Legislature(2005 - 2006)BELTZ 211

03/31/2005 03:30 PM Senate STATE AFFAIRS


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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
*+ SB 121 STATE OF AK CAPITAL CORP.; BONDS TELECONFERENCED
Heard & Held
*+ SB 122 AMERADA HESS INCOME; CAPITAL INCOME ACCT. TELECONFERENCED
Heard & Held
*+ SB 152 APPROP: COST-OF-LIVING SURVEY TELECONFERENCED
Heard & Held
+ Bills Previously Heard/Scheduled TELECONFERENCED
            SB 121-STATE OF AK CAPITAL CORP.; BONDS                                                                         
        SB 122-AMERADA HESS INCOME; CAPITAL INCOME ACCT.                                                                    
                                                                                                                                
3:57:16 PM                                                                                                                    
                                                                                                                                
CHAIR  THERRIAULT announced  SB  121  and SB  122  to  be up  for                                                               
consideration.                                                                                                                  
                                                                                                                                
CHERYL FRASCA, Director  of the Office of  Management and Budget,                                                               
Office  of  the  Governor,  said  she  would  present  the  bills                                                               
together.                                                                                                                       
                                                                                                                                
3:58:23 PM                                                                                                                    
                                                                                                                                
The Governor proposes to  finance capital infrastructure projects                                                               
by  issuing bonds  and the  interest earnings  from the  "Amerada                                                               
Hess"  settlement would  be used  to pay  them off.  The list  of                                                               
capital projects that  would be funded through  this mechanism is                                                               
included in  the December  Capital Budget  that was  submitted to                                                               
the Legislature. This is very similar  to state funds in that the                                                               
final decision  as to which  projects are  funded is left  to the                                                               
Legislature through the Finance Committees.                                                                                     
                                                                                                                                
The Amerada Hess settlement relates  to a lawsuit the state filed                                                               
against  the oil  companies  in  the late  '70s  relating to  the                                                               
valuation of the state's royalty  oil. The oil companies tried to                                                               
keep  the suit  from proceeding  in  Alaska by  arguing that  all                                                               
Alaskans   would  be   biased.  The   federal  court   urged  the                                                               
Legislature  to  step in  and  address  the  issue. As  a  result                                                               
legislation   was  passed   in   both  the   Cooper  and   Hickel                                                               
Administrations that excluded the  settlement proceeds from being                                                               
included in the calculation of the Permanent Fund dividend.                                                                     
                                                                                                                                
A sub-account was established within  the Permanent Fund to which                                                               
all  the  settlement precedes  have  accumulated.  In FY  92  $82                                                               
million was  deposited and at  the end of  FY 04 the  balance had                                                               
grown to about $424 million.  Unlike the dividend, there has been                                                               
no return to  the Alaska economy from the  earnings. The proposal                                                               
is  to put  those earnings  to  work. The  bond mechanism  allows                                                               
leverage of  the annual  earnings over time  to finance  a larger                                                               
package of capital projects.                                                                                                    
                                                                                                                                
4:01:24 PM                                                                                                                    
                                                                                                                                
CHAIR THERRIAULT asked  if the initial deposit was  25 percent of                                                               
the Amerada Hess  settlement and the rest of the  money went into                                                               
the state treasury.                                                                                                             
                                                                                                                                
MS. FRASCA speculated  that the 75 percent balance  went into the                                                               
Constitutional Budget Reserve  (CBR) once it was  created. At the                                                               
time that Amerada Hess was negotiated there was no CBR.                                                                         
                                                                                                                                
SB 122 creates an account into  which the earnings of the Amerada                                                               
Hess  settlement  would   be  placed  and  SB   121  creates  the                                                               
corporation that would issue the debt.                                                                                          
                                                                                                                                
4:03:36 PM                                                                                                                    
                                                                                                                                
SENATOR KIM  ELTON said  he assumes the  Amerada Hess  account is                                                               
inflation proofed in the same way as the Permanent Fund.                                                                        
                                                                                                                                
MS. FRASCA  said yes it  is and the Legislature  appropriates the                                                               
earnings into the account.                                                                                                      
                                                                                                                                
SENATOR ELTON  asked if the  inflation proofing is  designated to                                                               
Amerada Hess or to the pot that includes Amerada Hess.                                                                          
                                                                                                                                
MS.  FRASCA replied  it's designated  into the  Amerada Hess  sub                                                               
account.                                                                                                                        
                                                                                                                                
SENATOR  ELTON asked  if  it's correct  that  under the  proposal                                                               
there would be no inflation proofing of Amerada Hess.                                                                           
                                                                                                                                
MS. FRESKA  said that is  correct. The $424 million  in principal                                                               
would stay in the account and  each year the earnings would go to                                                               
pay  the debt  service  on  the bond  package.  The $424  million                                                               
wouldn't grow any larger, she said.                                                                                             
                                                                                                                                
SENATOR ELTON  declared that  is a  substantive policy  shift and                                                               
someone  might  want to  discuss  the  net  effect of  no  longer                                                               
inflation proofing. This isn't just  about spending the earnings.                                                               
This is  about spending principal  because inflation  would erode                                                               
it over time, he said.                                                                                                          
                                                                                                                                
4:05:24 PM                                                                                                                    
                                                                                                                                
DEVEN  MITCHELL,  Debt  Manager,  Department  of  Revenue  (DOR),                                                               
explained that  the historical use  of all the earnings  has been                                                               
appropriation  to  principal so  it's  been  more than  inflation                                                               
proofed.  As  to  the  policy  matter of  whether  it  should  be                                                               
inflation proofed moving forward or not he said:                                                                                
                                                                                                                                
     There is a slight  automatic inflation proofing as much                                                                    
     as the  realized return rate  of the Permanent  Fund is                                                                    
     less than  their expected  total return  rate -  to the                                                                    
     tune  of 57  basis points.  So theoretically  your fund                                                                    
     will grow  on an  accrual or  an accounting  basis over                                                                    
     time  even  though  you   do  anticipate  removing  all                                                                    
     realized  earnings from  the fund  - from  this Amerada                                                                    
     Hess account. And  so if you looked at it  on a balance                                                                    
     sheet  it   will  grow  from  $424   million  if  those                                                                    
     assumptions materialize over time.                                                                                         
                                                                                                                                
It's a separate  issue as to whether there should  be a statutory                                                               
requirement that it be inflation proofed, he said.                                                                              
                                                                                                                                
4:06:48 PM                                                                                                                    
                                                                                                                                
MR. MITCHELL  said there  are two distinct  things going  on with                                                               
the two  bills. The  first bill would  create the  Alaska Capital                                                               
Income  Account. It  would change  the flow  of money  within the                                                               
Amerada  Hess settlement  from accruing  to principal  to flowing                                                               
into the  new Alaska Capital  Income sub-account in  the Earnings                                                               
Reserve.  From there  the  funds would  be  available for  annual                                                               
appropriation for any purpose by the Legislature.                                                                               
                                                                                                                                
The second bill  would create a new corporation  called the State                                                               
of  Alaska Capital  Corporation.  It would  have  the ability  to                                                               
issue up to $350 million  in revenue bonds. The corporation would                                                               
receive  funding  on  an  operating   basis  from  agencies  that                                                               
benefited from capital projects.  The operating leases would have                                                               
to  be renewed  every year,  which  creates a  mechanism for  the                                                               
funds to  flow to the  corporation. The corporation would  have a                                                               
variety of security  features and financial tools  to ensure that                                                               
there would be  a means to deal with volatility  and to avoid use                                                               
of any credit enhancements the state might provide.                                                                             
                                                                                                                                
4:08:56 PM                                                                                                                    
                                                                                                                                
He  drew attention  to the  schematics  in the  bill packet  [see                                                               
file].  They are  designed to  help explain  how the  corporation                                                               
would  work.  He suggested  the  concept  of the  Alaska  Capital                                                               
Income Account is fairly easy to grasp.                                                                                         
                                                                                                                                
The second  schematic shows how  money might flow into  the State                                                               
of  Alaska Capital  Corporation. The  annual appropriation  flows                                                               
into a revenue fund of  the corporation. It would fund operations                                                               
of the  corporation; the debt  service reserve fund,  which would                                                               
have a moral obligation pledge of  the State Alaska; and the bond                                                               
redemption fund,  which would  advance fund  debt service  of the                                                               
corporation on an annual basis.                                                                                                 
                                                                                                                                
Corporate bond  payments flow  from the  bond redemption  fund to                                                               
investors and  investors would purchase bonds  from the corporate                                                               
bond issue and that cash  would fund the construction fund. There                                                               
would be an  obligation to repay those  investors. The obligation                                                               
would  be  made   in  a  flexible  manner  such   as  a  flexible                                                               
amortization  bond.  They  would   pay  interest  only  and  have                                                               
reserves  in  place  to  accommodate  market  volatility  on  the                                                               
earnings side.  The model they  used results in  a 17 to  18 year                                                               
amortization of all principal associated with the borrowing.                                                                    
                                                                                                                                
The  construction fund  would  be managed  by  the Department  of                                                               
Revenue under  the fiduciary  responsibility of  the commissioner                                                               
and  reinvested  in fund  projects  through  the existing  Alaska                                                               
Statewide  Accounting   System  (AKSAS)  system  so   no  special                                                               
accounting process would be needed to fund projects.                                                                            
                                                                                                                                
4:13:04 PM                                                                                                                    
                                                                                                                                
SENATOR  ELTON  referenced  the statement  that  the  anticipated                                                               
revenue stream of $30 million would  be available to pay off debt                                                               
and  questioned  what  the  annual revenue  stream  would  be  if                                                               
Amerada Hess  were inflation  proofed the  same as  the Permanent                                                               
Fund.                                                                                                                           
                                                                                                                                
MR.  MITCHELL  replied  it  would  reduce  borrowing  power.  The                                                               
proposal leverages  the revenue stream  as far as you  might want                                                               
while maintaining  the high probability  that it would  be repaid                                                               
and  be  stand-alone self-supporting  debt  rather  than a  state                                                               
obligation.                                                                                                                     
                                                                                                                                
A key  feature of the proposal  is that it wouldn't  be paid from                                                               
the general fund.  It has a moral obligation pledge  on a reserve                                                               
fund, but the expectation is that  all debt service would be paid                                                               
from  the  transfers  from the  Alaska  Capital  Income  Account.                                                               
Rating analysts for the State  of Alaska have indicated that this                                                               
would not  impact the  state's credit rating  and it  wouldn't be                                                               
included as net tax supported debt of the state.                                                                                
                                                                                                                                
SENATOR  ELTON asked  if those  problems couldn't  be avoided  by                                                               
simply incurring less  debt. If you reduce the  revenue stream it                                                               
would make sense to reduce the debt obligation.                                                                                 
                                                                                                                                
MR. MITCHELL  replied that would  probably help the  economics of                                                               
the transaction  but you'd  have to pull  back from  the proposed                                                               
project list.                                                                                                                   
                                                                                                                                
4:16:24 PM                                                                                                                    
                                                                                                                                
CHAIR  THERRIAULT recapped  saying the  entire Permanent  Fund is                                                               
inflation  proofed and  the portion  attributable to  the Amerada                                                               
Hess account currently goes into the "picket fence" too.                                                                        
                                                                                                                                
MR. MITCHELL said yes.                                                                                                          
                                                                                                                                
CHAIR THERRIAULT  questioned whether that is  required by statute                                                               
or whether just the earnings are addressed.                                                                                     
                                                                                                                                
MR.  MITCHELL  replied, "I  believe  they're  one and  the  same;                                                               
inflation proofing  would be earnings,  which would  be allocable                                                               
to this portion."                                                                                                               
                                                                                                                                
CHAIR THERRIAULT said he'd ask Mr. Burns the same question.                                                                     
He compared  the tobacco settlement  and Amerada Hess.  The state                                                               
couldn't control  the flow of  tobacco settlement funds  so there                                                               
was  no assurance  that  they  would continue,  but  part of  the                                                               
reason for  going that route  was so  it wouldn't become  a moral                                                               
obligation of  the state.  For Amerada  Hess there  isn't control                                                               
because of the vagaries of the market return, he said.                                                                          
                                                                                                                                
MR.  MITCHELL  agreed the  state  doesn't  want  any tie  to  the                                                               
tobacco  bonds  because  of the  potential  elimination  of  that                                                               
revenue  stream.  Therefore  the  state  sold  that  asset  to  a                                                               
subsidiary  of  a  public corporation  that  doesn't  have  other                                                               
assets or any  moral obligation of the state  associated with the                                                               
bonds.   The  investors   required  interest   rates  from   that                                                               
subsidiary that are commensurate with that type risk.                                                                           
                                                                                                                                
Amerada Hess  is different  in that the  state would  establish a                                                               
corporation that is closely linked  to the state. The corporation                                                               
board  would   be  the  state   bond  committee,   including  the                                                               
commissioners of  administration commerce  and revenue  and staff                                                               
would come from  Department of Revenue personnel.  There would be                                                               
a moral obligation on the reserve,  which is a requirement to get                                                               
to that investment-grade rating level.                                                                                          
                                                                                                                                
He  reiterated  that  structural  and financial  tools  would  be                                                               
included  to  ensure that  there  is  no  draw on  that  reserve.                                                               
Modeling  for this  has  included a  Great  Depression type  down                                                               
market to  ensure that  there is  the ability  to survive  such a                                                               
period, because  "that's where we  want to be  at the end  of the                                                               
day." he concluded.                                                                                                             
                                                                                                                                
4:20:11 PM                                                                                                                    
                                                                                                                                
CHAIR THERRIAULT asked Mike Burns  where the Amerada Hess "picket                                                               
fence" is located in statute.                                                                                                   
                                                                                                                                
MIKE   BURNS,   Executive   Director,   Alaska   Permanent   Fund                                                               
Corporation, pointed to AS 37.13.145(d).                                                                                        
                                                                                                                                
CHAIR  THERRIAULT said  he reviewed  the statute  and understands                                                               
that the earnings  are put back into the account.  He wasn't sure                                                               
whether  the statute  specifically  requires  that the  inflation                                                               
proofing  go back  into  the "picket  fence"  as well.  Inflation                                                               
proofing and earnings are two  different things, he asserted; the                                                               
earnings  come  from  the  inflation proofing  but  it  takes  an                                                               
appropriation.                                                                                                                  
                                                                                                                                
MR.   BURNS  responded   he  didn't   think   it's  a   statutory                                                               
requirement. He  explained that the actual  cash settlements were                                                               
about  $194 million  over  a  number of  years.  Those have  been                                                               
inflation  proofed over  the years  by about  $77 million.  About                                                               
$153 million  in earnings have  been added in bringing  the total                                                               
to $424  million. The  original $194  million is,  by definition,                                                               
the  principal of  the fund  and  is statutorily  required to  be                                                               
inflation proofed the same way as the Permanent Fund.                                                                           
                                                                                                                                
CHAIR  THERRIAULT questioned  whether statute  required that  the                                                               
money go into  the "picket fence" or could it  have gone into the                                                               
general principal of the Permanent Fund.                                                                                        
                                                                                                                                
MR.  BURNS  said  all  of  it's  principal  and  the  concept  or                                                               
existence of  the "picket  fence" is  for accounting  purposes so                                                               
that the  earnings from Amerada  Hess don't go into  the dividend                                                               
calculation. Although  reference is  made to  a sub  account it's                                                               
really managed together and is indistinguishable.                                                                               
                                                                                                                                
CHAIR  THERRIAULT called  a  brief  at ease  from  4:23:34 PM  to                                                             
4:25:24 PM to provide time to read the statute.                                                                               
                                                                                                                                
CHAIR THERRIAULT  observed that AS 37.13.145(d)  doesn't speak to                                                               
inflation proofing, but subsection  (c) does talk about inflation                                                               
proofing  the  fund.  He questioned  why  there's  an  accounting                                                               
reason that  the inflation  proofing has to  go into  the Amerada                                                               
Hess sub-account.                                                                                                               
                                                                                                                                
MR. BURNS explained  that the original $194  million was received                                                               
in the  same way  as any  other royalty  the state  has received.                                                               
It's principal when  it's received so under (c)  it's required to                                                               
be  inflation  proofed.  Once it's  inflation  proofed  then  the                                                               
inflation proofing becomes principal.                                                                                           
                                                                                                                                
CHAIR  THERRIAULT  referenced the  flow  chart  showing that  the                                                               
earnings come  out of the  Amerada Hess  sub account and  then go                                                               
back  in  and  remarked  there should  be  some  indication  that                                                               
inflation proofing goes back into  the sub-account. He questioned                                                               
why  all the  inflation proofing  doesn't go  into the  Permanent                                                               
Fund.                                                                                                                           
                                                                                                                                
MR.  BURNS replied  the arrow  showing earnings  returned to  the                                                               
Amerada Hess sub account includes  inflation proofing. For a fund                                                               
that  can't be  used  for dividends  there  isn't any  difference                                                               
between the earnings and the inflation proofing.                                                                                
                                                                                                                                
CHAIR THERRIAULT said he understands but isn't sure he agrees.                                                                  
                                                                                                                                
MR. BURNS  said that's the  reason the sub-fund has  grown faster                                                               
than  all  the  other  funds;  the  earnings  haven't  ever  been                                                               
touched.                                                                                                                        
                                                                                                                                
4:30:18 PM                                                                                                                    
                                                                                                                                
SENATOR  ELTON said  the  proposal suggests  that  when the  sub-                                                               
account  was established  the  oil companies  made  a mistake  by                                                               
assuming that  the only way  the state would receive  benefit and                                                               
perhaps prejudice a jury would  be through an increased dividend.                                                               
If the proposal is successful  the oil companies could argue that                                                               
a jury  could be  prejudiced because the  earnings would  be used                                                               
for capital projects.                                                                                                           
                                                                                                                                
MR. BURNS  acknowledged you  could make  that argument,  but this                                                               
was an  out of court  settlement and the sub-account  was created                                                               
for something that ultimately never happened                                                                                    
                                                                                                                                
CHAIR THERRIAULT  asked Mr. Barnhill  to come forward  to respond                                                               
to Senator Elton's assertion.                                                                                                   
                                                                                                                                
MIKE  BARNHILL, Assistant  Attorney  General,  Department of  Law                                                               
(DOL), said if  you made that argument then you  could say no tax                                                               
case could go  to an Alaskan judge and jury,  but those cases are                                                               
litigated all the time.                                                                                                         
                                                                                                                                
When the Permanent  Fund dividend issue first came  up the Alaska                                                               
Supreme Court  amended the civil  and criminal rules to  say that                                                               
the  receipt of  a Permanent  Fund dividend  does not  constitute                                                               
good cause for  disqualifying jurors. He declared  the same would                                                               
hold  true for  using  the  earnings from  the  Amerada Hess  for                                                               
capital projects.                                                                                                               
                                                                                                                                
CHAIR  THERRIAULT acknowledged  that  the statute  was passed  in                                                               
anticipation  of a  court challenge.  He  questioned whether  the                                                               
terms of the settlement agreement included similar language.                                                                    
                                                                                                                                
MR. BARNHILL  said there are  so many settlement  agreements that                                                               
he couldn't say  for sure that any referred  specifically to this                                                               
language and whether  it should stay on the  books. Wilson Condon                                                               
has looked  at the issue  and he may  have given an  opinion. DOL                                                               
opines that if  the Legislature wants to repeal  the statutes and                                                               
allow  the  earnings  to  flow   back  into  the  Permanent  Fund                                                               
dividends  it could  do  so  as a  matter  of  law. Whether  it's                                                               
advisable as a matter of policy is a different issue.                                                                           
                                                                                                                                
Of principle  concern is that  the state said it  would segregate                                                               
the  money  so that  the  earnings  wouldn't flow  to  dividends.                                                               
Perception is  important here because there  might be opportunity                                                               
to do that again in future litigation.                                                                                          
                                                                                                                                
SENATOR ELTON suggested you could  get beyond that problem in the                                                               
future by simply making it part of the settlement agreement.                                                                    
                                                                                                                                
MR.  BARNHILL responded  there is  no litigation  on the  horizon                                                               
that's  the size  of the  Amerada  Hess litigation  but it  could                                                               
happen.                                                                                                                         
                                                                                                                                
SENATOR  ELTON  said it'd  be  interesting  to know  whether  any                                                               
settlements mention the "picket fence."                                                                                         
                                                                                                                                
MR. BARNHILL replied he could  get the information, but his guess                                                               
is that it's not there. DOL  has opined that it's legal to repeal                                                               
the statute  but the  legislation does  not repeal.  It redirects                                                               
the earnings from principal to the proposed income account.                                                                     
                                                                                                                                
CHAIR THERRIAULT  said the  account has  been characterized  as a                                                               
self-licking  ice  cream cone  in  that  no  one gets  to  derive                                                               
pleasure from it. The proposed mechanism  is the only way for the                                                               
state to  derive benefit. The  underlying question is do  we have                                                               
to continue to allow it to self-lick?                                                                                           
                                                                                                                                
SENATOR ELTON said this might not  be the only use of the Amerada                                                               
Hess  money. If  the statute  were  repealed another  use of  the                                                               
money could be for dividends. In  that case the choice before the                                                               
committee would be whether to  use the money for capital projects                                                               
or for dividends.                                                                                                               
                                                                                                                                
MR. BARNHILL referenced Wilson Condon's memo that says it's                                                                     
legal but inadvisable to let the money flow to dividends.                                                                       
                                                                                                                                
CHAIR THERRIAULT noted the memo was in the bill packet. He asked                                                                
if there were further questions.                                                                                                
                                                                                                                                
SENATOR ELTON said it would be  helpful to know the annual income                                                               
and the size  of debt package that is sustainable  if the Amerada                                                               
Hess account  were inflation  proofed in the  same manner  as the                                                               
rest of the fund.                                                                                                               
                                                                                                                                
CHAIR THERRIAULT asked Mr. Mitchell if that would be possible.                                                                  
                                                                                                                                
MR. MITCHELL answered yes.                                                                                                      
                                                                                                                                
CHAIR THERRIAULT concluded the hearing on SB 121 and SB 122.                                                                    

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