HJR 19 - CONST. AM: PERMANENT FUND P.O.M.V. 1:45:03 PM CHAIR McGUIRE announced that the next order of business would be HOUSE JOINT RESOLUTION NO. 19, Proposing amendments to the Constitution of the State of Alaska relating to and limiting appropriations from the Alaska permanent fund based on an averaged percent of the fund market value. 1:45:14 PM TERRY HARVEY, Staff to Representative Bruce Weyhrauch, Alaska State Legislature, relayed on behalf of the House Special Committee on Ways and Means, sponsor of HJR 19, that the resolution proposes changing the Alaska State Constitution to require inflation proofing of the entire permanent fund through the use of a system known as percent of market value (POMV). After noting that this is the same legislation that passed the house last year as House Joint Resolution 26, he explained that if passed by the legislature, HJR 19 would place an initiative on the next statewide ballot for approval. This is not about the permanent fund dividend (PFD), he assured the committee; rather, this is about using the most effective modern means to manage $30 billion. The goal of the resolution is to ensure that the fund is invested prudently and without interference. The resolution aims to achieve this goal by giving fund managers a target to hit, the flexibility to hit it, and the independence to do it efficiently. In conclusion, he relayed that representatives from the Alaska Permanent Fund Corporation (APFC) were available to answer questions. 1:46:49 PM MICHAEL J. BURNS, Executive Director, Alaska Permanent Fund Corporation (APFC), Department of Revenue (DOR), offered the following comments: First of all, I would like to emphasize that the [Board of Trustees of the Alaska Permanent Fund Corporation] do not see POMV as a "fiscal plan"; POMV would not allow the legislature greater access to the earnings of the fund, and, in fact, in most years, would lower the amount available for appropriations compared to our current system. The trustees believe that the implementation of POMV and the use of permanent fund earnings are two separate issues. [Percent of market value] is, one, predictable, but much more importantly we think it is understandable by the people of Alaska. Is it any wonder that people are confused and easily mislead by the arcane nature of our fund's distribution formula? We manage the fund with a methodology simply based upon real return. This is quite simply the total return of the fund minus inflation - [this] gives us a real return. This is how public and private foundations, pension funds, and endowments, and their trustees, directors, and managers view their fiduciary duty and assignment. What is broken then? The current statutory "realized income-based distribution formula" is the culprit. As opposed to the "real return" methodology, we are using the confusing and misunderstood formula, or the Alaska version of, "return" and "income." MR. BURNS continued: Let me walk you through that calculation just for a moment. This starts with income, which is dividends, interest, and rent. To that we add or subtract gains and losses, both realized and unrealized. From that we subtract operating expenses, from that we subtract any appropriations, and we get to what is referred to as "accounting net income." From this, we subtract unrealized net income, and this gets us to realized net income. From that we subtract any earnings associated [with] ... the Amerada Hess [litigation] monies. This gets us to statutory net income; this is what's used in the distribution formula. Confusing, out of date, and unworkable are but a few of the adjectives that come to mind. How did we get to this state of confusion? When the fund was created it was prudent to restrict its investment authority to a "bond only" strategy. That being the case, it is important to remember that a bond portfolio generates income in two ways: interest or coupon income received, and capital gains from bonds sold at appreciated prices. These are both traditional realized income, and the distribution formula based upon this concept made perfect sense - at the time. However, because the fund's asset allocation now incorporates investments that generate significant unrealized gains as well as realized income, the current payout methodology and protection of principal no longer serve the fund as well as they once did. The trustees believe that only a percent of market value payout, limited by the sustainable yield from the fund, can provide the necessary protection for the fund while allowing current generations their equitable share of fund earnings. Furthermore, they believe that the only way to ensure full protection for the fund is to place this limit in the Constitution. MR. BURNS concluded: The percent of market value proposal is simple: no more than 5 percent of the market value of the fund, averaged over the previous five years, may be appropriated from the fund. This leaves a minimum of 95 percent of the fund protected from spending in any given year. As I noted earlier, POMV is not a fiscal plan. And I must admit, with oil in the $50 range, your interest [in] and focus on a fiscal plan may well be elsewhere. But is this not the opportune time to modernize and increase the transparency of the fund so that it can not only be managed in harmony with its distribution formula, but also understood by Alaskans when other decisions have to be made? Modernization, clarity, better protection - I urge the committee members to support this proposal, and [I'm] prepared to answer any questions that you may have. 1:52:03 PM REPRESENTATIVE GARA suggested that a POMV proposal might pass if people were assured that their PFDs wouldn't be reduced as a result, and offered his understanding that such a stipulation could be part of a POMV methodology. MR. BURNS said that the APFC will do whatever the legislature requires, but would prefer that it not be forced into realizing income when doing so would not be in the best interest of the investment performance of the fund. In response to a question, he explained that the APFC does not wish to become involved in the legislature's policy decision regarding PFD payout amounts. CHAIR McGUIRE said that all the significant, major trusts in the world of which she is aware have been managed for years and years with great success in the way that HJR 19 is proposing for the permanent fund. She indicated that although some are concerned with how to assure the voters that adopting a POMV methodology will not result in a decrease in their PFDs, her concern centers on the financial aspects of managing the fund, and remarked that she would rather the APFC focus on managing the fund in such a way that it continues to grow and benefit all of Alaska. She suggested that perhaps the two seemingly differing concerns could both be addressed via a POMV methodology that contains stipulations with regard to PFD payouts. 1:58:25 PM LAURA ACHEE, Research and Communications Liaison, Alaska Permanent Fund Corporation (APFC), Department of Revenue (DOR), remarked that under the APFC's point of view, a POMV methodology gets to the issue of how money is paid out of the fund while also limiting the amount paid out of the fund to what the trustees believe is a sustainable yield. Therefore, although it is possible that a POMV methodology might have an effect on PFD amounts during years when the PFD calculation results in a figure greater than 5 percent, it would be accurate to say that the actual calculation for the PFD is not changing. She offered her belief that the most logical approach is to change the dividend statutes to conform to a POMV methodology so that the APFC will no longer have to keep two sets of books as is currently the case. She concluded by noting, however, that the APFC will accommodate the legislature's wishes regardless of whether they involve keeping two sets of books or maintaining PFD payouts at a specific amount even under a POMV methodology. CHAIR McGUIRE offered a hypothetical example wherein the current PFD calculation results in payouts that exceed the proposed 5 percent amount, and asked what kind of an effect making those higher payouts would have on future generations. MR. BURNS offered his belief that the endowment concept coupled with a POMV distribution formula will provide the fairest way for all generations to benefit from the fund, that such will result in generational equity. MS. ACHEE indicated that for at least the next 10 years, the APFC is not anticipating that the payout calculation will result in an amount even close to 5 percent. CHAIR McGUIRE indicated, however, that the possibility that a payout calculation could exceed 5 percent in the future is still of concern to her. MS. ACHEE, in response to questions, explained what the various charts provided in members' packets illustrate, and that at the end of every month, the APFC accounts for both unrealized gains and realized gains. REPRESENTATIVE COGHILL asked whether, in converting to a POMV methodology, the APFC will have to reevaluate the value of the fund and, if so, whether there is the possibility that the value of the fund will change. MR. BURNS explained that the only unrealized gains that are changed during the end-of-month accounting are marketable securities, and that real estate is carried at cost plus improvements, though for performance measures, the APFC does mark up real estate internally. In response to a further question, he said that [realized gains] from real estate are not listed in the books until the real estate is sold, adding that such is considered to be a generally accepted accounting practice. MS. ACHEE, in response to questions, reiterated her earlier comments regarding the aforementioned charts and the fact that a POMV methodology would not in and of itself change the current dividend calculation. MR. BURNS added that all a POMV methodology does is measure how much permanent fund money is made available for appropriation by the legislature. REPRESENTATIVE COGHILL characterized the change proposed by HJR 19 as a spending limit, and concluded that as such, passage and adoption of the proposed change could result in a lower dividend for Alaskans. 2:12:44 PM MR. BURNS concurred with that summation, adding that both the current distribution formula and the proposed POMV methodology make calculations based on five-year averages, and this acts to buffer [the payout] from market swings. REPRESENTATIVE GRUENBERG mentioned that his concern is that HJR 19 allows the legislature to invade the principal of the permanent fund, and therefore he does not support [the resolution]. MR. BURNS said that the concept of "principal" and "earnings reserve" do go away under an endowment concept, and that is the reason for using a conservative number to base the distribution formula on. He went on to say: Most of the projections that we put forth assumed a 5 percent real return after inflation, which is almost 8 percent. ... If you take a five-year growing fund at that basis and have a five-year average, you're really not paying out 5 percent. The math on a fund that grows just at the rate of inflation is about 4.65. ... So ... I think it falls within a very acceptable range of not invading the historical concept of principal. But that's not to say it certainly couldn't happen. REPRESENTATIVE GRUENBERG opined that the people won't draw that distinction, and concurred that under a POMV methodology, the permanent fund will no longer have a dividing line between principal and earnings. MR. BURNS opined that a POMV methodology will provide the permanent fund with more protection than it currently receives, since the amount currently available for appropriation is markedly higher than what it would be under the proposed POMV calculation. 2:17:08 PM CHAIR McGUIRE, after ascertaining that no one else wished to testify, closed public testimony on HJR 19. CHAIR McGUIRE relayed that she has been asked to forward the resolution on to the House Finance Committee. REPRESENTATIVE GRUENBERG mentioned that the House Special Committee on Ways and Means might introduce a bill that would institute a POMV methodology via statute. 2:18:54 PM REPRESENTATIVE GARA mentioned municipal revenue sharing via a municipal dividend; indicated that he doesn't want to impact the principal of the permanent fund; and offered his understanding that even under a POMV methodology using 5 percent, depending on market conditions, it would still be possible to decrease the principal of the permanent fund. He asked members to consider incorporating a provision that stipulates there will be no invasion of the principal. 2:21:03 PM REPRESENTATIVE COGHILL offered his belief that simply saying no more than 5 percent will be available for appropriations will be sufficient, particularly if the APFC uses a prudent method of evaluating the fund. He pointed out that nothing in the resolution says that the entirety of that 5 percent must be appropriated. In conclusion, he said he doesn't want to put in the constitution items that are appropriately matters of legislative policy discussion. REPRESENTATIVE COGHILL moved to report HJR 19 out of committee with individual recommendations and the accompanying fiscal notes. REPRESENTATIVE DAHLSTROM objected. 2:23:20 PM A roll call vote was taken. Representatives McGuire, Coghill, Kott, and Gruenberg voted in favor of reporting HJR 19 from committee. Representatives Dahlstrom and Gara voted against it. Therefore, HJR 19 was reported from the House Judiciary Standing Committee by a vote of 4-2.