HB 165-APPROP: EARNINGS RESERVE TO PERM FUND  11:35:40 AM CHAIR SPOHNHOLZ announced that the first order of business would be HOUSE BILL NO. 165, "An Act making a special appropriation to the Alaska permanent fund; and providing for an effective date." 11:35:54 AM REPRESENTATIVE JONATHAN KREISS-TOMKINS, Alaska State Legislature, prime sponsor, introduced HB 165. He explained that the proposed legislation was a vehicle for contemplating the transfer of money [$4.35 billion] from the earnings reserve account (ERA) to the principal of the Alaska permanent fund to be protected in perpetuity for future generations of Alaskans and from legislative spending. He noted that he had introduced similar legislation last year; further, that this notion had been implemented in past budget cycles via amendments to the operating budget, which were bipartisan, bi-caucus, and bicameral. He stated that as the bull market continued, he wanted to propose HB 165 as a vehicle for exploring another transfer from the ERA to the principal - especially given the legislature's "pent up budget angst" due to the drainage of the state's savings accounts. Consequently, he believed that the ERA was at risk more than ever before of being overspent - much like the other accounts that the legislature had at its disposure over the last decade. He concluded that the proposed legislation would be a mitigative measure against overspending. 11:38:11 AM CHAIR SPOHNHOLZ pointed out that the bill contained only three sections. 11:38:21 AM REPRESENTATIVE KREISS-TOMKINS confirmed. He noted that the bill proposed a transfer of $4.35 billion, which he characterized as a "Lorem Ipsum," or placeholder, value. He said that either Legislative Finance Division (LFD) would put forward a number or he would defer to the will of the committee. He believed that an appropriate amount was a figure that would leave three times the 5 percent POMV [percent of market value] draw in the ERA. 11:40:00 AM REPRESENTATIVE KREISS-TOMKINS provided a sectional analysis of the bill [included in the committee packet], which read as follows [original punctuation provided]: Sec. 1 $4,350,000,000 is appropriated from the Earnings Reserve Account to the Sec. 2 The appropriations made in Section 1 do not lapse. Sec. 3 There is an immediate effective date. REPRESENTATIVE KREISS-TOMKINS surmised that almost all [legislators] shared the goal of protecting and growing the permanent fund. He believed that the countervailing consideration was that if there were a market downturn, the balance in the ERA could diminish quickly leaving the legislature in a tough situation. However, he pointed out that even without a transfer of funds, that risk was always present under the current structure of the fund. He concluded that it would be a calculation of risk versus benefit for the legislature to keep in mind. 11:42:40 AM CHAIR SPOHNHOLZ opened invited testimony. 11:43:02 AM ANGELA RODELL, Chief Executive Officer, Alaska Permanent Fund Corporation (APFC), stated that this idea was one that legislators had done throughout the history of the permanent fund. She reported that more than one-third of the current principal was derived from special appropriations, which indicated their value to the fund. She emphasized that APFC's Board of Trustees recommended leaving a portion in the ERA to serve as a buffer in the event of market fluctuations. The buffer, she said, was ideally three to four times any draw amount, which the proposed legislation would conform to. 11:44:29 AM REPRESENTATIVE JOSEPHSON expressed concern about the statement of "three to four times" [the annual draw], as those were two "very different" amounts. He believed that APFC had voiced a preference of four times in previous testimony. 11:44:47 AM MS. RODELL referenced Trustee Resolution 1804, which recommended four times - an amount that was reduced to three times in Trustee Paper 9. She acknowledged that there were differenced within the trustee's own recommendations; however, she indicated that she valued a resolution over a paper. CHAIR SPOHNHOLZ inquired about the date of Trustee Paper 9. MS. RODELL stated that the paper was issued in December 2019, whereas the resolution was from 2018. 11:45:43 AM CHAIR SPOHNHOLZ sought to confirm that the paper reduced the recommended amount from four times to three. MS. RODELL confirmed that the resolution was adopted in 2018; subsequently, the trustees embarked on a paper, which studied these issues. She reported that in lesson no. 5, "Reforming the Earnings Reserve Account," the trustees reduced it to three times. 11:46:19 AM REPRESENTATIVE PRAX asked whether it made sense to reduce liquidity given the future outlook of the state. 11:47:04 AM MS. RODELL said the bill would not reduce liquidity in the fund. She clarified that the bill would reduce the amount available for future appropriations. 11:47:20 AM REPRESENTATIVE PRAX believed that because it would reduce the amount of cash available to spend, it would reduce liquidity. He opined that if an individual had lost his/her job, it would not make sense to move money from a savings account to a CD, as that person's future income was uncertain. Further, he shared his belief that the idea of preserving the permanent fund "as an end in itself" did not make sense. He pointed out that if Alaska had not received pandemic relief funding from the federal government, the legislature may have wanted to draw a considerable amount from the ERA. He added that the same situation could occur again, in which case, should the proposed legislation pass, "we would be sitting on $60 or $70 billion dollars and no ability to spend it." He questioned whether anyone had considered that. 11:49:14 AM MS. RODELL noted that firstly, this movement of money would allow it to continue to be invested similar to the current principal; therefore, it would be generating future revenues for the state. She clarified that the transfer would not preclude some spending in the future. Secondly, she conveyed that this concept was more akin to a retirement account and the restrictions placed on spending from that account when the account holder knows they need to rely on that retirement account to deliver income for 20-plus years in the future. Thus, she likened the proposed transfer to putting additional money into a retirement account. 11:50:41 AM REPRESENTATIVE STORY asked for the rationale behind changing the recommended amount. 11:51:12 AM MS. RODELL explained that the ERA collected all the statutory income of the fund, therefore, realized gains or losses flow into that account. She reminded the committee that the principal did not grow because it didn't keep any of its gains, so inflation proofing ensured that the principal held onto its purchasing power. She added that inflation proofing and the POMV [draw] came out of the ERA, as well as the POMV [draw]. Further, investment, growth, assets, and risk all impacted the ERA. Thus, the recommended figure was associated with creating a buffer to allow for obligations to be met under the current construct. 11:52:48 AM REPRESENTATIVE JOSEPHSON asked whether he should be concerned about unrealized earnings. He suggested that if the ERA was reduced in this fashion, it could change investment decisions or require liquidation that would not otherwise be necessary. MS. RODELL stated that there would be a real concern if this bill had proposed draining the ERA to zero because the buffer would be gone. She said that's when realized gains become important because if they turned to unrealized losses it could result in a negative balance in the ERA. 11:53:58 AM REPRESENTATIVE JOSEPHSON questioned whether a negative balance in the ERA was allowable. MS. RODEELL said that had never occurred. She explained that accounting and statutes were not aligned on this issue, as a negative balance was allowed under Governmental Accounting Standards Board (GASB) Rules, but not under a traditional budget reserve construct. She added that if that scenario were to occur, APFC would seek guidance from the Department of Law as to how to proceed. She expounded that from an investment perspective, an unrealized net loss could turn positive if the markets took a favorable turn, which was why a negative balance was allowed under an accounting construct. 11:55:14 AM REPRESENTATIVE JOSEPHSON remarked: When we're looking at this "three or four times" the draw test, is July 1 the wrong date to look at? Because I looked at July 1 last year, and it was either $5.3 or $5.5 billion, and that had been reduced, in my mind, by that part that was unrealized and that part that was anticipated for transfer. REPRESENTATIVE JOSEPHSON asked whether he was thinking about it incorrectly. MS. RODELL confirmed that Representative Josephson was thinking about it correctly. She stated that when the $4 billion transfer for fiscal year 2020 (FY 20) was put into the budget bill and adopted, it was "in the waterfall after all other things had been done." She said it was set at "up to" $4 billion, which had been reduced by the governor's line-item veto power. Consequently, there was a recognition that the balance on the start of July 1 might be different from what it was when the appropriation language was adopted by the legislature. 11:56:39 AM REPRESENTATIVE EASTMAN asked how the state's credit rating would be impacted by the proposed legislation should it pass. 11:57:22 AM MS. RODELL noted that interactions with the credit rating agencies fell on the Department of Revenue (DOR). Nonetheless, she indicated that their reaction could be mixed. She speculated that the agencies would value the fact that money would be generating revenue for a longer timeframe. Alternatively, the ability to meet short-term obligations could be in question. She deferred the question to DOR. 11:58:19 AM REPRESENTATIVE EASTMAN acknowledged that the bill would comply with the recommendation of leaving three times the draw amount in the ERA; however, he asked whether there was "something special" about this year and whether that recommendation would be ongoing. 11:59:04 AM MS. RODELL confirmed that the recommendation was ongoing. She noted that APFC had not requested this appropriation; therefore, it was a policy decision to be made by the legislature. 11:59:29 AM REPRESENTATIVE WOOL inquired about the flow of money to and from the ERA, as well as from the ERA to the corpus of the permanent fund. He considered a scenario in which there were several down years, surmising that ideally, there would be enough money in the ERA to "survive" the 5 percent POMV draw, which was approximately $3 billion at present. He noted that three times that amount would be $9 billion. Thus, if the ERA had a balance of $9 billion or $12 billion, he questioned whether a stock market downturn could reduce the balance regardless of POMV draws. MS. RODELL stated that a reduction in total size would be seen in the unrealized gain portion of the ERA. She recalled that on February 28, [2020], which corresponded to the most recent financial statement available, there was $9.9 billion in realized earnings and $3.1 in unrealized gain associated with ERA investments. She explained that any reduction would have impacted that $3.1 billion. REPRESENTATIVE WOOL considered a scenario in which the ERA balance was significantly exhausted due to down years. At that point, he asked whether APFC could decide to sell assets to realize a gain. Additionally, he sought to confirm that the earnings from that sale would be placed into the ERA. 12:02:34 PM MS. RODELL confirmed that if an investment action was taken to realize any unrealized gains, they would move into the ERA. 12:02:48 PM REPRESENTATIVE WOOL concluded that a sale [of assets] could "beef up" the ERA if the balance became extremely low. 12:03:04 PM MS. RODELL answered that the ERA received regular cash income throughout the year. She reported that roughly $1.2 billion to $1.5 billion came from stock dividend payments, rentals, etcetera. The rest of the cash that flowed into the ERA, she said, was generated off commercial financial investment decisions, which were not made for any other reason. She shared her belief that APFC would not want to be put in a position where they had to make investment decisions for non-commercial financial reasons. REPRESENTATIVE WOOL surmised that the recommended balance in the ERA was either $9 billion or $12 billion, as that would be three or four times the amount of the 5 percent POMV draw. However, as money trickled in, that figure could increase. He asked whether instead of providing for a draw amount, the solution would be to specify via statute that the ERA shall contain three times five percent of the value of the permanent fund. He questioned whether that statutory language would serve the same purpose without the legislature having to transfer several billion over subsequent years. 12:05:01 PM MS. RODELL stated that due to a Supreme Court ruling, any ERA movement required an active appropriation by the legislature. 12:05:21 PM CHAIR SPOHNHOLZ recalled that Ms. Rodell had stated that in Paper 9, [APFC] reduced the proposed buffer from four times the annual draw to three times the annual draw. Further, as of the most recent reporting period, she reported that there was approximately $16 billion in the ERA including unrealized gains of $3.1 billion. She asked whether the paper specified that the recommended amount must be amongst realized gains. 12:06:17 PM MS. RODELL shared her belief that the paper did not specify what the measurement was against. She understood that it was a recognition of the entire ERA - not just the realized portion. CHAIR SPOHNHOLZ sought to confirm that theoretically, if the legislature were to transfer enough money into the corpus to allow for three times the annual draw in the ERA including unrealized gains, that would be consistent with paper 9 and prudent policy. 12:07:13 PM MS. RODELL confirmed. She reminded the committee that the ERA did not have its own a standalone portfolio. Instead, it owned a proportionate share of every single asset, and the principal owned a majority of that asset. She explained that when the ERA was smaller in comparison to the principal, a proportionate amount of the unrealized gain also moved back over to the principal. Consequently, fluctuations were visible in the unrealized gains portion of the ERA due to the phenomenon of monthly reallocation based on the proportion of the ERA to the principal. She said when discussing a draw, it was not unreasonable to consider the balance referred to as "uncommitted realized" rather than the unrealized gain portion. 12:08:59 PM CHAIR SPOHNHOLZ sought to clarify whether Ms. Rodell was suggesting that the unrealized gains should be excluded from the calculation or included in the calculation. 12:10:55 PM MS. RODELL clarified that if $4.3 billion was transferred from the ERA to the principal under the proposed legislation, half of the $3 billion in unrealized gain would be transferred along with it. Therefore, after the transfer, the ERA would be reduced by more than $4.3 billion. She reminded the committee that of the $16.1 billion in the ERA, $9.9 billion was uncommitted, $3.1 billion was committed, and $3.1 was unrealized gain. Thus, if $4.3 billion was transferred from the uncommitted, a proportion of the unrealized gain would be moved as well. CHAIR SPOHNHOLZ sought to verify that the unrealized gain was associated with the realized gain assets. MS. RODELL answered yes. Further, she pointed out that unrealized gain was not cash - it was a figure that had to be shown on paper due to the financial accounting requirements. 12:12:26 PM REPRESENTATIVE EASTMAN asked whether passage of the bill would impact APFC's ability to respond to higher inflation. 12:12:54 PM MS. RODELL answered no. 12:13:00 PM REPRESENTATIVE SCHRAGE questioned whether APFC ever changed its investment strategy in response to a need for liquidity given that the ERA was subject to any appropriation by the legislature. 12:13:31 PM MS. RODELL stated that when the ERA was created, the statutes specified that it shall be invested like the permanent fund, which the trustees interpreted as the asset allocation of the principal. She added that nothing pertaining to APFC's mandate had changed, nor had they been directed to make a change. She shared her belief that APFC could manage under the current statutes. 12:14:19 PM CHAIR SPOHNHOLZ announced that HB 165 was held over.