SJR 8-CONST. AM: PERMANENT FUND P.O.M.V.  CHAIR THERRIAULT announced SJR 8 to be up for consideration. He explained that the Alaska Permanent Fund trustees asked him to bring the idea forward for discussion in the State Affairs Committee because it's the logical place to hear proposals about the management of the Permanent Fund. 3:49:23 PM MIKE BURNS, Chief Executive Officer of the Alaska Permanent Fund Corporation (APFC), recapped why the trustees believe the Percent of Market Value (POMV) method is the best way to manage the fund. He emphasized that the trustees do not view the POMV as a fiscal plan. It wouldn't allow the Legislature greater access to the earnings and most years it would reduce the amount available for appropriation. Implementation of POMV and the use of earnings are entirely separate issues. POMV is predictable and understandable, but most people are confused by the arcane nature of the current distribution formula of the permanent fund. Most fund trustees manage their funds on a real return methodology - the total return of the fund less inflation. Most pension fund and endowment fund managers view their fiduciary duties in the same way. MR. BURNS said the trustees have proposed the POMV method because the current statutory realized-income based distribution formula is broken. When the fund was created it was prudent to restrict its investment authority to a bond only strategy. A bond portfolio generates income in two ways: interest or coupon income and capital gains from bonds that are sold at appreciated prices. This formula made perfect sense at that time for that portfolio. However, because the fund's asset allocation now incorporates investments that generate significant unrealized gains and realized income, the current payout methodology and protection of principal doesn't serve the fund as well as it did previously. Only a POMV payout limited by the sustainable yield from the fund can provide the necessary protection for the future while allowing current generations an equitable share of fund earnings. The only way to ensure full protection of the fund is to place constitutional limitations. The POMV proposal allows no more than 5 percent of the average market value of the fund averaged over the previous 5 years may be appropriated from the fund. This protects a minimum of 95 percent of the fund from being spent in any given year. MR. BURNS concluded: "As I noted earlier, POMV is not a fiscal plan and with oil at $50 plus, 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 it can, not only be managed in harmony with its distribution formula, but also be understood by Alaskans when other decisions must be made?" He urged committee members to support the trustees' proposal for reasons of modernization, clarity, and better protection. 3:54:25 PM SENATOR WAGONER arrived. 3:54:43 PM CHAIR THERRIAULT asked if the primary motivation is to ensure that inflation proofing is guaranteed for the future. MR. BURNS replied inflation proofing is built in. The belief is that over time a real return of 5 percent in addition to inflation proofing is attainable. Over time a return of 5 percent allows a distribution to the Legislature, protects the fund from inflation, and allows the fund to grow. CHAIR THERRIAULT asked if the inflation proofing is deposited with an annual appropriation and whether there is concern that during tight times the appropriation might not be made. MR. BURNS said the annual appropriation for inflation proofing is in the province of the Legislature so a question about what a future Legislature might do is clearly a legitimate question. CHAIR THERRIAULT said if the goal is for the fund to be multi- generational, that goal couldn't be achieved if the fund's purchasing power isn't protected. MR. BURNS agreed. SENATOR ELTON said he had two questions. Legislators have frequently heard that over time a 5 percent withdrawal is workable. He wondered whether using the "over time argument" because of language on page 2, line 2. He questioned whether use of the word "annual" precludes the ability of looking at a multi-year strategy. MR. BURNS replied if line 2 were read in conjunction with a 5- year average, the 5-year average would be the controlling number. With respect to whether or not 5 percent is attainable over time he said: If you take our example of 8 percent and the fund grows each year, it's 5 percent of the maximum amount only in one year. And you go back the trailing 5 years - the actual amount of the fund is smaller. And I think if you use a straight 8 percent growth on the balance of the fund, the payout actually is less than 4.7. It's 5 percent but it's 5 percent of a smaller year - 5 a little bit bigger - year 4 a little bigger still. So it's only 5 percent of the very last year in the 5-year formula - if you think of a stair-step. SENATOR ELTON said he assumed POMV supplants the 5-year rule and he questioned whether Mr. Burns was saying that the 5-year rule would still control when the Legislature makes the annual decision. MR. BURNS said yes, the formula is based on taking 5 percent of the average of the last 5 years. CHAIR THERRIAULT added the 5 percent would turn out to be less than 5 percent each year because it is based on the 5-year average of a growing balance. MR. BURNS said that is correct and the trustees' have estimated the amount to be 4.65 percent each distribution year. CHAIR THERRIAULT asked about the average return over the life of the permanent fund given recent down markets. MR. BURNS said the return has been about 10 percent over the life of the fund. Last year, the return was 14.1 percent. SENATOR ELTON questioned whether the word "predictable" on page 2 would constrain the Legislature from deciding to appropriate less than 5 percent. MR. BURNS responded it's what the fund makes available to this process. Whether the Legislature distributes that amount or not is a separate issue. SENATOR ELTON said the annual appropriation would be predictable, but it isn't if the percentage varies from year to year. He again questioned whether the word "predictable" would constrain the Legislature from appropriating a lower percentage. 4:02:52 PM LAURA ACHEE, Communications and Research Liaison, Alaska Permanent Fund Corporation, said the Legislature would not be constrained to take 5 percent. The word "predictable" goes to two issues. First is knowing that no more than 5 percent of the market value for the previous five years would be available. The other side of the issue is that as the Legislature contemplates use of earnings using a funding source that has a lot of volatility makes it difficult for the Legislature to know that in any given year they're going to have 5 percent of the average market value of the fund available to them. 4:05:20 PM CHAIR THERRIAULT read from page 2, line 2: ...and limited so the real value of the permanent fund is preserved over time. He asked if the trustees would be tracking the value of the fund and the added inflation-proofing amount. If a protracted down market occurred and the 5 percent allowed an erosion of the fund going forward, he questioned whether that would put a limit on the 5 percent. MR. BURNS said not as currently proposed. In a down market you could actually take 5 percent of principal or reserved assets. MS. ACHEE said keep in mind it would take several years of protracted down markets before dipping into the fund would occur. At that point, the same mechanism that stair stepped up would kick in as well because the annual appropriation would be 5 percent of values that were going down. Certainly it should be within the Legislature's purview to take the full 5 percent or to not withdraw any money. She pointed out that a few years ago - because of market changes - the realized earnings account was almost dry so paying any dividend was questionable. SENATOR ELTON noted the current proposal contains language such as "predictable" and "real value" that weren't discussed last year. 4:08:04 PM MS. ACHEE said that's correct. Both resolutions in the last Legislature started out reading as SJR 8 does but one body removed that language in an early committee hearing. SENATOR ELTON noted it would be instructive for the committee to find out why those words were removed. MR. BURNS responded this proposal has been the trustees' starting point over a number of years. CHAIR THERRIAULT asked about the dollar amount outside of the protected principal. MR. BURNS estimated that about 11 percent isn't protected today, but that number jumps to about 16 percent if one goes through the process of realizing the unrealized gains. CHAIR THERRIAULT calculated that there would be a starting $5 billion cushion above and beyond the protected principal if POMV is adopted. MR. BURNS said yes but it would all be protected principal if the POMV method were adopted. CHAIR THERRIAULT offered the opinion that many citizens don't understand that under the Alaska State Constitution, the Legislature has access to about $5 billion. MS. ACHEE clarified, "Of that $5 billion some of it is - at this point - considered principal. However it is unrealized gains so it's merely the matter of realizing." They're partially protected because until realized they are part of the principal. 4:11:15 PM WAYNE STEVENS, President and CEO of the Alaska State Chamber of Commerce, stated support for SJR 8. The chamber business advisory committee lists the adoption of a state fiscal plan as a priority and one part is to statutorily establish the POMV management tool for the Alaska Permanent Fund. "Recognizing that SJR 8 speaks to a constitutional percentage of market value we would support that. But as an intermediate step perhaps one would consider a statutory percent of market value." He suggested that had the POMV method been adopted last year, Alaskans wouldn't have seen a significant change in the dividend checks. The chamber supports steadying the budget process now and in the future and SJR 8 would help accomplish that. CHAIR THERRIAULT noted there was no further testimony and announced that he would set SJR 8 aside.