Legislature(2003 - 2004)

06/26/2003 06:10 PM Senate JUD

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
                    ALASKA STATE LEGISLATURE                                                                                  
                         JOINT MEETING                                                                                        
              SENATE JUDICIARY STANDING COMMITTEE                                                                             
                 HOUSE FINANCE SUBCOMMITTEE ON                                                                                
               PERCENTAGE OF MARKET VALUE PAYOUT                                                                              
                           Fairbanks                                                                                            
                         June 26, 2003                                                                                          
                           6:10 p.m.                                                                                            
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
SENATE JUDICIARY                                                                                                                
                                                                                                                                
Senator Ralph Seekins, Chair                                                                                                    
Senator Gene Therriault                                                                                                         
Senator Hollis French                                                                                                           
                                                                                                                                
HOUSE FINANCE SUBCOMMITTEE ON PERCENTAGE OF MARKET VALUE PAYOUT                                                                 
                                                                                                                                
Representative Jim Whitaker                                                                                                     
Representative Reggie Joule                                                                                                     
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
SENATE JUDICIARY                                                                                                                
                                                                                                                                
Senator Scott Ogan, Vice Chair                                                                                                  
Senator Johnny Ellis                                                                                                            
                                                                                                                                
HOUSE FINANCE SUBCOMMITTEE ON PERCENTAGE OF MARKET VALUE PAYOUT                                                                 
                                                                                                                                
Representative Kevin Meyer                                                                                                      
Representative Mike Chenault                                                                                                    
Representative Mike Hawker                                                                                                      
Representative Eric Croft                                                                                                       
                                                                                                                                
COMMITTEE CALENDAR                                                                                                            
                                                                                                                                
Percent of Market Value Briefing by Bob Storer, Executive                                                                       
Director, and Bob Bartholomew, Chief Operating Officer, Alaska                                                                  
Permanent Fund Corporation                                                                                                      
                                                                                                                                
WITNESS REGISTER                                                                                                              
                                                                                                                                
Professor Rich Seifert                                                                                                          
University of Alaska Fairbanks                                                                                                  
475 Panorama Drive                                                                                                              
Fairbanks, AK 99701                                                                                                             
                                                                                                                                
Mr. Eleazar Baker                                                                                                               
Fairbanks, AK 99701                                                                                                             
                                                                                                                                
Mr. Jerry Macbeth                                                                                                               
1777 Red Fox Dr.                                                                                                                
Fairbanks, AK 99701                                                                                                             
                                                                                                                                
Ms. Mary Nordale                                                                                                                
Private Attorney                                                                                                                
No address provided                                                                                                             
                                                                                                                                
Mr. Cary Dewit                                                                                                                  
1812 Whippoorwill                                                                                                               
Fairbanks, AK 99701                                                                                                             
                                                                                                                                
Ms. Mary Bishop                                                                                                                 
1555 Gus's Grind                                                                                                                
Fairbanks, AK 99701                                                                                                             
                                                                                                                                
Mr. Dan Revero                                                                                                                  
2709 Park Way                                                                                                                   
North Pole AK 99705                                                                                                             
                                                                                                                                
ACTION NARRATIVE                                                                                                              
                                                                                                                                
TAPE 03-54, SIDE A                                                                                                            
                                                                                                                                
CHAIR  RALPH  SEEKINS called  the  joint  meeting of  the  Senate                                                             
Judiciary  Committee  and  the   House  Finance  Subcommittee  on                                                               
Percent  of Market  Value Payout  to order  at 6:10  p.m. Present                                                               
were Senators  Therriault and  Seekins and  Representatives Joule                                                               
and  Whitaker. The  Chair announced  that  Bob Storer,  Executive                                                               
Director, and  Bob Bartholomew,  Chief Operating  Officer, Alaska                                                               
Permanent Fund Corporation (APFC), would testify.                                                                               
                                                                                                                                
MR. BOB  STORER, Executive  Director, APFC,  said he  would speak                                                               
from  a  handout  called  "The  Need For  Change"  and  that  Mr.                                                               
Bartholomew would  speak to the  actual language of  the proposed                                                               
amendment,  which is  to memorialize  inflation  proofing in  the                                                               
constitution. He  said it  has been  a time-honored  tradition of                                                               
the Permanent Fund  Board of Trustees to insure that  the fund is                                                               
inflation-proofed so that all generations are treated equally.                                                                  
                                                                                                                                
     What we  propose to  do in this  change is  protect the                                                                    
     entire fund  against inflation. The  key issue  here is                                                                    
     an option  on an  annual fund payout  and it  should be                                                                    
     assured in  the amount that  should be more  stable and                                                                    
     not   only   are   we  memorializing,   or   suggesting                                                                    
     memorializing, inflation proofing  in the constitution,                                                                    
     it increases the  stability of the payout  from year to                                                                    
     year and  we'll show  a slide to  emphasize that  a bit                                                                    
     later.  We're doing  this by  limiting the  amount that                                                                    
     can be  distributed to  the real  earnings of  the fund                                                                    
     over time. The solution is  what we call the Percentage                                                                    
     of Market Value Payout.                                                                                                    
                                                                                                                                
     If I could  ask everyone to go to slide  three. What is                                                                    
     the percentage  of market value payout?  It is actually                                                                    
     a  formula  that  most  of  the  endowment  funds  have                                                                    
     adopted  in terms  of methodology  for  payout. It's  a                                                                    
     limit to the  amount of funds that  can be appropriated                                                                    
     at any  given time  to the real  earnings of  the fund.                                                                    
     The proposal to  do this would be to limit  the fund to                                                                    
     no more  than 5  percent payout,  based on  a five-year                                                                    
     moving average of the fund.                                                                                                
                                                                                                                                
     When  the stakeholders  depend on  the fund  today, the                                                                    
     proposal   that  the   permanent   fund  trustees   are                                                                    
     suggesting  is the  entire fund  is not  protected from                                                                    
     inflation as it is now  structured and the change would                                                                    
     adjust that.  We also believe that  this methodology is                                                                    
     consistent   with  the   fund's  long-term   investment                                                                    
     strategies.                                                                                                                
                                                                                                                                
     Currently,  we use  a  realized  income methodology  to                                                                    
     compute distribution.  That was fine 26  years ago when                                                                    
     the  fund  was  created;  and most  public  funds  were                                                                    
     invested only  in fixed income where  virtually all the                                                                    
     earnings  were  the  realized income  or  the  interest                                                                    
     payments based on those investments.                                                                                       
                                                                                                                                
     Modern  funds -  public,  private, etcetera  - are  far                                                                    
     more mature  and have  a substantial  weighting towards                                                                    
     the  equity  market and  most  of  the appreciation  in                                                                    
     equities is  not based on  current income  - dividends,                                                                    
     in fact,  are quite small,  but on the  appreciation of                                                                    
     the asset and may be turned  over or may be sold in the                                                                    
     near term.  Or it may  be held  for the very  long term                                                                    
     and the  income would not necessarily  be realized but,                                                                    
     in fact,  the fund and  the citizens of Alaska  and the                                                                    
     state would have benefited from that appreciation.                                                                         
                                                                                                                                
     The  fund  currently  cannot  assure  that  the  annual                                                                    
     payments are available. If we  were having this meeting                                                                    
     about early  October of last  year, we would  have told                                                                    
     you there's  about a 10 percent  probability that there                                                                    
     would be no dividend payout  and that's because of what                                                                    
     had happened in the market  over the last few years. If                                                                    
     we'd have  had this  meeting last  March, I  would have                                                                    
     told you  the same  thing. There's  about a  10 percent                                                                    
     chance  there would  be no  payout. That's  because our                                                                    
     income of  dividends and interest was  being dwarfed by                                                                    
     losses in the securities that  were held. It's not just                                                                    
     the  permanent  fund, every  fund  in  the country  and                                                                    
     individuals were suffering as well.  I can tell you now                                                                    
     over the last  three or four months that  there will be                                                                    
     a full  dividend payout. I  noted as of last  night for                                                                    
     the fiscal  year with only a  few days to go,  the fund                                                                    
     has earned a positive 4.5  percent real rate of return.                                                                    
     So, we've  had a dramatic  rebound in the  stock market                                                                    
     over the last few months.                                                                                                  
                                                                                                                                
     The size of  the payouts in the  current methodology is                                                                    
     far  more unpredictable  and less  stable from  year to                                                                    
     year than if we would  move to the percentage of market                                                                    
     value payout.                                                                                                              
                                                                                                                                
MR. BARTHOLOMEW,  Chief Operating  Officer, APFC, said  he wanted                                                               
to make  sure that  they understood that  this proposal  does not                                                               
directly affect  the dividend  or compute how  big it  should be.                                                               
Before they  get to the  question of  how big the  dividend check                                                               
should be, they  should answer how much money should  come out of                                                               
the permanent fund each year.                                                                                                   
                                                                                                                                
     The proposal for a percent  of market value - its whole                                                                    
     purpose  is  to  say  the   rules  we  have  today  for                                                                    
     determining  how big  the  pie is  and  how much  money                                                                    
     should come out or should  be available isn't the right                                                                    
     way to do it and there's a better way...                                                                                   
                                                                                                                                
CHAIR SEEKINS  clarified that  is not  what they  are considering                                                               
under SJR  18. They are considering  a maximum of 5  percent, but                                                               
that is not a fixed number.                                                                                                     
                                                                                                                                
MR. SHORER said that the question was asked which formula best                                                                  
protects the fund against inflation. His answer is that the                                                                     
current formula is in statute and is discretionary.                                                                             
                                                                                                                                
     While the fund has  been fully inflation-proofed in the                                                                    
     past that is not to  suggest that it will be inflation-                                                                    
     proofed  in the  future.  We're suggesting  that it  be                                                                    
     done  constitutionally  although  it's  implicit.  It's                                                                    
     implicit because the amount  of inflation, the residual                                                                    
     remains  in the  fund and  only the  real earnings  are                                                                    
     paid out. That's the 5 percent.                                                                                            
                                                                                                                                
     The  current formula  inflation-proofs principal  only.                                                                    
     There's  a formula  in the  statutes  that follows  the                                                                    
     dividend, that instructs how  you compute the inflation                                                                    
     and then you inflation-proof  the principal every year.                                                                    
     The  proposed  methodology  would  inflation-proof  the                                                                    
     entire  fund over  some long  period of  time. Granted,                                                                    
     with a 5  percent payout, some years  you're paying out                                                                    
     more and some  years you're paying out less.  I like to                                                                    
     call it a disciplined  approach. People think about can                                                                    
     you  achieve it  in  a  bear market.  What  I think  is                                                                    
     important  is it  provides the  discipline in  the bull                                                                    
     market to  stay the course.  There are many  people, if                                                                    
     you went  back a  couple of years  ago, that  would say                                                                    
     that 5  percent was way  too conservative. Now,  in the                                                                    
     throes of  a bear market  that we hope has  just ended,                                                                    
     you'll hear 5 percent is way to optimistic.                                                                                
                                                                                                                                
     This  formula can  best assure  an  annual payout.  The                                                                    
     current  realized earnings  base  formula  can vary  in                                                                    
     size from  - I've got a  slide later on that  will show                                                                    
     you  that one  year  we had  $2.5  billion in  realized                                                                    
     earnings.  The  potential,  somewhat limited,  but  the                                                                    
     potential  exists that  there  could  be zero  realized                                                                    
     earnings in a  given year. The 5 percent  of the moving                                                                    
     average  assures that  every  year we  have this  known                                                                    
     payout...                                                                                                                  
                                                                                                                                
     I didn't  say this is  a limit -  up to 5  percent, but                                                                    
     that  would be  available from  year to  year. So,  the                                                                    
     amount of  funds that would  be available would  be far                                                                    
     more predictable than the current methodology.                                                                             
                                                                                                                                
     The  earnings reserve,  the  realized earnings  reserve                                                                    
     has varied from as much  as $3 billion to several times                                                                    
     your special appropriations and  that will include this                                                                    
     July 1 of  $100 million - as I noted,  a spending limit                                                                    
     in the good  years, but it assures spending  in the bad                                                                    
     years as well...                                                                                                           
                                                                                                                                
     A realized  earning base really absorbs  all the market                                                                    
     volatility  from  year to  year  and  the principal  is                                                                    
     intractable.  But  the  5  percent  limit,  while  it's                                                                    
     smooth, the payout would vary  from the market value of                                                                    
     the fund over time.  Markets are volatile; anytime it's                                                                    
     volatile;  it's  been more  volatile  of  late; but  in                                                                    
     recent  years realized  earnings in  a given  year -  I                                                                    
     said $2.5  billion. It was  as high as $2.7  billion; a                                                                    
     year ago we were about  $257 million in realized income                                                                    
     for that year.  I think we saw this  morning about $350                                                                    
     million  this  year.  The percentage  of  market  value                                                                    
     smoothed  out the  volatility; it's  far less  volatile                                                                    
     than realized income and does provide the stability.                                                                       
                                                                                                                                
MR. SHORER  used a graph  to accentuate the  point on page  8. He                                                               
noted that  slide 9 shows  the current statutory payout  to date,                                                               
which has  been dividends  only. There  has been  a high  of $1.2                                                               
billion, but  there was  as much  as $3  billion that  could have                                                               
been  available  for  appropriations [in  the  realized  earnings                                                               
reserve - it was not used].                                                                                                     
                                                                                                                                
MR. BARTHOLOMEW explained that the  slide shows under the current                                                               
rules what happens in bull and  bear markets. The $3 billion that                                                               
was  not  used -  one  of  the problems  with  that  is that  the                                                               
permanent fund was invested in  long-term assets and if they know                                                               
that   money  is   available,  maybe   they   should  invest   it                                                               
differently.                                                                                                                    
                                                                                                                                
     Historically,  they haven't  taken  out as  much as  is                                                                    
     available. The flip  side is in the  low markets, which                                                                    
     is where  we're headed  right now,  what we  are headed                                                                    
     into in the  next few years, we're showing  - and we're                                                                    
     using  a model  that we  used to  the project  into the                                                                    
     future if you  had continued low markets  - there would                                                                    
     only be $175 million to  $300 million available for the                                                                    
     dividends.  That's a  much smaller  number. If  you had                                                                    
     extremely  low   markets,  after   you  paid   out  the                                                                    
     dividends, there wouldn't be  anything else left. There                                                                    
     would be zero available for other appropriations...                                                                        
                                                                                                                                
SENATOR THERRIAULT asked if that  is one reason the trustees feel                                                               
moving  to  the  percentage  of market  value  payout  (POMV)  is                                                               
beneficial -  you always  keep up  with inflation,  never letting                                                               
the value of the principal be eroded.                                                                                           
                                                                                                                                
MR. SHORER  replied that  word "guarantee"  might be  too strong,                                                               
because in the short term there  might be some down markets where                                                               
you don't earn enough to fully  cover inflation in the short term                                                               
(a year or  two). The trustee's proposal over the  long term will                                                               
earn enough in  the good years to make up  for inflation that may                                                               
not have gotten covered when you  had one or two down years. Over                                                               
the long  term, inflation  has a  higher priority  because you're                                                               
going  to limit  the spending  to earnings  after inflation  over                                                               
time.                                                                                                                           
                                                                                                                                
MR. BARTHOLOMEW added  that it's important to know  that the fund                                                               
will grow under  this scenario for two reasons,  because it would                                                               
retain enough of  the earnings to cover the  effects of inflation                                                               
so the  fund will grow  at the rate  of inflation. It  also grows                                                               
because you get $250 to $300  million a year in deposits from oil                                                               
revenues.                                                                                                                       
                                                                                                                                
MR. SHORER explained that the  proposal limits the payout of real                                                               
rate of  return over time  and on  a realized income  base, there                                                               
are times  when it  will be  very low, but  there are  times when                                                               
there has  been over  $3 billion  in realized  income and  all of                                                               
that money could be  appropriated well beyond inflation-proofing,                                                               
if deemed  appropriate. The POMV  does insure over time  that the                                                               
fund is inflation-proofed.                                                                                                      
                                                                                                                                
He reminded  them that the existing  formula is 26 years  old and                                                               
while it has served the fund  well, the reality is that a 15-year                                                               
bull market  masked what is a  very serious issue -  changing the                                                               
payout  methodology.  The  National Association  of  College  and                                                               
Universities  Business Offices  (NACUBO) conducts  a study  every                                                               
year. They surveyed 574 foundations  and found that 85 percent of                                                               
the members use some form of  payout methodology based on a POMV.                                                               
Some use three years, others use  more or less. Larger funds tend                                                               
to have  a bit of a  smaller payout. He guessed  that was because                                                               
they tend to have  a lot more new donors coming  in every year so                                                               
they can be  a bit more conservative, but it's  going to grow and                                                               
grow.                                                                                                                           
                                                                                                                                
SENATOR THERRIAULT  asked if  they computed  a scenario  based on                                                               
the history of  the fund if a POMV methodology  had been in place                                                               
and how that would affect the current value of the fund.                                                                        
                                                                                                                                
MR. SHORER replied that they had, but it is difficult to                                                                        
compare, because the payouts have been less than the 5 percent                                                                  
moving average of the fund. Because it's always been less and                                                                   
because the Legislature has always inflation-proofed, the                                                                       
problem becomes a compounding issue. If you started paying out                                                                  
the entire 5 percent way back in 1983, then the fund would be                                                                   
smaller simply because there would have been greater payouts.                                                                   
                                                                                                                                
MR.  BARTHOLOMEW  added  that  when the  fund  was  invested  100                                                               
percent in bonds 20 years ago,  there was a year when the formula                                                               
for payout of the dividend exceeded  5 percent of the total value                                                               
of the  fund. Since the  fund has  been invested in  equities, in                                                               
1983 the  earnings of the  fund have  grown faster than  they did                                                               
under the  fixed income  bonds. Since 1983,  the amount  paid out                                                               
for  the dividend  has  actually been  quite a  bit  less than  5                                                               
percent. For the  most part it's been around 3  percent. The fund                                                               
would probably  be the same  size today if  the POMV had  been in                                                               
place. If  you split the  dividends as proposed, they  would have                                                               
been smaller than under the existing formula.                                                                                   
                                                                                                                                
     One of  the reasons  we are proposing  this is  that it                                                                    
     keeps the  dividend or any  distribution from  the fund                                                                    
     from  going really  high in  the good  years and  going                                                                    
     really low in the bad years...                                                                                             
                                                                                                                                
REPRESENTATIVE WHITAKER  asked what  they expect the  dividend to                                                               
be this year under the current methodology.                                                                                     
                                                                                                                                
MR. SHORER  replied that he thought  it would be below  3 percent                                                               
of the fund value, about $690 million.                                                                                          
                                                                                                                                
REPRESENTATIVE  WHITAKER   said  his   question  was   about  the                                                               
individual check.                                                                                                               
                                                                                                                                
MR. SHORER replied that it would be about $1,100.                                                                               
                                                                                                                                
REPRESENTATIVE  WHITAKER  asked  what   it  would  be  under  the                                                               
proposed POMV methodology.                                                                                                      
                                                                                                                                
MR. SHORER  replied that  he really  couldn't answer,  because if                                                               
you take 5 percent of the  five-year average of the market value,                                                               
you would have roughly $1.2  billion available to spend. It would                                                               
be up to  the Legislature to decide how much  of the $1.2 billion                                                               
would go  to the  dividend as  opposed to  other purposes.  If he                                                               
knew what  percentage of the  pie he was  going to use,  he could                                                               
estimate a rough dividend. The  amount available for distribution                                                               
would be  about 2.5 percent.  They project about $690  million to                                                               
$700 million would be available, divided by 620,000 people.                                                                     
                                                                                                                                
REPRESENTATIVE  WHITAKER  asked  how  they  transition  from  one                                                               
formula to another.                                                                                                             
                                                                                                                                
MR. SHORER replied:                                                                                                             
                                                                                                                                
     If we  went to the  payout methodology and  stayed with                                                                    
     the  2.5 percent  for dividends,  what would  happen is                                                                    
     over  the next  few  years,  if you  went  to the  POMV                                                                    
     approach,  it would  actually be  slightly higher  than                                                                    
     what we're projecting under the existing formula.                                                                          
                                                                                                                                
REPRESENTATIVE WHITAKER  asked if it  would be fair to  say there                                                               
would be adequate  funding to pay an equivalent  dividend to what                                                               
is paid out today.                                                                                                              
                                                                                                                                
MR. SHORER replied yes.                                                                                                         
                                                                                                                                
REPRESENTATIVE JOULE asked if the  Legislature had ever chosen to                                                               
not  inflation-proof the  fund and  how much  is it  in terms  of                                                               
dollars.                                                                                                                        
                                                                                                                                
MR. BARTHOLOMEW replied by giving  them a perspective on how they                                                               
do  inflation-proofing today.  They  look at  the  change in  the                                                               
national consumer  price index  from one year  to the  next. They                                                               
take that  amount and multiply  it by  the size of  the permanent                                                               
fund's principal.  Last year it  took $600 million; this  year it                                                               
will  take $350  million. They  will  move that  amount from  the                                                               
earnings pool to the principal where it can no longer be spent.                                                                 
                                                                                                                                
MR.  SHORER  explained  that the  Legislature  always  inflation-                                                               
proofed in the past and  excess earnings were appropriated to the                                                               
principal as well.                                                                                                              
                                                                                                                                
CHAIR SEEKINS asked if those  appropriations amounted to about $7                                                               
billion.                                                                                                                        
                                                                                                                                
MR. SHORER  replied that is  correct and  added that the  fund is                                                               
divided   equally   between  mineral   contributions,   inflation                                                               
proofing and  special appropriations.  The principal of  the fund                                                               
is about $22.2 billion today.                                                                                                   
                                                                                                                                
SENATOR THERRIAULT confirmed that  the inflation proofing is done                                                               
as an appropriation by the Legislature.                                                                                         
                                                                                                                                
MR. SHORER agreed.                                                                                                              
                                                                                                                                
SENATOR  THERRIAULT  asked if  it  was  true  then of  the  $22.2                                                               
billion that the Legislature put two-thirds of it there.                                                                        
                                                                                                                                
MR. SHORER replied that is correct.                                                                                             
                                                                                                                                
SENATOR THERRIAULT noted  that under the proposal,  the 5 percent                                                               
is  all that's  available  for appropriations  and dividends  and                                                               
asked  if  the  only  change  they  are  making  is  not  to  the                                                               
calculation,   but  to   the  amount   that   is  available   for                                                               
distribution.                                                                                                                   
                                                                                                                                
MR. SHORER replied  that is correct and they have  always said it                                                               
is the prerogative of the  Legislature to determine how the money                                                               
is  used.  They  recognize  there  is a  benefit  to  creating  a                                                               
dividend payout formula that is  also based on the POMV approach,                                                               
but  they  are proposing  to  memorialize  inflation proofing  by                                                               
limiting  the amount  of money  that can  be appropriated  in any                                                               
single year.                                                                                                                    
                                                                                                                                
SENATOR FRENCH  asked how  many years the  other funds  have been                                                               
using a POMV formula according to the NACUBO study.                                                                             
                                                                                                                                
MR. SHORER  said it is a  phenomenon over the last  20 years, but                                                               
he would have to do research for a precise answer.                                                                              
                                                                                                                                
SENATOR FRENCH asked  to what extent our vision is  skewed by the                                                               
recent bull  market and  what would  happen if  a long  period of                                                               
stagnant returns were to occur.                                                                                                 
                                                                                                                                
MR. SHORER replied the permanent  fund decision is independent of                                                               
any  market,  including  the  recent  bull  market.  One  of  the                                                               
benefits of the  5 percent limit is that you  don't get caught up                                                               
in  the bull  market. The  permanent fund  has not  achieved a  5                                                               
percent real rate of return over the  last 3 to 5 years. Over the                                                               
last 15  years, they benefited in  excess of the 5  percent. "Our                                                               
look  forward is  naïve. It  doesn't have  a bull  market and  it                                                               
doesn't have  bear market scenario,  but it recognizes  that both                                                               
will probably occur in our expectation."                                                                                        
                                                                                                                                
SENATOR  FRENCH asked  which  funds were  using  the POMV  market                                                               
prior to  1983, before  the long  bull run  and what  payout were                                                               
they using based on the models they formulated before it began.                                                                 
                                                                                                                                
MR. SHORER replied he would have to research that question.                                                                     
                                                                                                                                
CHAIR  SEEKINS  said he  didn't  think  the permanent  fund  took                                                               
advantage  of that  bull market  starting in  1983. They  started                                                               
increasing  the  asset allocation  in  the  early 1990s  to  take                                                               
advantage of the equities market.                                                                                               
                                                                                                                                
MR. SHORER  said that is  right. There was  a strong bias  at the                                                               
time  to  be  conservative  to maintain  the  confidence  of  the                                                               
citizens  of Alaska.  "But from  1983 to  1993, it  didn't matter                                                               
whether you  held stocks or bonds;  you were going to  earn about                                                               
13.5 percent  with either one.  So, it was actually  a fortuitous                                                               
period to own bonds."                                                                                                           
                                                                                                                                
REPRESENTATIVE MEYER  asked what  would happen  if they  said the                                                               
payout would be 5.5 percent.                                                                                                    
                                                                                                                                
MR. SHORER replied that to  achieve that goal, the permanent fund                                                               
would  have to  have  a more  aggressive  asset allocation.  They                                                               
might  even have  to change  the current  constraints on  what it                                                               
must  invest in  to allow  it to  exceed its  existing limits  in                                                               
terms  of  equities.  A  5.5 percent  payout  under  the  current                                                               
scenario is spending 5 percent of  the real income and .5 percent                                                               
of  the  inflation  proofing.  Ultimately,  it  would  erode  the                                                               
principal.                                                                                                                      
                                                                                                                                
REPRESENTATIVE MEYER said  he had been asked  why they inflation-                                                               
proof, because the stock market  will inflation-proof itself over                                                               
time. Stock values go up with inflation.                                                                                        
                                                                                                                                
MR. SHORER  replied if  they change the  legislation to  POMV, he                                                               
would agree  with that  statement. However,  they are  not double                                                               
inflation-proofing  as the  stock market  appreciates over  time,                                                               
because  assets must  be converted  into realized  income and  be                                                               
appropriated by the Legislature. Using  the POMV would allow them                                                               
to make purely investment decisions based on asset allocation.                                                                  
                                                                                                                                
REPRESENTATIVE MEYER said in 1999 the  House passed a bill to use                                                               
the permanent  fund earnings  in some sort  of fashion  and asked                                                               
him how the two plans differ.                                                                                                   
                                                                                                                                
TAPE 03-54, SIDE B                                                                                                            
                                                                                                                              
[Indiscernible answer because tape was turned over manually.]                                                                   
                                                                                                                                
MR. BARTHOLOMEW said there was a  handout with an analysis of SJR
18  setting  forth six  bullets.  He  wanted  to make  sure  they                                                               
understood what changes to the constitution were being proposed.                                                                
                                                                                                                                
Page  1,   line  10  adds   a  second  paragraph,  (b),   to  the                                                               
constitutional provision on the permanent fund.                                                                                 
                                                                                                                                
Page,   line   11  removes   the   word   "principal"  from   the                                                               
constitution.  That  leaves  the   earnings  reserve,  which  had                                                               
different rules.  Under the POMV  proposal, "principal"  would be                                                               
deleted and the  fund would be one pool of  money. Today they are                                                               
all invested  as one;  it's simply  an accounting  mechanism that                                                               
they do.  This is a  significant policy question, as  it's become                                                               
known  that the  principal is  off-limits and  is protected.  The                                                               
protection that  is being  proposed by the  POMV is  the spending                                                               
limit of 5 percent a year of  the total fund value. What it means                                                               
today is  if there  are a  couple more  down years,  the earnings                                                               
reserve could  spike down for a  short term when the  markets do.                                                               
That's  what leads  to the  possibility  of a  zero payout  being                                                               
available in any one year.                                                                                                      
                                                                                                                                
     By  eliminating it  and replacing  it  with a  spending                                                                    
     limit, you  will be  able to have  money each  year and                                                                    
     the policy question is balancing  the benefit of having                                                                    
     a  controlled limited  distribution every  year against                                                                    
     the risk of having no distribution.                                                                                        
                                                                                                                                
Page 1, lines 13 - 14 say  that all the income from the permanent                                                               
fund shall  be deposited into  the general fund  unless otherwise                                                               
provided by  law and for  the last  21 years the  Legislature has                                                               
provided that all the earnings  of the permanent fund will remain                                                               
there   until  it's   appropriated.   It  has   not  been   going                                                               
automatically  into  the general  fund.  This  language is  being                                                               
removed, because under POMV there will  one pool of money and all                                                               
the  earnings of  the  permanent  fund will  stay  in until  it's                                                               
appropriated. The legal  guidance they have says  they don't have                                                               
to refer to  the "income" of the permanent  fund anymore, because                                                               
it will stay there.                                                                                                             
                                                                                                                                
Page 2,  lines 2  - 6, adds  a long sentence  that says  they are                                                               
going to  protect the  permanent fund  from inflation  and assure                                                               
that the real  value of it will be preserved  over the long term.                                                               
Lines 4 - 5 describe how  that will be accomplished. Line 5 says,                                                               
"of the  average market  values of  the fund on  June 30  for the                                                               
first  five of  the six  fiscal years  immediately preceding  the                                                               
fiscal year."                                                                                                                   
                                                                                                                                
MR. BARTHOLOMEW explained:                                                                                                      
                                                                                                                                
     There is a reason we had  to put that wording in there.                                                                    
     If we just said - take  the average market value of the                                                                    
     last five  years - that  includes the year  that you're                                                                    
     in. So,  the Legislature just completed  their work and                                                                    
     they've  appropriated  next  year's  budget,  but  they                                                                    
     still don't  know how much  will be available  from the                                                                    
     permanent fund until we get  to June 30. So, they start                                                                    
     their work in  January and we're doing  the budget, but                                                                    
     we  don't  know  what's  available.  That's  why  we're                                                                    
     saying go back one more year  - going back six years so                                                                    
     that we  know a year  early. So,  a year ahead  of time                                                                    
     the  Legislature  and  the  administration  would  know                                                                    
     what's going  to be available  from the  permanent fund                                                                    
     in the  future. It's  to give a  whole level  of surety                                                                    
     and not have to do all these projections.                                                                                  
                                                                                                                                
Page 2, lines  9 - 12, is a transitional  provision. It says that                                                               
right  now  the  permanent  fund  is  two  pools  of  money,  the                                                               
principal  and  earnings reserve.  Attorneys  wanted  to make  it                                                               
perfectly clear  that the earnings  of the permanent fund  at the                                                               
time people vote  on this becomes part of the  permanent fund and                                                               
is subject the constitutional protection.                                                                                       
                                                                                                                                
The last change is on page 2, line  13, that says since this is a                                                               
constitutional amendment,  it will  go before  the voters  of the                                                               
state  of  Alaska  at  the  next general  election  which  is  in                                                               
November 2004.                                                                                                                  
                                                                                                                                
REPRESENTATIVE WHITAKER said  he was comparing SJR 18  and HJR 26                                                               
and the  only difference he  could see is on  page 2, line  2 and                                                               
asked if that is the only one.                                                                                                  
                                                                                                                                
MR. BARTHOLOMEW replied that is exactly  right. Lines 2 - 3 are a                                                               
policy statement and the House version doesn't have that.                                                                       
                                                                                                                                
MR. RICH SEIFERT,  Professor at UAF, endorsed the POMV  idea as a                                                               
sound  approach. About  a year  ago, he  brought up  his concerns                                                               
about corporate  crime and the  erosion of the permanent  fund to                                                               
the board and  he didn't think it had been  adequately dealt with                                                               
at the national level.                                                                                                          
                                                                                                                                
     If our equity  is 50 percent in the  stock market, it's                                                                    
     all right to have the  prudent investor rule hold sway,                                                                    
     but it's only a prudent  investment if you're not being                                                                    
     defrauded.                                                                                                                 
                                                                                                                                
He  said  that  people  voted to  protect  the  fund's  principal                                                               
originally. One  of the  best ways  they could  protect it  is to                                                               
invoke an income tax. "What  would be the incentive to inflation-                                                               
proof the  fund if the  Legislature has  available to it  a fixed                                                               
well known  amount of money, maybe  half of the 5  percent, every                                                               
year?"                                                                                                                          
                                                                                                                                
He also  wondered if  changing to this  formula would  change the                                                               
IRS status.                                                                                                                     
                                                                                                                                
CHAIR  SEEKINS  said he  likes  the  predictability of  the  POMV                                                               
regardless of  what other sources  of revenue there might  be out                                                               
there.                                                                                                                          
                                                                                                                                
MR.  ELEAZAR BAKER,  Fairbanks resident  since territorial  time,                                                               
said he  will be  retiring soon  and will need  to depend  on the                                                               
dividend as part of his fixed income.                                                                                           
                                                                                                                                
SENATOR THERRIAULT asked  him if he took the  long-term view that                                                               
inflation proofing  should always be assured  or the shorter-term                                                               
view of a higher dividend.                                                                                                      
                                                                                                                                
MR. BAKER  replied he doesn't  care about a higher  dividend, but                                                               
he does care about the stability of the fund.                                                                                   
                                                                                                                                
SENATOR  THERRIAULT  asked  if  he  would  like  to  see  a  more                                                               
predictable payout as opposed to widely divergent amounts.                                                                      
                                                                                                                                
MR. BAKER replied  that the more they can put  the formula in the                                                               
constitution, the safer it will be from attack.                                                                                 
                                                                                                                                
MR.  JERRY MACBETH,  Fairbanks  resident, said  he  works at  the                                                               
University  and looked  at the  financial spreadsheet  projection                                                               
comparison of  the status  quo versus  POMV. The  projection from                                                               
2003 to 2012  under the status quo has the  fund growing from $24                                                               
billion to $40  billion; and under the POMV, the  fund would grow                                                               
from $24 billion  to $33 billion - $7 billion  less. He wanted to                                                               
know where that $7 billion is.                                                                                                  
                                                                                                                                
MR.  BARTHOLOMEW explained  that this  particular scenario  shows                                                               
that the Legislature  appropriated for usage of the dividend.                                                                   
                                                                                                                                
     So,  the top  half just  shows  each year  how much  we                                                                    
     earned, payment of dividend and  then we go to the next                                                                    
     year.  Under  POMV, we  assumed  the  entire 5  percent                                                                    
     that's  available -  we wanted  to show  that scenario.                                                                    
     It's not an apples and apples.                                                                                             
                                                                                                                                
MR. MACBETH  said he  is undecided  about whether  it is  wise to                                                               
amend the  constitution to  provide the  POMV payout.  He doesn't                                                               
see  the   need  based  on   the  Legislature's   performance  of                                                               
inflation-proofing it since it was  established. He was concerned                                                               
about predictability and volatility of  the fund. If you decrease                                                               
the volatility,  you also increase  the culture of  dependence on                                                               
the permanent  fund dividend,  which he  thinks is  unhealthy for                                                               
the state's development over the long term.                                                                                     
                                                                                                                                
MS.   MARY  NORDALE,   private   attorney,  said   she  was   the                                                               
Commissioner of  the Department of  Revenue from 1984 -  1986 and                                                               
was  a member  of  the Permanent  Fund Board  of  Trustees.   She                                                               
commented:                                                                                                                      
                                                                                                                                
     In 1986  what we had anticipated  within the department                                                                    
     during 1985 happened and that  was the big crash in the                                                                    
     price of oil. And we had  to scramble around and try to                                                                    
     figure out  how to  dig about $800  million out  of the                                                                    
     budget for FY87. That faced  legislators when they came                                                                    
     to  Juneau in  1987 and  it was  a very,  very, painful                                                                    
     period, as you well know. At  the time, in 1984, as has                                                                    
     been  noted  earlier,  the  constraints  on  investment                                                                    
     opportunities  for  the fund  were  very  severe. As  a                                                                    
     consequence,  inflation  proofing  as an  element  that                                                                    
     needed  to   be  taken   into  account   was  extremely                                                                    
     important because the bulk of  the fund was invested in                                                                    
     fixed  income.  The  effects  of  inflation  were  more                                                                    
     severe at that time on  those investments than it would                                                                    
     be in the equity market -  this would be over time. So,                                                                    
     I am very  much supportive of the  Senate Resolution. I                                                                    
     hope  if  it  does   pass,  that  it  incorporates  the                                                                    
     language of  the policy statement because  that is both                                                                    
     a  pledge  to  the  people  and  a  constraint  on  the                                                                    
     investment  technique  opportunities available  to  the                                                                    
     trustees.  It's a  joint effort  to retain  the fund  -                                                                    
     permanently retain its integrity and keep it growing.                                                                      
                                                                                                                                
     When  you are  considering,  however, opportunities  to                                                                    
     fund our state, I hope  you will not dismiss lightly an                                                                    
     income  tax.   I  served  on  a   long-range  financial                                                                    
     planning  commission  in  1995,  which  recommended  an                                                                    
     array of spending cuts and  revenues to avoid the crash                                                                    
     that we predicted in 2005.  That is when we figured the                                                                    
     state would  hit the  wall if no  changes were  made in                                                                    
     both spending and in revenues.  The problem is not that                                                                    
     the  permanent fund  earnings  are  not available;  the                                                                    
     problem is that most of  the programs that absorb a lot                                                                    
     of  the  state's  revenues   are  population  driven  -                                                                    
     schools,  welfare  payments,   support  of  Medicaid  -                                                                    
     whatever.  But, you  will see  that most  of the  large                                                                    
     items in the budget are  population driven and the only                                                                    
     income source  available to the  state at this  time is                                                                    
     an income  tax. If you  go to  a sales tax,  all you're                                                                    
     doing  is   taking  out  of  the   pockets  of  smaller                                                                    
     communities and  putting it in  the hands of  the state                                                                    
     which is  not a  fair exchange at  all, because  in the                                                                    
     long run,  it's a  benefit to  the state  to strengthen                                                                    
     local government.  Getting back to the  original point,                                                                    
     I  firmly  support  the  resolution   and  I  hope  the                                                                    
     Legislature will adopt it...                                                                                               
                                                                                                                                
SENATOR THERRIAULT  said an income  tax sort of  supercharges the                                                               
redistribution of  wealth by,  for instance,  taxing his  and his                                                               
wife's  $2,000 worth  of  dividends  at their  tax  rate and  not                                                               
necessarily taxing  his neighbor  who might not  be in  a taxable                                                               
category at all and who has  access to all the different sorts of                                                               
welfare available.                                                                                                              
                                                                                                                                
MS. NORDALE  replied that might be  true, but if you  own a share                                                               
of stock  in General Motors  and she owns  a share, you  will pay                                                               
federal income tax  at a different rates because  the incomes are                                                               
different. That is part of the whole system.                                                                                    
                                                                                                                                
     I don't see  how we can make an adjustment  in terms of                                                                    
     the dividend to  affect some sort of  super equality, a                                                                    
     negative  income tax,  just to  protect the  person who                                                                    
     might,  because of  a higher  income,  pay more  income                                                                    
     tax. I think one of things  you need to realize is that                                                                    
     the dividend  is taxable by the  federal government. If                                                                    
     it were taxable  as income here in the  state, it would                                                                    
     be money  that would stay  in the  state and not  go to                                                                    
     the federal government.                                                                                                    
                                                                                                                                
CHAIR SEEKINS said  that only the portion that came  to the state                                                               
couldn't be taxed by the federal government.                                                                                    
                                                                                                                                
MS. NORDALE responded  that under the old system  of taxation, 16                                                               
percent of  federal tax went  to the  state treasury and  that is                                                               
better than nothing, basically.                                                                                                 
                                                                                                                                
MR. CARY DEWIT  said he thinks the POMV  makes sense particularly                                                               
the part  that allows the  Legislature to predict how  much money                                                               
is coming in  ahead of time. However, he is  concerned if this is                                                               
in the form of a  constitutional amendment. He suggested that the                                                               
5 percent figure  not be fixed there, but be  made to reflect the                                                               
actual market  growth. He  also read  something in  the Fairbanks                                                               
paper about including a cap on government spending.                                                                             
                                                                                                                                
CHAIR SEEKINS said that is in  a separate bill that Senator Dyson                                                               
had introduced.                                                                                                                 
                                                                                                                                
MR. DEWIT said he also supports  an income tax. It is the fairest                                                               
and  most  sensible  way  of providing  a  long-range  source  of                                                               
revenue for the state.                                                                                                          
                                                                                                                                
SENATOR THERRIAULT remarked that  it's acceptable public sport in                                                               
America to distrust  anyone who has anything to  do with spending                                                               
a  public dollar.  He asked  why  an income  tax would  magically                                                               
transform that.                                                                                                                 
                                                                                                                                
MR. DEWIT replied  when a person sees a  solid connection between                                                               
money going  out of  their pocket  into government  revenue, they                                                               
are going to be much more interested in how that money is spent.                                                                
                                                                                                                                
TAPE 03-55, SIDE A                                                                                                            
                                                                                                                              
SENATOR  THERRIAULT commented  there isn't  that dynamic  when he                                                               
and thousands of other people write their property tax check.                                                                   
                                                                                                                                
MR. DEWIT said maybe there is a public apathy problem.                                                                          
                                                                                                                                
MS.  MARY BISHOP,  Fairbanks resident,  said  she is  on a  fixed                                                               
income  and  definitely  supports inflation  proofing.  She  also                                                               
supports  the  Legislature  and the  administration  knowing  the                                                               
amount  available  for appropriation  one  year  in advance.  She                                                               
wondered  if that  would  also  mean knowing  the  amount of  the                                                               
dividend ahead of time as well.                                                                                                 
                                                                                                                                
MS. BISHOP  said that this proposal  seems to allow the  state to                                                               
use  some  of the  money  for  their  regular budget,  which  she                                                               
doesn't think happened before.                                                                                                  
                                                                                                                                
CHAIR SEEKINS clarified  that every year millions  of dollars are                                                               
spent out of the permanent fund  on things like public safety and                                                               
hold  harmless agreements.  This year  it amounts  to around  $40                                                               
million.                                                                                                                        
                                                                                                                                
MS. BISHOP  asked who decides how  much of the 5  percent goes to                                                               
pay dividends and how much will pay for government.                                                                             
                                                                                                                                
SENATOR THERRIAULT replied all that  is under discussion. Current                                                               
wording is just up to 5  percent and the Legislature could have a                                                               
statutory scheme  on how  the dividend  would be  calculated. The                                                               
current statutory  computation of  the rolling  five-year average                                                               
could be retained.                                                                                                              
                                                                                                                                
CHAIR SEEKINS  added that currently  the Permanent Fund  Board of                                                               
Trustees  is able  to determine  the size  of the  dividend to  a                                                               
degree  by deciding  whether or  not  to sell  or retain  shares.                                                               
Right now the  size of the realized income is  a function of what                                                               
the board  and the executives  instruct the managers to  do. "You                                                               
can play god with the size of the earnings now."                                                                                
                                                                                                                                
MR.  BARTHOLOMEW  said their  goal  is  to  earn 5  percent  over                                                               
inflation. Their consultants estimate  that going forward for the                                                               
next five years they  are going to do 8 percent  or a little less                                                               
and inflation is going  to be 3 percent or a  little less. If you                                                               
leave 3  percent in  the fund,  you have 5  percent to  spend and                                                               
they  don't know  what the  capital markets  might do.  Inflation                                                               
might go  up, which could affect  how much interest you  get from                                                               
bonds.                                                                                                                          
                                                                                                                                
SENATOR THERRIAULT  commented that it  would be very handy  to be                                                               
able to  know how much money  they are working with  and the only                                                               
thing  that would  give the  Legislature surety  would be  if all                                                               
state revenues  went into the  permanent fund and  the percentage                                                               
draw off  limited every  year. This was  originally known  as the                                                               
Cremo Plan  after the  person who developed  it years  ago. Right                                                               
now,  corporate  taxes, rents  and  royalties  still need  to  be                                                               
projected.                                                                                                                      
                                                                                                                                
MR.  DAN REVERO,  North Pole  resident, said  he opposes  a state                                                               
income tax,  but is inclined to  favor a sales tax  to spread the                                                               
money to municipalities. He supports the POMV.                                                                                  
                                                                                                                                
CHAIR  SEEKINS asked  further questions  or further  questions or                                                               
comments.                                                                                                                       
                                                                                                                                
SENATOR THERRIAULT said  this year the Legislature  used 17(b) of                                                               
the  constitution  to get  access  to  the constitutional  budget                                                               
reserve with  a simple majority, but  to do so, they  had to make                                                               
an advance appropriation for  the next year's inflation-proofing,                                                               
leaving $100  million in  the earnings reserve.  At the  time, it                                                               
was projected  to have $360  million; the $260 million  was moved                                                               
in advance.  He asked  Mr. Bartholomew  what the  advance deposit                                                               
would be under  the proposal. Currently, everything  in excess of                                                               
$100 million is moved into the principal of the permanent fund.                                                                 
                                                                                                                                
MR.  BARTHOLOMEW responded  that  one of  the  components in  the                                                               
letter of  explanation is that  the Legislature would  take money                                                               
out  of the  earnings reserve  and  move it  into the  principal,                                                               
earmarking that for  next year's inflation proofing.  At the same                                                               
time  next year's  inflation proofing  appropriation is  repealed                                                               
and moved ahead one year.                                                                                                       
                                                                                                                                
     To give you the perspective  of inflation, last year it                                                                    
     took $600  million to fully inflation  proof. This June                                                                    
     30  that will  end here  in less  than one  week, we're                                                                    
     predicting  it's   going  to   take  $350   million  to                                                                    
     inflation proof. Looking forward  to next year, I think                                                                    
     we're looking at about $550  million to fully inflation                                                                    
     proof. All of  these are projections. At  the time that                                                                    
     the  Legislature made  the decision,  we projected  the                                                                    
     sweep  to be  $250 million.  So you  would have  paid a                                                                    
     little less  than half of  next year's  inflation ahead                                                                    
     of  time. The  only change  since then  as the  markets                                                                    
     have changed  and as our managers  have made decisions,                                                                    
     the amount of  realized income has risen  and we expect                                                                    
     that  transfer  or  sweep,  now,  to  be  roughly  $350                                                                    
     million. So, we're going to  sweep more and we're going                                                                    
     to  - if  you apply  that to  inflation proofing,  then                                                                    
     there  will be  less  needed next  year.  And the  only                                                                    
     other comment  is when we  get to  next year it  is the                                                                    
     balance that is in the  earnings reserve, which will be                                                                    
     the $100 million  that we're going to  start with. What                                                                    
     we will  earn next year  in realized earnings,  when we                                                                    
     get to  the end of the  year - that will  determine how                                                                    
     much is available for the  Legislature for dividends or                                                                    
     inflation proofing.                                                                                                        
                                                                                                                                
SENATOR THERRIAULT  asked him to  explain the  inflation proofing                                                               
at $600 million, going down to  $350 and that they are projecting                                                               
it to  go back  up to  $580 million.  He questioned  whether they                                                               
overestimated what's going to be needed.                                                                                        
                                                                                                                                
MR.  BARTHOLOMEW answered  that he  could make  a statement  like                                                               
that looking  at just next  month or next  year, but they  try to                                                               
get away from  one year windows. When the trustees  talk to their                                                               
consultants, they  look at  five years and  over five  years they                                                               
are projecting inflation to be  2.6 percent. "So, when I estimate                                                               
to  you  that it's  going  to  cost  $550 million  for  inflation                                                               
proofing, it's based on a five year average."                                                                                   
                                                                                                                                
MR.  SHORER  added  that  the  inflation number  is  based  on  a                                                               
calendar year and we are six months through that for this year.                                                                 
                                                                                                                                
CHAIR SEEKINS  thanked everyone for their  comments and adjourned                                                               
the meeting at approximately 8:00 p.m.                                                                                          

Document Name Date/Time Subjects