Legislature(2001 - 2002)

04/26/2001 03:40 PM STA

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
                 SJR 13-CONST. AM: PERMANENT FUND                                                                           
CLARK GRUENING, Alaska  Permanent Fund Board of Trustees Chair, gave                                                            
the following testimony in support of SJR 13.                                                                                   
For the  last five  years,  the board  of trustees  has discussed  a                                                            
notion  referred to  as a  pay out of  market  value, the  endowment                                                            
model and what  could be done to strengthen inflation  proofing. The                                                            
current  inflation  proofing was  passed into  statute  in 1982  and                                                            
implemented in 1983.                                                                                                            
There is no  investment that can be  identified as principal  in the                                                            
Permanent  Fund, it's  a notional concept  and it  is a figure  that                                                            
does not fluctuate with the market. MR. GRUENING said,                                                                          
     It is simply the amount  of oil revenues that are mandated                                                                 
     by  the constitution  plus, what I  would call, voluntary                                                                  
     either  additional contributions  under  the formula  that                                                                 
     takes  it out  of our  mineral wealth  or by  the statute                                                                  
     itself  that  calls for  an  appropriation  and voluntary                                                                  
     additional      appropriations.       Those     voluntary                                                                  
     appropriations,  both  inflation proofing  and additional                                                                  
     appropriations  to principal,  have totaled a little  over                                                                 
     $13 billion.                                                                                                               
We are now approaching  a time in which the fund may  be asked to do                                                            
more than  it is now  so you must  be clear  on the priorities.  The                                                            
trustees feel strongly  that the fund is permanent and an inflation-                                                            
proofing proposal that  establishes it in the constitution using the                                                            
endowment model  that has a payout  limit is the most effective  way                                                            
to inflation-proof the entire fund.                                                                                             
It's a simple concept but  it raises many questions about the impact                                                            
it may have on  statutes. The trustees believe the  amendment itself                                                            
requires no statutory change.  This does not mandate a payout; it is                                                            
a payout limit.                                                                                                                 
CHAIRMAN THERRIAULT said  they had received a memo from Tamara Cook,                                                            
Director of Legislative  Legal & Research Services, with a number of                                                            
questions.  If  they  weren't  answered  during the  course  of  the                                                            
presentation they would address them afterwards.                                                                                
JIM KELLY, Director of  Communications for the Alaska Permanent Fund                                                            
Corporation gave the following power point presentation.                                                                        
SJR 13 accomplishes inflation proofing by limiting the annual                                                                   
payout of fund income to no more than 5 percent of the fund's five-                                                             
year average market value. They think it accomplishes three things:                                                             
       1. It protects the purchasing power of the entire fund.                                                                  
       2. It provides the maximum amount of sustainable income to                                                               
         benefit the current and future generations.                                                                            
       3. It minimizes fluctuations in annual payouts.                                                                          
If the legislature  approves SJR 13, the general public  approves it                                                            
in the general election  of November 2002 and it goes into effect in                                                            
February 2003.   Over time, the fund  will have retained  everything                                                            
it needs  to be protected  against inflation  while the rest  of the                                                            
income would be available for the legislature to use.                                                                           
The benefits                                                                                                                  
   1. SJR 13 provides constitutional protection, which is different                                                             
     than the  existing inflation  proofing and therefore  enhanced.                                                            
     Although the legislature  has done very well during the last 18                                                            
     years,  this is  better because  it's in  the constitution  and                                                            
     ensures that it will go on if things change in the future.                                                                 
   2. It maximizes the total amount of fund income which can be paid                                                            
     out  in the  future and  does  so in  a way  that balances  the                                                            
     fund's benefits fairly  between current and future generations.                                                            
   3. It increases the likelihood that both the fund's principal and                                                            
     income will continue  to grow in perpetuity in both nominal and                                                            
     real, inflation-adjusted  dollars. The purchasing  power of the                                                            
      principal and the money available to spend will go up.                                                                    
   4. The 5 percent limit is actually higher than the amount that is                                                            
     being  paid out  now  for dividends.  If the  dividend  program                                                            
     continues  as it is  now, but with the  5 percent limit,  there                                                            
     would  be about  $175- $300  million of  additional money  that                                                            
     could be spent on  a sustainable basis and that would grow over                                                            
     time as the fund grew.                                                                                                     
   5. The market value payout is one that institutions similar to                                                               
     the  Permanent  Fund  use and  have  used  for many  years  and                                                            
     conforms  more  to  generally  accepted  accounting  principals                                                            
     (GAAP) than  what is currently used. This is  because generally                                                            
     accepted  accounting principals  have changed and the  statutes                                                            
   6. Legislators will know how much money is available from the                                                                
     Permanent Fund every January.                                                                                              
The analysis                                                                                                                  
Principal and inflation-proofing.                                                                                           
Under SJR  13, both the  Fund's principal  and the earnings  reserve                                                            
account  would be inflation-proofed  by  constitutional mandate.  In                                                            
addition,  there would  be two  constitutional  limits on  Permanent                                                            
Fund spending:  (1) principal would  continue to be unavailable  for                                                            
appropriation;  and (2)  appropriations  from the  earnings  reserve                                                            
account in the future would  be limited to no more than 5 percent of                                                            
the fund's average market  value for the past five years. This would                                                            
provide full inflation-proofing  averaged over long periods of time.                                                            
Accordingly,  statutory inflation-proofing   transfers to  principal                                                            
would no longer be necessary.                                                                                                   
Earnings reserve.                                                                                                           
This proposal  enhances the earnings reserve by allowing  inflation-                                                            
proofing to  accumulate with the constitutional  protection  against                                                            
it being  spent  by a subsequent  legislature.  It  allows money  to                                                            
continue to accumulate  in the earnings reserve account  which would                                                            
provide a cushion  if there are several poor years  in a row. At the                                                            
beginning  of  this  year the  earnings  reserve  account  had  $6.5                                                            
billion  and it  fell to  under  $4 billion  because  of the  market                                                            
decline.  In 2003,  the fund's  five-year  average  market value  is                                                            
projected at $28 billion,  which would limit the maximum payout that                                                            
year to no more than $1.4 billion.                                                                                              
5 percent payout.                                                                                                           
The 5 percent  limit is chosen for  three reasons: (1) 5  percent is                                                            
on the high end of sustainable  payout rate that still maintains the                                                            
fund's real value;  (2) 5 percent allows greater distributions  over                                                            
time than a  higher payout; and (3)  5 percent is what the  majority                                                            
of endowments  pay out;  e.g., 85  percent of  all public  endowment                                                            
funds  pay  out  5  percent  or  less,  and  the  median  payout  of                                                            
endowments, according  to a 1999 Greenwich Associates  study, is 4.9                                                            
Side B                                                                                                                          
Five-year averaging.                                                                                                        
Under SJR  13, the  annual payout  may not exceed  5 percent  of the                                                            
fund's market  value averaged over  the prior five years,  including                                                            
the fiscal  year just ended.  This methodology  is chosen to  dampen                                                            
volatility and  is consistent with the existing statutory  five-year                                                            
averaging provision for computation of the annual dividend.                                                                     
20-year perspective.                                                                                                        
Under SJR 13, if the full  5 percent of the fund's five-year average                                                            
market value was paid out,  the fund would earn $57 billion of total                                                            
investment  return over  the  next 20 years,  $28  billion of  which                                                            
would  be earmarked  for dividends  and  $20 billion  to  inflation-                                                            
proofing,  leaving  $9  billion in  residual  income  available  for                                                            
appropriation. The ending  market value of the fund in 2020 would be                                                            
$51 billion.                                                                                                                    
This proposal  does  not affect  the existing  dividend program.  It                                                            
should be noted, however,  that any future public policy decision to                                                            
use  an additional  portion  of fund  income  for any  purpose  will                                                            
affect the  dividend, as will market  volatility, but under  SJR 13,                                                            
these impacts  would either be equal  or diminished compared  to the                                                            
status quo.                                                                                                                     
Residual income available for appropriation.                                                                                
Except in the case of extraordinarily  good financial markets, the 5                                                            
percent  limit  set by  SJR 13  is above  what  is required  to  pay                                                            
dividends per  current law, leaving a residual amount  available for                                                            
appropriation.  If the entire 5 percent  was paid out, the  residual                                                            
amount is  expected to range  from $175-$300  million per year  in a                                                            
median case,  growing over  time as the Fund  grows. Because  of the                                                            
mechanics of  the existing statutory  dividend formula, however,  if                                                            
the dividend is extraordinarily  high in any one year, the amount of                                                            
the residual could be reduced to zero.                                                                                          
MR.  GRUENING  said  there  is  a sincere  desire  to  have  a  full                                                            
discussion  about the legislation.  The concept of a permanent  fund                                                            
had been around  many years before  the ninth legislature  acted and                                                            
they took two years to discuss and review it. He commented,                                                                     
     If the  22nd legislature  passed this,  this would be  the                                                                 
     most significant  addition to  our constitution since  the                                                                 
     permanent  fund  original  amendment.  I  can't  think  of                                                                 
     anything that would leave  a greater legacy for the people                                                                 
     of Alaska  than this; but that's something that  they have                                                                 
     to be convinced of.                                                                                                        
This  not only  requires a  two-thirds vote  of each  body, it  also                                                            
requires  a majority  vote.  The political  effort  and review  that                                                            
needs  to be expended  is  perhaps greater  than  with the  original                                                            
amendment.  Although  the  concept  is simple,  it  is not  an  easy                                                            
decision  even  though  the  impact would  be  profound  and  deeply                                                            
appreciated by Alaskans.                                                                                                        
SENATOR PHILLIPS  asked whether  there was  an expectation  that the                                                            
legislation  would be moved  this session and  if it passed  through                                                            
both  bodies would  the corporation  and  trustees be  in charge  of                                                            
educating the public.                                                                                                           
MR. KELLY said they were  selling the idea now and would continue to                                                            
sell it as long as it has a chance of passage.                                                                                  
SENATOR PHILLIPS  asked whether they would be taking  credit for the                                                            
plan rather than giving that credit to the legislature.                                                                         
MR. GRUENING  responded it is their  plan but the legislature  would                                                            
have to take a two-thirds ownership in the plan at some point.                                                                  
SENATOR PHILLIPS  pointed out that  in 1976 there was a legislative                                                             
proposal to  form the permanent fund,  and this time the  concept is                                                            
coming  from  the  Alaska  Permanent  Fund  Corporation  and  Alaska                                                            
Permanent Fund Board of  Trustees, not the legislature. It should be                                                            
clear that  it is their  idea and the legislature  is simply  giving                                                            
them the opportunity  to defend it.  "If it goes sour, I  don't want                                                            
to hear it was my team that did this."                                                                                          
MR. KELLY said they like  this proposal, and they have been studying                                                            
it intensively  for the last five  years and discussing it  for much                                                            
longer  than that. Of  course there  may be  unintended and  unknown                                                            
consequences  but the board is unanimously  and strongly  in support                                                            
of the proposal.                                                                                                                
CHAIRMAN  THERRIAULT said he  has had a number  of discussions  with                                                            
both  presenters and  he wanted  to briefly  touch on  them so  they                                                            
would be a matter of record.                                                                                                    
First, Tamara  Cook, the Director of Legislative Legal  and Research                                                            
Services, noted that in  drafting the resolution there were a number                                                            
of exceptions  to standard  drafting procedures  with regard  to the                                                            
title, the contents and the way information is shown.                                                                           
The title says the resolution  is relating to inflation-proofing the                                                            
permanent  fund and it  does not really  do that.  It does not  make                                                            
appropriations  to the permanent fund. In fact, testimony  today was                                                            
that  statutes  that  make  a  yearly  appropriation  might  not  be                                                            
advisable to continue.                                                                                                          
There  was  some confusion  about  whether  or  not  a copy  of  the                                                            
memorandum from Ms. Cook was sent to Mr. Gruening or Mr. Kelly.                                                                 
MR.  KELLY  said  inflation-proofing  does  not  appear  in  current                                                            
statutes. The proposal  will provide for the effects of inflation in                                                            
a statutory  formula. It  provides for the  effects of inflation  by                                                            
limiting  the payout  to  5 percent.  Over the  next  75 years  they                                                            
believe the fund  will earn 8.25 percent and inflation  will average                                                            
3l25 percent.                                                                                                                   
CHAIRMAN THERRIAULT  remarked that  individuals with a knowledge  of                                                            
"how this works"  know that there is a computation  done on a yearly                                                            
basis on  the consumer price  index (CPI)  then an appropriation  is                                                            
made to offset  that erosion. He was not sure whether  they proposed                                                            
that statute  stay in place  and the computation  and appropriation                                                             
continue to  be made to the principal  on a yearly basis  or whether                                                            
they  want to  ensure a  healthier buffer  in the  earnings  reserve                                                            
MR. GRUENING  responded that  is a legislative  decision.  Currently                                                            
there is  not a 5  percent payout.  The only  payout that is  taking                                                            
place is for  the dividend. That may  change at some point  and when                                                            
it does,  there will  be statutes  that deal with  that change.  The                                                            
priority  in  the  statutes  now  is  the  dividend  and  inflation-                                                            
proofing.  The trustees  have taken  no position  on not  inflation-                                                            
proofing  under the statute.  As long as no  more than 5 percent  is                                                            
paid out, you  are inflation-proofing the entire fund  including the                                                            
earnings reserve  and principal. This  proposal could be  passed now                                                            
and  the current  statutes  could stay  unchanged.  However, at  the                                                            
point at which  other payouts are designed, if they  stay within the                                                            
5 percent  there is no  need to additionally  pay it into  principal                                                            
because  you would  be  reducing the  earnings  reserve.  This is  a                                                            
warning given  when there  are plans to appropriate  money  from the                                                            
earnings  reserve  to  principal.   There  was  a  House  bill  that                                                            
deposited $250 million.  There was a desire by some to deposit more.                                                            
The board's  analysis  is that  would have  created  a situation  in                                                            
which the  dividend would  have been affected.  The same applies  if                                                            
this amendment was in place;  the board would give their projections                                                            
of  what  would  happen   as  a  result  of  any  action   including                                                            
appropriating  a large  sum out of  the fund  to the constitutional                                                             
budget reserve.  That entire amount is available for  appropriation,                                                            
not just the realized  portion. Once the amendment  is in place they                                                            
want to  be clear that  this would  no longer be  an option.  Just 5                                                            
percent of the  market value would be available. With  this in mind,                                                            
they haven't  taken  an official position  on that  and they  aren't                                                            
likely to do so. It's a legislative decision.                                                                                   
CHAIRMAN  THERRIAULT noted  that the trustees  have been advised  to                                                            
stay clear of  policy decisions so he understands  the reluctance to                                                            
take a stand.  However, this would trigger a number  of consequences                                                            
that the legislature would have to deal with.                                                                                   
MR.  KELLY responded  the  legislature wouldn't  have  to deal  with                                                            
consequences  any  more  if this  was  passed  than they  do  today.                                                            
Nothing has changed  except the amount of money that  may be removed                                                            
from the fund.                                                                                                                  
MR. GRUENING  said what will really  trigger events are external  to                                                            
the fund.  For instance,  what will  be done  if the constitutional                                                             
budget reserve is near  exhaustion? What will be done to reorder the                                                            
priorities  to  deal with  this?  This  will  need to  be  addressed                                                            
regardless  of passage  of the  legislation. The  proposal does  not                                                            
drive  this situation  - it's already  there.  Because the  trustees                                                            
want the permanent fund  to be permanent, this proposal should be in                                                            
SENATOR PHILLIPS  noted they said  it would not affect the  dividend                                                            
but wondered whether there  might not be some circumstances where it                                                            
would be affected.                                                                                                              
MR. KELLY  said if there  is the 5 percent  payout and the  dividend                                                            
formula  is left in  place there  is one circumstance  in which  the                                                            
dividend   would   be  affected.   If   there   are  a   number   of                                                            
extraordinarily  good years such as we just experienced,  there is a                                                            
limit on  how high the  dividend can grow.  However, analysis  shows                                                            
that,  at that  point,  the dividend  would  be between  $3,000  and                                                            
$4,000 per person.  If people were getting that size  dividend there                                                            
probably won't be complaints  because there was the 5 percent limit.                                                            
SENATOR PHILLIPS pointed  out there were lots people that envisioned                                                            
$4,000 dividends.                                                                                                               
MR. KELLY said  this doesn't mean  you can't have $4,000  dividends.                                                            
This gives  the assurance  there will  be dividends  that grow  over                                                            
time as long as the fund grows.                                                                                                 
MR. GRUENING  said this goes to the  question of inner-generational                                                             
equity and  generations are addressed  in the statutes. The  maximum                                                            
sustainable  yield of a fisheries  stock is a workable analogy  even                                                            
though the investment field  is more predictable than the scientific                                                            
predictions  of fisheries  stocks. If  you take  six percent  of the                                                            
stock rather  than five percent, you  can get more fish for  awhile.                                                            
However, over the long  term you'll pay for this in the outer years.                                                            
The permanent  fund will take care of everyone now  and our children                                                            
and grandchildren so we're  looking at other generations. If we look                                                            
beyond our  immediate needs to our  children and grandchildren  this                                                            
will look like  a good idea. Even if your only support  for the fund                                                            
is the fact  that it gives  a dividend, this  makes sense.  It's not                                                            
tied  to a fiscal  plan  but to  the idea  you can  get the  maximum                                                            
distributions  over  time by  limiting the  payout  to a  reasonable                                                            
CHAIRMAN THERRIAULT said,                                                                                                       
     The question about the 5  percent limiting the size of the                                                                 
     dividend is  the product of the fact that if you  have a 5                                                                 
     percent   maximum   payout  and   you  have   a  separate                                                                  
     calculation  that  is the 5  year rolling  average of  the                                                                 
     realized earnings,  you might have one that obligates  you                                                                 
     or computes more money than you have money to pay.                                                                         
MR. KELLY said that is correct.                                                                                                 
MR. GRUENING agreed but said that is a very rare situation.                                                                     
MR. KELLY said  it is not only rare, it only happens  on the top end                                                            
not the bottom end.                                                                                                             
CHAIRMAN  THERRIAULT commented  that principal  was not included  in                                                            
the wording on  page 1, line 9 & 10 that says, "All  income from the                                                            
permanent fund  shall be deposited in the permanent  fund." He noted                                                        
they don't want it in the principal.                                                                                            
MR. KELLY said that is  correct. They define permanent fund as it is                                                            
by  statute,  which  is  the  principal  and  the  earnings  reserve                                                            
For 20 years  they have said  there are two  parts to the  permanent                                                            
fund. There is  the principal and there is the income.  Principal is                                                            
defined as (1) oil revenues,  (2) inflation-proofing and (3) special                                                            
appropriations.  Everything  else is  earnings  reserve account  and                                                            
available for appropriation.                                                                                                    
CHAIRMAN  THERRIAULT  asked  about  the  possibility   of  principal                                                            
erosion if  5 percent of the value  was withdrawn on a yearly  basis                                                            
and there was  a consecutive number of flat or negative  years. Page                                                            
1, line 8 of the resolution  says, "principal of which shall be used                                                            
only for those  income-producing investments" while  another part of                                                            
the constitution says you  may have a draw of up to 5 percent of the                                                            
value. There could be situations  in which those two are in conflict                                                            
and in  drawing up  to 5 percent  there could be  an erosion  of the                                                            
principal. He  was not sure the language on line 8  is strong enough                                                            
to prevent  the erosion of  principal value.  Of course, the  longer                                                            
money is  put into  the earnings  reserve portion  of the  permanent                                                            
fund the  less potential  there would be  for erosion of  principal.                                                            
Individual  Alaskans might  look at  this as a  departure from  what                                                            
they are accustomed to.                                                                                                         
MR. GRUENING  responded that they  have discussed this question  and                                                            
it is critical to the promotion  of the proposal that they intend to                                                            
have no  repeal or impairment  of the prohibition  that exists  now.                                                            
Principal  may not  be spent.  If there  were any way  to make  this                                                            
clearer  than it is  now then he  would be in  favor of the  change.                                                            
They don't want to lose  any protection and they haven't changed the                                                            
wording.  The discussion  of whether  there is a  conflict tends  to                                                            
come  up in groups  of attorneys  and  if enough  attorneys work  on                                                            
writing the amendment there  is a great possibility that most people                                                            
won't be able  to understand what has been written.  They would like                                                            
to keep it  as simple and straightforward  as possible but  if there                                                            
is doubt about their clear  intention they would be open to changing                                                            
the  wording.  They did  not  touch  the word  principal,  it  still                                                            
CHAIRMAN  THERRIAULT said  the percentage that  is dedicated  by the                                                            
constitution,  the 25 percent and  any deposits made into  principal                                                            
by the legislature  to this point, including inflation-proofing  and                                                            
any future oil  revenues. It would include inflation-proofing  if we                                                            
kept the statute  that did the computation and the  deposits but not                                                            
inflation-proofing if it was just the retention of earnings.                                                                    
MR. KELLY said  he understands it  the way they do. For the  record,                                                            
there are  two limits: the  first limit that  cannot be breached  is                                                            
you cannot  invade  principal; and  second, you  cannot payout  more                                                            
than 5 percent of the market  value. If there was a conflict between                                                            
the  two limits,  there  would be  less  money to  pay  out and  the                                                            
principal would still be protected.                                                                                             
MR. GRUENING  said he doesn't believe  they have received  a copy of                                                            
the  memo by  Tamara  Cook. He  may  have seen  a copy  in  Chairman                                                            
Therriault's office but they don't have a copy in their files.                                                                  
CHAIRMAN THERRIAULT  said they would  make sure a copy was  sent. He                                                            
noted there was some tension  between legislative counsel, permanent                                                            
fund counsel and the drafters.                                                                                                  
MR. GRUENING replied it was in a different area.                                                                                
CHAIRMAN THERRIAULT  agreed and added style was also  questioned. He                                                            
wanted  to  work toward  ensuring  that  principal  would  still  be                                                            
protected  even  in  the unlikely  situation  there  is  a  conflict                                                            
between  the allowable  5 percent  draw and where  that money  could                                                            
come from.  He didn't know whether  there was so much discussion  in                                                            
the House that they deemed it unworkable.                                                                                       
MR. GRUENING  said they didn't see  the two as in conflict  but they                                                            
would be happy to look at the memo.                                                                                             
CHAIRMAN THERRIAULT said  the memo also pointed out the difficulties                                                            
involved for the  amendment to "spring into effect  in the middle of                                                            
a fiscal year"  and she [Ms. Cook]  suggested adding a July  1, 2003                                                            
effective  date. "Otherwise,  for part of  the year the legislature                                                             
will be  able to appropriate  fund income,  while at the end  of the                                                            
same year it will have  access to an amount based on market value of                                                            
the fund."                                                                                                                      
MR. KELLY  said he  had thought of  that as well.  The voters  would                                                            
approve this in November  and it would go into effect 90 days later,                                                            
which  would be  some time  in February.  The legislature  meets  in                                                            
January and the  constitutional amendment won't be  in effect. Until                                                            
that moment,  everything in  the earnings  reserve account  could be                                                            
CHAIRMAN  THERRIAULT said  there is  a real  potential problem  with                                                            
that.  If  the earnings   reserve,  which is  the  cushion  that  is                                                            
depended upon,  is either transferred into principal  or transferred                                                            
into the  constitutional  budget reserve before  the effective  date                                                            
for the  new language, there  would be a  very real problem  because                                                            
there might  be no earnings reserve  to provide the cushion  to keep                                                            
from invading principal.                                                                                                        
MR. KELLY said  the problem is not  with the methodology  because it                                                            
continues to work. The  problem is if you choose to do that you will                                                            
have put yourself  at significant  risk. If you did that,  you would                                                            
have to be  content living with the  earnings for that year  even if                                                            
they were negative.                                                                                                             
CHAIRMAN THERRIAULT  said that's if  the language on page  1, line 8                                                            
supercedes  the language about the  5 percent draw. Otherwise,  that                                                            
potential conflict between  the 5 percent allowable draw and whether                                                            
that can  invade principal  will be heightened  because the  cushion                                                            
might not be there anymore.                                                                                                     
MR. GRUENING said  that exists now regardless of whether  or not the                                                            
amendment  becomes  part of  the  constitution.  It's theoretically                                                             
possible but hopefully won't ever occur.                                                                                        
CHAIRMAN  THERRIAULT   said  he  would  like  this  proposal  to  be                                                            
considered at  the same time as the resolution sponsored  by Senator                                                            
Ward  that  deals  with  the  permanent   fund.  The  resolution  is                                                            
currently  in the finance  committee and unlikely  to move  out this                                                            
session.  He would like  to hear  from committee  members about  the                                                            
issues and  questions that have been  raised before they  reconsider                                                            
the resolution as a committee.                                                                                                  

Document Name Date/Time Subjects