adjusted value at the end
of the 10-year period was less than 100 percent. At the end
of a 20-year period it remained less than 100 percent but
was incrementally better. He explained that by inserting
the "not more than" language, the department would be
required to do better by course correcting periodically in
order to stay closer to 100 percent. He added that over
long periods of time hitting 97 percent to 100 percent
would mean managers were doing a good job.
2:14:48 PM
Representative Wilson asked someone to explain Section 1 of
the amendment. Mr. Barnhill asked whether Representative
Wilson was referring to the first part of the Amendment.
Representative Wilson responded affirmatively.
Mr. Barnhill replied that the first part of the amendment,
lines 1-19, simply had conforming changes. The deleted
language included reference to AS 37.14.110(c) and
AS 37.14.160. All that was being done was conforming the
language to the amendment. The last section of the
amendment deleted AS 37.14.110(c) which was what created
the distinction between principle and income in the trust.
The bill was deleting the distinction between principle and
income or the requirement to account for it. The amendment
simply removed AS 37.14 110(c) from statue.
Representative Wilson asked for further clarification. She
thought the person that made the determination, the
commissioner, was being removed. She asked who would make
the determination. Representative Parish directed attention
to page 2, lines 9-10. The duties of the commissioner
included determining the monthly average market value of
the fund for the 5 fiscal years preceding the previous year
on July 1st of each year. There was a calculation in place.
Mr. Barnhill explained that the repeal of Section 1, lines
1-10 took place in 2 parts of the amendment: the deletion
of all material (lines 4-10) and the last part of the
amendment, the repealer. In lieu of Section 1, there was a
new conforming Section 1. Representative Wilson asked,
"Conforming to what?" Mr. Barnhill responded that it
deleted reference to AS 37.14.110(c) which was being
repealed. Representative Wilson did not understand the
amendment. She relayed her understanding of the amendment.
Vice-Chair Gara explained the lines in section 1. He
thought the amendment could have been written with more
clarity. Representative Wilson read from the amendment. She
wondered if the amendment was referring to a person.
Vice-Chair Gara responded from line 4-19 was already in
statute. The only change was the deletion of AS
37.14.110(c) which addressed the issue of whether the
principle could be tapped. The only change had to do with
the one statutory reference. Representative Wilson asked,
if the statute was kept in the bill, whether the principle
would remain untouched. Vice-Chair Gara replied that if AS
37.14.110(c)the system would remain a principle trust
instead of a prudent expenditure rule trust.
2:20:32 PM
Representative Wilson relayed she did not want to keep the
trust as a principle trust. She wanted to protect the
principle. She was fine with the changes and was glad the
"up to" language was included. She did not trust the
legislature not to use the entire 4.75 percent, as times
were unpredictable. She indicated she had seen similar
decisions made by the legislature about other funds such as
the Power Cost Equalization (PCE) fund. She wanted to make
sure that the money was protected for students. She did not
like that there was the possibility that, even after a
recommendation from the department for a smaller draw, the
legislature would take a higher amount.
Representative Wilson WITHDREW her OBJECTION.
There being NO OBJECTION, Amendment 1 was ADOPTED.
Co-Chair Foster asked Vice-Chair Gara to review the fiscal
notes.
Vice-Chair Gara indicated there were 3 fiscal notes for the
bill. The first fiscal note with an OMB component number of
2804 by DEED listed the department and the appropriation as
fund capitalization. The allocation was the public
education fund. The second fiscal note by DEED, OMB
component number 1060, listed the allocation and
appropriation as Mt. Edgecumbe Boarding School. There was a
fiscal impact of $4.6 million for operating expenditures
which was included in the governor's budget request. He
continued that the third DEED fiscal note, OMB component
number 141, had an appropriation of K-12 aid to school
districts and an allocation of foundation program. The bill
had a fiscal impact listing the governor's FY 19 request
for operating expenditures.
2:23:49 PM
AT EASE
2:24:19 PM
RECONVENED
Representative Wilson was truly concerned with the
possibility of going into the principle. Although she liked
the possibility of the fund earning more money, she was
very concerned about touching the principle. She thought
that someone from the Legislative Finance Division should
respond.
2:25:37 PM
ALEXEI PAINTER, ANALYST, LEGISLATIVE FINANCE DIVISION,
explained that by removing the distinction between
principle and income, it was possible to dip into what was
considered the principle. It was his understanding that the
addition of the words "up to" in the amendment would allow
the legislature to choose not to do so. He reconfirmed that
the legislature could dip into the current value of the
principle.
Representative Parish thought that, while the management
structure was designed to maintain the inflation-adjusted
value of the fund, having separate accounts for principle
and income did not achieve the objective. He thought, over
the long-term, the most real representation of the value of
the fund was not principle income but rather inflation-
adjusted value and being able to maximize the amount
available to public education in the current year and years
to come.
Vice-Chair Gara asked Mr. Barnhill about moving to the
Prudent Expenditure Rule. He asked, by allowing the
department to manage the fund for long-term returns,
whether the bill would have any impact on investment
returns possibly leading to better returns.
Mr. Barnhill replied that if the legislature switched to an
endowment methodology (the prudent expenditure rule) the
department would change the asset allocation from a 55/45
equity fixed income allocation to a 70/30 allocation. He
commented that over periods of time the change should
generate enhanced growth over a portfolio weighted more
heavily towards fixed income. Over specific periods of time
the equity markets were more volatile. He could not
guarantee that it would produce more income in any
particular year but thought that over longer periods it
should.
Co-Chair Seaton MOVED to report CSHB 213 (FIN) out of
Committee with individual recommendations and the
accompanying fiscal notes.
There being NO OBJECTION, it was so ordered
HB 213 was REPORTED out of committee with three "do pass"
recommendations, three "no recommendation" recommendations,
and three "amend" recommendations and with one zero fiscal
note and with two fiscal impact notes by the Department of
Education and Early Development.
Co-Chair Foster reviewed the agenda for the following day.
| Document Name | Date/Time | Subjects |
|---|---|---|
| HB 142 Testimony.pdf |
HFIN 2/8/2018 1:30:00 PM |
HB 142 |
| HB 213 Letter to House Finance Co-Chairs.pdf |
HFIN 2/8/2018 1:30:00 PM |
HB 213 |
| HB 142 Amendment #1 Foster.pdf |
HFIN 2/8/2018 1:30:00 PM |
HB 142 |
| HB 213 Letter to House Finance Co-Chairs.pdf |
HFIN 2/8/2018 1:30:00 PM |
HB 213 |
| HB 213 Amendment 1 Gara.pdf |
HFIN 2/8/2018 1:30:00 PM |
HB 213 |
| HB142 Support Document - Support Letters 2.7.18.pdf |
HFIN 2/8/2018 1:30:00 PM |
HB 142 |
| HB 213 - DOR 10yr what if payout.pdf |
HFIN 2/8/2018 1:30:00 PM |
HB 213 |
| DOR Response to Amendments to HB 213 2-14-2018.pdf |
HFIN 2/8/2018 1:30:00 PM |
HB 213 |
| HFSC Follow Up Public Libraries Receiving OWL Support in FY2018.pdf |
HFIN 2/8/2018 1:30:00 PM |
DEED Response Qs HFIN |
| HFSC Follow Up FY2018 School BAG Awards by School.pdf |
HFIN 2/8/2018 1:30:00 PM |
DEED Response Qs HFIN |
| HFSC Follow Up FY2017 E-Rate Overview.pdf |
HFIN 2/8/2018 1:30:00 PM |
DEED Response Qs HFIN |
| HFSC Follow Up FY15-FY18 Funding by District.pdf |
HFIN 2/8/2018 1:30:00 PM |
DEED Response Qs HFIN |