Legislature(1999 - 2000)
02/02/1999 03:32 PM Senate STA
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* first hearing in first committee of referral
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= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
SB 43-APPROP: EARNINGS RESERVE TO PERM FUND
MARK HODGINS, staff to Senator Ward, sponsor of SB 43, explained SB
43 will transfer an amount, equal to the unappropriated balance of
the Earnings Reserve Account on June 30, 1999, into the principal
of the Permanent Fund.
Number 162
JIM KELLY, Director of Communications for the Alaska Permanent Fund
Corporation (APFC), made the following comments. SB 43 would
appropriate the funds in the Earnings Reserve, less the dividend
and inflation proofing costs, into the principal of the Permanent
Fund. SB 43 is similar to past legislation except that the
Government Accounting Standards Board (GASB) has adopted Rule 31
which changes the accounting standards applied to the Permanent
Fund. The 6/30/98 annual balance sheet for the Permanent Fund was
calculated using GASB Rule 31. That rule requires both unrealized
and realized gains be considered as income. By including the
unrealized gains, the total Earnings Reserve amount is probably
higher than the amount the Legislature expects to appropriate. MR.
KELLY explained in the past the balance sheet total did not include
unrealized earnings, but GASB Rule 31 requires the APFC to mark its
funds to market.
VICE-CHAIR GREEN asked what the difference was under the previous
accounting system.
MR. KELLY replied if one looked at the regular projection sheet,
the Earnings Reserve for the year ending June 30, 1999, will be
about $2.7 billion. The dividends, based on the statutory formula,
will reduce that amount by $989 million. Inflation proofing,
calculated at 1.54 percent, will reduce it further by $287 million,
leaving $695 million in current year income to add to the Earnings
Reserve balance. The 1998 cash balance in the Earnings Reserve was
about $1.4 billion; the $695 million will increase the cash balance
to $2.084 billion. In addition, the Earnings Reserve contains an
unrealized cash balance of $3.8 billion. It is unclear whether SB
43 would appropriate $2.084 billion or $5.8 billion according to
GASB Rule 31. The APFC has contracted with a legal firm to review
the GASB ruling and Alaska statutes to provide an opinion on what
"earnings reserves" means.
Number 222
SENATOR PHILLIPS noted that his staff contacted Mr. Kelly's office
in early January and was told the projected amount for 6/30/99 was
$1.9 billion, after inflation proofing and dividend costs were
deducted. He questioned why the projection is now over $2 billion.
MR. KELLY replied his office was probably basing the earlier
projection on the September quarterly report; the latest projection
was based on the December quarterly report which wasn't available
in early January.
SENATOR MACKIE asked Mr. Kelly if he thought SB 43, as written,
will appropriate the entire $5.8 billion.
MR. KELLY said SB 43 could be interpreted to do so.
SENATOR MACKIE asked what the projection for the excess interest
earnings is this year.
Number 253
MR. KELLY replied $695 million will be left after dividend and
inflation proofing costs are deducted.
SENATOR ELTON pointed out SB 43 does not mention inflation proofing
and asked if that omission will cause a problem.
MR. KELLY answered that the same dollars would be put into the
Permanent Fund, but not specifically into the inflation proofing
segment. The effect, in terms of dollars, would be the same, but
the explanation will be more complicated.
SENATOR ELTON suggested that the sponsor be informed.
Number 267
ROSS KINNEY, Deputy Commissioner of the Department of Revenue, gave
the following testimony. He echoed Mr. Kelly's statement that GASB
promulgates regulations, and in order to get a "clean" opinion from
the auditing firm that audits the Permanent Fund records, GASB
guidelines must be adhered to. GASB Rule 31 is unclear, for
accounting purposes, about how the Permanent Fund income is
recognized. A firm decision needs to be made as to whether the
unrealized gains and losses should actually be added to the corpus
of the fund.
MR. KINNEY stated that during the last few weeks, a tremendous
amount of discussion has occurred about Governor Knowles' long
range fiscal plan. The plan proposes that approximately $4 billion
be transferred from the Earnings Reserve to the Constitutional
Budget Reserve (CBR). If SB 43 is enacted as written, that
transfer could not occur. Additionally, the Legislature could not
appropriate funds from the Earnings Reserve for any other purpose
it desires. Once that appropriation is made it cannot be touched
because the principal of the Permanent Fund is constitutionally
protected. The principal of the Permanent Fund can be increased in
three ways: through dedicated oil revenues; through the
appropriation of Earnings Reserve or general funds; and through
inflation proofing, which has occurred on an annual basis.
MR. KINNEY cautioned that one risk the Legislature could incur, if
it appropriates the full amount of the Earnings Reserve to the
corpus of the Permanent Fund, is that Alaska could find itself in
a position where it cannot pay out the total dividend entitlement
if it is calculated using the traditional 5 year average and 10+
percent. The state might only be able to pay a dividend amount
based on 50 percent of the amount in the Earnings Reserve. That
situation could occur if a major market correction took place along
with high inflation. The state has never come up against the
Earnings Reserve limitation for dividend calculations, but it is
not out of the question. Also, the Earnings Reserve limitation
comes into play in years 2, 3, and 4, in the Governor's long range
plan. At this point in time, the Administration does not support
SB 43, pending a thorough review of the Governor's long range plan.
VICE-CHAIR GREEN asked for clarification of the GASB changes.
MR. KINNEY said the change was to a definition. Alaska statutory
language related to the Permanent Fund defines income as interest,
dividends, and realized gains. Up until 1997, GASB accepted that
definition. However, as the result of the Orange County situation
and other factors, the term "mark to market" has come into play.
That term means that all financial statements require that the
value of assets held have current market values placed upon them
based on current market conditions. That changes the definition of
income to interest, dividends, realized gains, and unrealized gains
and losses. That definition results in an income increase of $4
billion in the Earnings Reserve as compared to the statutory
definition, which does not include unrealized gains. The statutory
definition is used to calculate the dividend because APFC does not
want to pay a dividend based on unrealized gains.
VICE-CHAIR GREEN asked for an example of an unrealized gain.
MR. KINNEY explained that if a person bought Microsoft stock at $50
per share and that stock increased to $100 per share, the
unrealized gain would amount to the $50 increase. If the stock was
sold for $100 per share, you would realize a $50 gain. For
dividend calculations, that $50 gain is only recognized when the
stock is sold. Under GASB's definition, the $50 unrealized paper
gain must be recognized as income even though the stock has not
been sold. He noted all income from the Permanent Fund goes into
the Earnings Reserve. Mr. Kelly's financial statements now show a
fourth income component: unrealized gains and losses. That is
where the question comes into play. APFC does not know what the
interpretation for the Earnings Reserve amount under SB 43 would
be.
VICE-CHAIR GREEN asked if the bill could be crafted to exclude
unrealized gains.
MR. KINNEY replied that is the question the APFC has posed to its
legal counsel.
SENATOR MACKIE maintained an amendment could be offered during the
budget process to appropriate a specific amount of dollars to the
corpus.
MR. KINNEY stated there is no difference as to whether the money is
in the Permanent Fund corpus or in the Earnings Reserve from a
dividend calculation standpoint. The only difference is that the
corpus of the Permanent Fund is not inflation proofed for the
amount that sits in the Earnings Reserve but it is still added
together when looking at the total assets of the Permanent Fund.
SENATOR PHILLIPS asked how the $2 billion in the excess earnings
reserve is being invested.
MR. KELLY replied for investment purposes, all of the money is co-
mingled; he could not determine which investments were from the
principal and which were from the Earnings Reserve.
SENATOR MACKIE asked if it is earning at the same rate as the
Permanent Fund.
MR. KELLY said that it is.
SENATOR PHILLIPS asked if the CBR is being invested using the same
principles as the Permanent Fund.
MR. KELLY replied this year the Permanent Fund is earning about an
8.83 percent total rate of return, a little higher than the CBR.
VICE-CHAIR announced SB 43 would be held in committee for
consideration at a later date.
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