Legislature(2009 - 2010)SENATE FINANCE 532
03/12/2009 09:00 AM Senate FINANCE
| Audio | Topic |
|---|---|
| Start | |
| SJR9 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| *+ | SJR 9 | TELECONFERENCED | |
| + | TELECONFERENCED |
SENATE JOINT RESOLUTION NO. 9
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 to protect the fund from
inflation and assure that the real value of the fund
will be preserved over the long term.
9:07:56 AM
DARWIN PETERSON, STAFF, CO-CHAIR BERT STEDMAN, SPONSOR,
introduced a PowerPoint presentation, "Dividend
Stabilization Plan" (Copy on File). He read from AS
37.13.020(1), defining the permanent fund as providing "a
means of conserving a portion of the state's revenue from
mineral resources to benefit all generations of Alaskans."
He pointed out that SJR 9 intends to resurrect the idea that
the fund should benefit all generations.
9:10:48 AM
Mr. Peterson turned to Slide 3, "Is the Fund broken?"
· Only part of the Fund is protected from inflation.
· The Fund's long-term investment strategy conflicts with
its realized earnings-based payout policy.
· The Fund can't assure payouts in bad years.
· The Fund can be overspent in good years.
· The size of payouts is unpredictable and unstable from
year to year.
Mr. Peterson explained that earnings are not inflation-
proofed. Only the principle of the fund is protected from
inflation by a statutory annual appropriation. Overspending
is allowed in good years; in some years up to 20 percent of
the fund has been available for appropriation. However, in
bad years there is the possibility of reduced or zero
payouts for other purposes. Payouts are based on realized
income and are incompatible with the fund's current
investments.
Mr. Peterson detailed a graph on Slide 4, "Asset allocation
over time." When the fund was created, it was invested
entirely in bonds. A payout method based on realized income
made sense at that time. Now the payout method is outdated,
because the fund is invested in stocks, real estate, and
other asset classes, in addition to bonds. The assets
increase in value as well as provide cash income. The fund's
current portfolio would be more compatible with a payout
based on the fund's market value.
Mr. Peterson emphasized the dangers of overspending (Slide
5):
· Overspending in good years means there will be no
cushion for down years.
· Overspending can decrease a fund's benefit to future
generations.
Mr. Peterson added that an annual spending limit of no more
than 5 percent of the total value of the fund would protect
the entire fund from overspending.
Mr. Peterson explained that the graph in Slide 6, "FY 2008
comparison," shows actual numbers for FY08 and compares a 5
percent spending limit with the current method of allocating
the earnings. Under the current method, 81 percent of the
fund is constitutionally protected; $7.1 billion or 19
percent in the earnings account can be appropriated by the
legislature. Under the 5 percent spending limit, 95 percent
of the fund would be constitutionally protected. The graph
illustrates the danger of being able to overspend.
9:13:04 AM
Mr. Peterson turned to Slide 7, "Payout source volatility,"
with a graph delineating the percent of change from year to
year, comparing market value with realized income. The
orange line, which is fairly static, represents the annual
market value of the whole fund. The green line is much more
erratic and represents the realized income, which is what
the fund uses to determine the dividend distribution
amounts. Under a percent of market value (POMV) dividend
stabilization plan, the line would be more static.
Mr. Peterson Slide 8, "What is the answer?"
· Changing the spending limit for the Permanent Fund to
an endowment-like payout method based on market value.
· Under the dividend stabilization plan, no more than
five percent of the Fund's market value may be
withdrawn each year.
· Under the current system, all realized earnings are
available for spending from the Fund.
Mr. Peterson added that inflation-proofing is inherent and
no longer requires an appropriation by the legislature.
Mr. Peterson explained how the dividend stabilization plan
would work (Slide 9):
· 8% is the projected average annual return on
investments.
· 3% would be retained in the fund for inflation-
proofing.
· 5% can be used by the legislature as the maximum annual
payout.
9:14:46 AM
Mr. Peterson described Slide 10, "Is it really 5%?" as
showing how the amount would be calculated under the
dividend stabilization plan. Currently, an average is taken
of the last five fiscal years. Under the stabilization plan,
the first five of the preceding six fiscal years would be
considered, allowing a one-year buffer when calculating the
average. He used hypothetical numbers as an example:
· Year 1: $30 billion value
· Year 2: $31 billion
· Year 3: $32 billion
· Year 4: $33 billion
· Year 5: $36 billion
Mr. Peterson explained that the average amount of the five
hypothetical years is $32 billion. Five percent of that
average is $1.6 billion. If the current year value of the
fund in the example is $36 billion, 5 percent is more than
$1.6 billion.
Mr. Peterson turned to Slide 11, "Who uses the payout
method?" He reported that most fund trustees and managers
around the country use a similar payout method.
· Anchorage, Fairbanks, North Slope Borough and Sitka
residents voted to limit spending based on a percent of
the market value of municipal trust accounts.
· Private foundations are required by the IRS to pay out
at least 5% of their market value.
· 83% of college and university endowments use a payout
method based on a percent of their market value.
9:16:45 AM
MIKE BURNS, EXECUTIVE DIRECTOR, ALASKA PERMANENT FUND
CORPORATION, DEPARTMENT OF REVENUE, directed attention to a
handout from the Alaska Permanent Fund Corporation (APFC),
"Financial projections FY 2009 - FY 2018" (Copy on File). He
emphasized that the projections are fluid.
Mr. Burns reported that the corporation was expecting an
approximately $967 million dividend, or about $1,512 per
person. The number is subject to change as the portfolio is
adjusted. There has also been a change in management. He
explained that when the fund is down, there are unrealized
losses; any activity realizes losses.
Mr. Burns estimated that by the fall of 2010, the dividend
number may be $561 million. He did not think the change in
subsequent years would be for the better.
9:19:51 AM
Co-Chair Stedman asked for an explanation of how built up
unrealized losses are dealt with over time. Mr. Burns
estimated that a good number is about 30 percent, realizing
around one-third of unrealized losses on an on-going basis.
However, the value of the fund changes with rebalancing and
external turnover; other flaws, such as bad managers, are
revealed when the market is down. He pointed out that
actively managed assets are being moved to passive accounts.
Mr. Burns referred to the 2/10/09 presentation by Callan
Associates. Mr. O'Leary had presented a histogram showing
that 2008 was one of the five worst years in over 200 years
of U.S. stock market performance.
9:22:01 AM
Co-Chair Stedman asked for projections for upcoming years.
Mr. Burns explained that the projections assume an 8 percent
growth rate of the fund and 20 percent asset turnover, which
could be light.
· FY2009: $967 million dividend
· FY2010: $561 million dividend
· FY2011: $188 million dividend
· FY2012: $254 million dividend
· FY2013: $79 million dividend
Mr. Burns emphasized that the projections are speculative
because of the volatility of the market. The market has only
recently begun to turn back up. The projections illustrate
the long-range effect of unrealized earnings.
Co-Chair Hoffman found the swing in dividends under the
current program staggering. In fiscal year 2013, the
dividend could be as low as $68; in 2018 it could be as high
as $1,771. Under the dividend stabilization plan the numbers
fluctuate from $779 in 2014 to $1,512 this year, or a swing
of only $373, illustrating that stabilizing the dividends
could create more consistency. He compared totals over a
longer period: in ten years under the current plan,
individuals would receive a total of a little over $9,000,
while under the stabilization plan, individuals would
receive close to $12,900. He thought if the state adopted
the dividend stabilization plan, the dividends would be
stabilized and individuals would get larger checks.
9:26:32 AM
Mr. Burns added that extreme volatility contributed to large
differences in performance. Once the negative years drop
out, even a modest up year will change the formula
dramatically.
Mr. Burns reported that the position of the permanent fund
board has been dormant. Only two members of the current
board have ever voted on the issue.
Co-Chair Stedman requested that the board study the issue
over the coming period of time and make suggestions
regarding stabilizing the fund.
Mr. Burns stated that SJR 9 would help the board become
actively involved.
9:29:40 AM
Co-Chair Stedman wanted an opinion regarding the earnings
reserve account. Since the state has the ability to
appropriate from the account, the permanent fund has been
seen in the past as a last resort for emergency
appropriations. He queried the status of the permanent fund
in the current budgetary cycle and in the near future as a
fallback fund. Mr. Burns replied that between the
anticipated 2010 dividend and the inflation-proofing
appropriation, as well as estimated adjustments to the
portfolio for the balance of the year, there would not be
much available in the fund. He thought the projected 2010
dividend was optimistic. The reserve is being used rapidly.
He could not say exactly how rapidly. The Department of Law
has interpreted the availability of the earnings reserve for
appropriation. He opined that the bulk of the reserve would
be used up.
Co-Chair Stedman asked whether there would be funds
available if there were economic challenges in two years.
Mr. Burns answered that the markets would have to
dramatically turn for the fund to grow to that extent in the
near term. He stated that the reserve would be a limited
resource in the next two years.
Co-Chair Stedman agreed that it might be optimistic to view
the permanent fund as a fallback fund in the next two years.
Mr. Burns answered that making projections requires making
assumptions. Other scenarios could be drawn. The one given
is a middle case. The board has spoken of the 5 percent
number in previous discussions of a distribution method. He
suggested the board might ask if 5 percent is a reasonable
number in light of changing capital markets.
9:34:07 AM
Co-Chair Stedman pointed out that there was more than one
issue under discussion. One issue is capping the maximum
payout; the initial draft puts the maximum at 5 percent.
Another issue is the fiscal stability of the state. At some
point there needs to be protection of the fund as a fallback
fund for the state. Mr. Burns recalled when the pension
obligation bonds were first being discussed. The issue was
extensively discussed by the rating agencies.
Co-Chair Stedman asked for the per-person dividend under the
stabilization plan. Mr. Burns replied that the number was
one-half of 5 percent distribution.
Co-Chair Stedman stated that over the period of nine years,
the total payout would be $12,009 if paying out the entire 5
percent. Mr. Burns thought the number that would be left in
an earnings reserve account was $8.721 billion.
9:37:24 AM
Co-Chair Stedman recalled discussions about the earnings
reserve as a savings account and a cushion for the state.
Co-Chair Hoffman asked if there had been discussion
regarding the permanent fund investing in energy projects
such as the bullet line. Mr. Burns responded that a bill
introduced in the House authorizes the fund to invest up to
$1 billion in in-state energy projects. The corporation has
the statutory authority to invest in in-state projects if
the projects meet the same risk reward thresholds as other
projects. He noted the legislation was not requested by the
APFC.
Co-Chair Stedman opened public testimony.
9:39:12 AM
JASON BRUNE, EXECUTIVE DIRECTOR, ALASKA RESOURCE
DEVELOPMENT COUNCIL (RDC) (testified via teleconference),
spoke in support of the legislation. He explained that RDC
is a state-wide, non-profit, membership-funded organization
founded in 1975. The membership is comprised of individuals
and companies from Alaska's oil and gas, mining, timber,
tourism, and fisheries industries, as well as Alaska Native
corporations, local communities, organized labor, and
industry support firms. The organization's purpose is to
link diverse interests together to encourage a strong,
diversified, private sector in Alaska and expand the
state's economic base through the responsible development
of natural resources. The RDC board of directors has
supported the POMV approach for some time; the board of the
permanent fund has also endorsed the concept since 2000. He
listed three resolutions to that effect by chairs in 2000,
2003, and 2004.
Mr. Brune pointed out that the POMV approach is currently
used by many large endowments and public trusts. If enacted
for the permanent fund, the approach would balance the goal
of maximizing the availability of income from the fund with
the long-term goal of protecting its value through
inflation-proofing. Ultimately, the POMV approach will
simplify how the fund is distributed, making it a lot more
understandable to Alaskans. The approach will eliminate the
confusing distinction between principal and earnings and
provide for the option of an annual distribution through
dividends, while providing a means for conserving a portion
of the state's revenues for mineral resources in order to
benefit future generations of Alaskans.
Mr. Brune explained that although RDC has historically
supported using some of the distribution of the permanent
fund to help fund state government, they support the
current approach of not tying the constitutional amendment
and the POMV concept to how the money is used, whether for
dividends, funding public services, or otherwise. He
encouraged the committee to vote for the amendment to
protect future generations.
9:42:10 AM
Co-Chair Stedman reminded listeners that the committee is
not acting on the measure but addressing potentially low
future dividends.
Senator Ellis queried the wisdom of both the permanent fund
board and the state retirement board employing the same
financial advisor, Callan Associates. He wondered if more
diversity in financial advice would be prudent.
Mr. Burns reminded the committee that Callan Associates is
also the principal investment consultant for the University
of Alaska Foundation, for the Anchorage municipality as well
as fire and police departments, and possibly for other
organizations in the state. He stated that the permanent
fund corporation has been pleased with Callan's services of
over 20 years. He agreed that the corporation could benefit
somewhat from other points of view, but he pointed out that
the business of asset allocation is very slow moving. He
thought the difference between a firm like Callan Associates
and another firm would be minimal, and that the experience
the firm had with the state was valuable.
9:46:36 AM
Senator Ellis stated that from the legislative perspective,
he did not think it wise to have only one source of
financial advice for so many funds. He did not have
confidence in the situation. He referred to the recent
merger of Callan Associates with Mercer Investment
Consulting and stressed that the state had had a bad
experience with Mercer and had sued the firm because of bad
judgment. He questioned how the merger could be good for
Alaska. Mr. Burns replied that the corporation was
comfortable with the situation. He stated that the Mercer
controversy was related to actuarial activities, which the
state does not deal with. The corporation's primary concern
is whether Callan Associates will be affected; the current
assessment is that Callan's service will not change. The
corporation will watch carefully to determine if business
methods change.
Senator Ellis asked if the corporation would put the
question of remaining with Callan before the permanent fund
board. Mr. Burns answered that the Callan contract was up
for renewal at the end of June 2009. The renewal would be
for one year. He thought the one-year renewal was the last
one. Generally the contract is brought before the board's
February meeting. The announcement about The Mercer merger
came up a few days before last month's meeting. The current
feeling among board members was to move ahead with the
renewal and see how the new relationship with Mercer
develops. He reminded the committee that all contracts can
be cancelled at will at any time.
9:50:10 AM
Senator Ellis thought the ability to cancel a contract was
to the state's advantage. He asked if anyone on the board
was alarmed by the announcement that Callan was merging with
a firm that the state had had such terrible experience with.
He recalled mistakes and bad advice from Mercer regarding
the retirement funds and the unfunded liability. Mr. Burns
answered that the issue had been discussed; the corporation
and the board are aware and would remain the vigilant. He
emphasized that Callan does not have international
consulting experience, while Mercer does. The merger will
result in the largest financial consulting firm in the
country, which could be good or bad for the state.
Co-Chair Stedman echoed concerns that the state had one
advisor for both the retirement funds and permanent fund.
Senator Olson asked if the permanent fund board or
corporation had ever cancelled a contract because of poor
performance. Mr. Burns answered contracts with investment
managers had been cancelled. He stated that underperformance
is not usually the issue. He described a "lift-out"
situation, where a firm will lose an entire team of people,
which affects established relationships.
Senator Olson voiced grave concerns regarding the merger of
Callan and Mercer.
9:53:53 AM
Senator Thomas echoed the concerns of other committee
members. He understood remaining with a company because of
on-going relationships. Mr. Burns assured the committee that
the situation would be carefully monitored.
SJR 9 was HEARD and HELD in Committee for further
consideration.
9:56:04 AM
| Document Name | Date/Time | Subjects |
|---|---|---|
| 5% matrix.pdf |
SFIN 3/12/2009 9:00:00 AM |
SJR 9 |
| 2009_03_payout slides.ppt |
SFIN 3/12/2009 9:00:00 AM |
SJR 9 |
| POMV 5% SJR9 2009-02-26 (2).pdf |
SFIN 3/12/2009 9:00:00 AM |
SJR 9 |
| SJR009-OOG-DOE-3-3-09.pdf |
SFIN 3/12/2009 9:00:00 AM |
SJR 9 |
| Sponsor Statement.doc |
SFIN 3/12/2009 9:00:00 AM |
SJR 9 |