HJR 41-CONST AM: PERMANENT FUND; POMV;EARNINGS    3:22:23 PM CHAIR KREISS-TOMKINS announced that the first order of business would be HOUSE JOINT RESOLUTION NO. 41, Proposing amendments to the Constitution of the State of Alaska relating to the Alaska permanent fund, establishing the earnings reserve account, and relating to appropriations from the Alaska permanent fund. 3:23:03 PM REID MAGDANZ, Staff, Representative Jonathan Kreiss-Tomkins, Alaska State Legislature, advised that this amendment for the Constitution of the State of Alaska caps the draws on the Permanent Fund (PF) to a sustainable 4.75 percent of market value and it prevents ad hoc draws on the earnings reserve account (ERA), thereby, preventing any draws above that 4.75 percent threshold. The amendment maintains the principal and the ERA as separate accounts and prevents any spending from the principal account. 3:23:50 PM ROBERT ERVINE, Staff, Representative Jennifer Johnston, Alaska State Legislature, added that HJR 41 represents the consensus point discussed around the legislature as a whole, and it is the beginning of a conversation. It appears, he offered, that many legislators believe ad hoc draws are a bad idea because it changes the way in which the fund is managed, and the state needs some type of sustainable draw. REPRESENTATIVE BIRCH asked whether there is a reason this resolution cannot take place in statute, noting the hurdle it is to get anything through the whole constitutional amendment process. Basically, he said, at this point the $40 billion in the fund is fully fenced off and is constitutionally protected via the 1976 public vote for the PF. He further asked whether there is any reason the legislature could not set up something similar if it had the same net result, and then work to put it into statute. 3:25:30 PM REPRESENTATIVE WOOL referred to Mr. Ervine's statement regarding a consensus amongst the legislators and asked whether those were anecdotal water cooler discussions and whether that was "just your vibe." MR. ERVINE answered that Representative Wool was correct. CHAIR KREISS-TOMKINS added that another iteration of this idea is where a percent goes to the dividends and a percent is available for appropriation for public services. He noted that it could be 50/50, or 25/75, or many different versions, "and just not even going there and just starting with the most basic notion, which is, What is a sustainable draw of the PF?" 3:26:16 PM REPRESENTATIVE WOOL referred to the statement that this legislation would prevent ad hoc draws out of the ERA constitutionally, but yet there would still be an ERA and a PF corpus. He asked the reason for not merging it all into one if there are no ad hoc draws out of the ERA. MR. MAGDANZ responded that the main effect for not merging the accounts is that under this amendment, the $40 billion in the principal that Representative Birch mentioned would remain untouchable and un-spendable. For example, he said, if the market suffered a significant downturn immediately after passing this amendment, that $40 billion would remain protected and would still be unavailable for spending under any scenario. 3:27:15 PM REPRESENTATIVE WOOL pointed to the statement that this legislation would prevent ad hoc draws out of the ERA, and therefore the ERA would simply be the entity from which the 4.75 percent is drawn. He surmised that one is a checking account and the other is a savings account, but if there are no draws from it, it could ostensibly be looked at the same. He then clarified that when he said, "no draws," he meant other than the 4.75 percent. MR. MAGDANZ offered a hypothetical wherein for the next eight years the PF earned zero returns, and if 5 percent a year was being drawn, the ERA could potentially be drawn down to zero by maintaining a separate principal and no money would be available to draw. Whereas, if the 2 funds were combined, it would be possible to draw 5 percent forever, he offered. 3:28:25 PM REPRESENTATIVE WOOL said that under that scenario, if the corpus was separate from the principal and the ERA was used up for "your draw of 4.75 percent" and the earnings was zero for 8 years, the ERA would go to zero and "we couldn't tap into the principal. Then you'd be the dilemma of, what do we do now?" MR. MAGDANZ replied that Representative Wool was correct, the state would have to find the money to fund its budget from the different sources. 3:29:10 PM REPRESENTATIVE KNOPP asked whether that is similar to what the state has today wherein the ERA is separate from the principal amount, and the corpus is already protected under the Alaska State Constitution. Other than the structured draw at 4.75 percent, he said that he does not see a whole lot of difference in what is being proposed here, other than to protect it under the Alaska State Constitution. He asked whether he was on track with his statement. MR. ERVINE answered that Representative Knopp's statement was correct. 3:29:56 PM REPRESENTATIVE KNOPP noted that it had been stated that the ERA is subject to appropriation, yet Title 34 lays out the structured draw and inflation-proofing. He remarked that members of the public have argued that the legislature is breaking its own laws by not following its laws and he somewhat agrees in that sense. Mr. Magdanz said that everything in the ERA is subject to appropriation, and he asked whether that statement evolved from a legal opinion or authority. MR. MAGDANZ responded that that statement means, for instance, this year the legislature could, with 21 votes, choose to take all of the $16 billion in the ERA, put it in the constitutional budget reserve (CBR), and choose to spend it all in a single year. This constitutional amendment would prevent that scenario from taking place, and "it would say, really, truly, the legislature can only spend 4.75 percent of market value." REPRESENTATIVE KNOPP asked that if the legislature was following its own statutes right now, it wouldn't have that option. He asked where it read that it is all subject to appropriation because the legislature does not appear to be following the laws it created a few years ago. MR. MAGDANZ responded that the problem is that the legislature does not have to follow its statutes when it comes to the budget process. 3:32:41 PM REPRESENTATIVE BIRCH noted that a couple of different terms have been used for the PF, and the sponsor statement indicates that the goal is to prevent un-sustainable spending that threatens the future value of the fund. He opined that the $40 billion in the corpus is pretty well fenced off without some sort of constitutional question for the voters. He said he does understand the earnings for the 1976 amendment that basically moved those dollars into the general fund (GF) and asked whether the corpus is threatened in any manner. MR. MAGDANZ answered that Representative Birch is correct that the $40 billion attributed to the principal is currently untouchable. The question to be had with this amendment is that the total fund value, including the ERA, is roughly $66 billion. The difference between those 2 numbers, $26 billion, is not currently constitutionally protected. This amendment would protect all $66 billion currently in the PF, he explained. 3:34:23 PM REPRESENTATIVE WOOL remarked that he has been hearing that the legislature has not been following the statute, breaking the law with zero repercussions, and that within the last two years the statutory formula for the PFD has not been followed. He noted that the governor vetoed it a few years ago, then the legislature passed a less than statutory formula, and this year it appears the legislature is on track to do it again. He asked whether this is a common occurrence. MR. ERVINE offered the current pertinent example of the "90-day limit" wherein the voters of 2006 passed an initiative limiting the legislature to a 90-day session, and the legislature has "blown by it 8 of the last 10 years," he opined. 3:35:44 PM ANGELA RODELL, Chief Executive Officer, Alaska Permanent Fund Corporation (APFC), Department of Revenue (DOR), responded to Representative Knopp's question, and advised that the Alaska State Constitution creating the PF is "very clear" that the amounts on deposit in the fund will be used for income-producing investments only, the income of which shall go to the GF, and the legislature has been given the power of appropriation over the GF. That, she explained, is the mechanism by which the legislature has the ability to fully appropriate the ERA because the ERA became the repository rather than going directly to the GF. The legislature, through statute, created a sub-fund of the GF that is the ERA, she further explained. 3:36:48 PM REPRESENTATIVE KNOPP commented that there is also "another sub- account of that, we required to put in 50 percent of the projected dividend payments out of the ERA." In the event that is the case, he asked why the legislature put that formula in statute, whether it was "almost recommended language" but not mandatory as far as the formula for the PFD payouts. MS. RODELL noted that she was not here at the time of the debate as to how the PF would be used or how that income would be used. She offered that it is her understanding, through the materials she has read, that part of it was to "bifurcate that debate and leave that debate for days like today, which is why the constitutional language for the PF is actually very clean and very simple." This, she explained, was the compromise achieved through statute and was in place up until 2016. Interestingly, one of the historical observations she said that she would make is that the statutory language reads that, "50 percent of the income available for distribution shall be transferred for the PFD fund program." Except, she pointed out, there was no discussion regarding what was to be done with the other 50 percent of the amount available for distribution was to be used for, and at times that was used for inflation-proofing. Inflation-proofing is another example of a statute that has not been fulfilled since 2016, and/or it was appropriated back into the principal of the fund. There is almost $7 billion of additional appropriations outside of inflation-proofing and royalty deposits that comprise the $40 billion of the corpus of the fund. Therefore, she noted, one might argue that 50 percent is the amount that was available for state services that previous legislatures chose not to appropriate, but rather leave behind the buildup of the balance in the ERA. 3:39:10 PM REPRESENTATIVE KNOPP opined that he had read a legal memorandum in the past which discussed the powers of appropriation and that is how "we got around that." He said that he was pretty sure he did not support this, but he would support the inflation- proofing in the Alaska State Constitution. He noted that when he asked why the legislature was not inflation-proofing this year, he was advised that the fund made 12 percent, "we think that's more than enough to offset inflation-proofing." He asked Ms. Rodell's opinion on that advice. MS. RODELL answered that she strongly disagrees with that advice. The principal of the account only gets what the legislature chooses to appropriate back in, outside of the mandatory 25 percent. Therefore, she explained, all of those earnings are available for appropriation, and none of it - "not one penny of it" - is available to the principal of the account. In response to Representative Kopp's earlier comment, under Wielechowski v. State of Alaska, [403 P.3d 1141 (Alaska 2017)], there was a great deal of discussion as to the powers of appropriation on the ERA and the requirement of an appropriation for both a dividend and inflation-proofing, she offered. She said the decision had been made in 2017 by the Alaska Supreme Court. 3:40:48 PM CHAIR KREISS-TOMKINS asked whether in the House of Representative and Senate's operating budgets, either body is inflation-proofing this year. MS. RODELL responded that the budget passed by the House of Representatives and sent to the Senate includes inflation- proofing of $942 million for fiscal year (FY)19, it does not include restoring the inflation proofing amounts totaling $1.4 billion from FY16 through FY18. The Senate Finance Committee is discussing the current committee substitute (CS) in which inflation-proofing is not addressed, she said. CHAIR KREISS-TOMKINS noted that within three of the last four years, the legislature has not inflation-proofed but this year there is inflation-proofing within the operating budget that passed the House of Representatives. 3:41:54 PM REPRESENTATIVE KNOPP offered that the Senate Finance Committee moved the budget out of committee today without inflation- proofing, and that was his concern. CHAIR KREISS-TOMKINS commented, "Mine as well." 3:42:07 PM REPRESENTATIVE BIRCH commented, "Mine as well." He noted that the PF board has long suggested that a percentage of market value (POMV) might be a reasonable approach to provide a predictable and sustainable level of revenue to the state for whatever purpose. There had been some discussion around how to structure a POMV draw on a reliable basis, on an annual basis, and asked whether Ms. Rodell had experience in other large funds. He said he supports the idea of a POMV but worries about the entanglement of trying to get a constitutional amendment [passed], and how to get there without going through this exercise. MS. RODELL opined that it absolutely can be accomplished through statute. A number of statutes have been proposed since 2015, and HB 26 progressed the farthest in the legislative process. The challenge legislators face on the statutory front is that statutes were followed completely for 35 years and were not open for debate. Even though, she offered, legislators had been told that "this money" was available for appropriation, they could cut the dividend, they could cut inflation-proofing, that "this is your power under the constitution," it was done as a matter of course and there was no questioning about that, she said. She opined that the concerns being heard about a statutory solution versus a constitutional solution, is the recognition of the legislature's power of appropriation and what that means. It means, she explained, not appropriating for anything that is subject to appropriation and instituting that sort of political dynamic into those things that, which in the past were not viewed as political. From the standpoint of the APFC, it would appreciate a solution of any kind at this point because this "sort of ongoing year after year, not knowing, is very troubling." In the event there was consensus around a statute, she said that she personally believes legislators would follow the newly created statute. Having said that, she offered, a constitutional amendment provides a level of comfort that a statute "just can't get us there." 3:45:35 PM REPRESENTATIVE KNOPP reiterated that he believes putting the PFD or the ERA in the Alaska State Constitution is poor public policy. He described the Alaska State Constitution as a framework of guiding principle, not to enshrine everything "that you think needs to be in there." Although, he said, he does support a constitutional amendment with regard to inflation proofing. He noted that SB 26 does provide a structured draw, he likes that it has a three-year component, and since the future is unknown, he would like Ms. Rodell's opinion. MS. RODELL responded that she found HJR 41 interesting because it is very simple, it is a draw, and how the legislature spends that draw is entirely still open for debate. The amount being drawn out of what the state has historically referred to as the PF, is set at 4.5 percent. The three-year lookback is key to SB 26 being successful because it will provide the necessary information as to whether it is being overdrawn and if it needs to be reset, she advised. She acknowledged that the committee is not speaking to SB 26, but it has a mechanism for inflation- proofing with a recognition of the need for some inflation- proofing on the principle of the fund. She referred to the hypothetical offered by Mr. Magdanz regarding eight years of zero percent and spent down the ERA, "you still wouldn't touch the $40 billion." Ms. Rodell argued that that is possibly why there is a need to have a mechanism to move some of the ERA periodically over into the principal, some of those earnings to boost that up. She explained if the goal is to truly try to keep that limiter in there, then that is how to continue maintaining its purchasing power. In any event, she explained, this constitutional amendment makes a simple straight-forward 4.75 percent draw, and it limits it to the amounts in the ERA. The APFC can support this type of constitutional amendment, she said. 3:49:05 PM REPRESENTATIVE WOOL reminded the committee that it recently saw a version of this bill that had a 5 percent draw and now it is at 4.75 percent, he asked whether something had taken place within the last 10 days and what will happen in the next 10 days. CHAIR KREISS-TOMKINS explained that the version was a work draft and was not put on the record because there are different schools of thought as to what constitutes a sustainable draw. MS. RODELL replied that the board has had a long-standing resolution in place supporting 5 percent. Obviously, 4.75 percent is more sustainable than 5 percent because less is being removed, but that percentage amount is a call for the policy makers, she said. CHAIR KREISS-TOMKINS added a comment to the question of sustainability and advised that he and his staff recently spoke with Greg Erickson, former publisher of the Budget Report, who is a staunch advocate of a 4 percent draw. 3:50:28 PM REPRESENTATIVE WOOL noted that the presenters initially said this was a 4.75 percent sustainable draw. However, he pointed out, when presented with the hypothetical of 8 years with zero returns, suddenly the 4.75 percent may not be sustainable so possibly it should not be placed in the Alaska State Constitution. He offered that no one expects zero returns for eight years, yet that is why there is a barrier between the ERA and the principal. MS. RODELL answered that it is important to talk about doomsday scenarios in order to create an awareness that the future is unknown in terms of investing and markets. In terms of the stress analyses that APFC ran, it believes that 4.75 percent and 5 percent are reasonably sustainable numbers for draws. She opined that the three year look back becomes an interesting question and she suspects that if this happened, there will come a time when she is sitting in front of the committee discussing the balance in the ERA, the performance of the investments, and whether overdraws will potentially occur at some point. Therefore, she advised, part of what is helpful in this constitutional amendment is smoothing it out, "out of 5 of the last 6, so you're really creating a long time period, and the effective draws then end up being significantly less than the nominal draw of 4.75 percent or 5 percent." 3:53:16 PM REPRESENTATIVE WOOL noted that Ms. Rodell commented that the APFC would like to see some type of structure "like this," thereby removing the uncertainty that APFC has faced during the last few years. He asked whether it is simply the anticipation of a draw that puts the corporation on edge. MS. RODELL referred to her testimony a few weeks prior when she discussed what it means to be prudent investors and advised that it means following a formal portfolio theory that takes into account distributions. When the board assembles its asset allocation and determines how to invest the fund, it should also take into account the distribution requirement except, currently, it does not have a distribution requirement, so it is anything between zero and 100 percent. Therefore, she pointed out, the board tries to successfully manage through that in order to deliver maximum returns to the state while also recognizing that the principal must be protected and "not go all in on black, as they say." She explained that having this structure in place will provide the sideboards through which the board can then make very real determinations as to how much can be put into illiquid investments like real estate, like private equity that generates the big returns. 3:55:18 PM REPRESENTATIVE WOOL noted that Ms. Rodell stated that she preferred a constitutional formula like this, as opposed to statutory because statutes can be ignored to some extent. As far as the structure of the fund itself, (audio difficulties) constitutional draw of up to 4.75 percent, and he would like to see "it just one super fund," a true endowment. CHAIR KREISS-TOMKINS commented that "super funds" are something else. REPRESENTATIVE WOOL (audio difficulties) consistent draw of 4.75 percent, what remains in the fund essentially counts as inflation-proofing. He continued, "And, if you took too much, then it wasn't inflation-proofing, well then you've taken too much. And so, you have a set fund with a set draw and that's it. And, I know the answer but I'm going to ask anyway, would that be your preference in the hierarchy of options here?" MS. RODELL answered that that would absolutely be "our preference." [HJR 41 was held over.]