SENATE STATE AFFAIRS COMMITTEE February 2, 1999 3:32 p.m. MEMBERS PRESENT Senator Lyda Green, Vice Chair Senator Jerry Mackie Senator Randy Phillips Senator Kim Elton MEMBERS ABSENT Senator Jerry Ward, Chair COMMITTEE CALENDAR SENATE JOINT RESOLUTION NO. 4 Relating to a national ballistic missile defense system. -MOVED CSSJR 4(STA) OUT OF COMMITTEE SENATE BILL NO. 46 "An Act naming the Alex Miller Building." -SCHEDULED BUT NOT HEARD SENATE BILL NO. 43 "An Act making a special appropriation from the earnings reserve account to the principal of the permanent fund; and providing for an effective date." -HEARD AND HELD SENATE BILL NO. 36 "An Act relating to state procurement of certain computer-related contracts." -MOVED SB 36 OUT OF COMMITTEE PREVIOUS SENATE COMMITTEE ACTION SJR 4 - No previous Senate action. SB 43 - No previous Senate action. SB 36 - See State Affairs minutes dated 1/28/99. WITNESS REGISTER Senator Tim Kelly Alaska State Capitol Juneau, Alaska 99801-1182 POSITION STATEMENT: Sponsor of SJR 4 Chris Nelson, Staff Joint Committee on Military Bases Alaska State Capitol Juneau, Alaska 99801-1182 POSITION STATEMENT: Supports SJR 4 Jim Kelly Director of Communications Alaska Permanent Fund Corporation PO Box 25500 Juneau, AK 99802-5500 POSITION STATEMENT: Commented on SB 43 Ross A. Kinney Deputy Commissioner Department of Revenue PO Box 110405 Juneau, AK 99811-0405 POSITION STATEMENT: Commented on SB 43 ACTION NARRATIVE TAPE 99-2, SIDE A Number 001 VICE-CHAIR GREEN called the Senate State Affairs Committee to order at 3:32 p.m. Present were Senators Phillips, Elton, and Vice-Chair Green. The first order of business to come before the committee was SJR 4. SJR 4-NATIONAL BALLISTIC MISSILE DEFENSE SYSTEM SENATOR TIM KELLY, sponsor of SJR 4, informed committee members that Secretary of Defense William Cohen announced that the United States will proceed with the deployment of a national ballistic missile defense system and confirmed that Alaska and North Dakota are under active consideration as potential sites. SJR 4 states the reasons why that system should be deployed in Alaska, primarily because its strategic location makes it the only site in which all 50 states can be defended. The North Dakota base cannot defend Alaska and Hawaii. Alaskans have always supported a strong national defense system. Brigadier General Willy Nance, Program Manager for the National Ballistic Missile Defense Organization, is making a special trip to Juneau on February 22 to brief the Legislature on the details of the program. SENATOR KELLY urged bipartisan support of SJR 4 so that the resolution can be presented to Brigadier General Nance upon his arrival. He requested the committee amend SJR 4 to include Secretary of Defense William Cohen as a recipient of the resolution. VICE-CHAIR GREEN noted that SJR 4 does not make any reference to the fact that North Dakota's location does not have Alaska's strategic advantage. SENATOR KELLY reiterated that the problem with a North Dakotan site is that it cannot protect Alaska and Hawaii. He added it is possible that missiles will be located in both Alaska and North Dakota. CHRIS NELSON, staff director for the Joint Committee on Military Bases, gave the following testimony. Five months ago North Korea launched a multi-stage ballistic missile that landed in the North Pacific. The New York Times made the following comments in an editorial the next day. North Korea's test of a medium range missile, capable of reaching targets in Japan and beyond, represents a technological breakthrough. Officials and arms experts said that the test suggested that North Korea had made real progress in its efforts to build a longer range missile, the Tapo Dawn (ph) II, which is reportedly capable of traveling 2400 to 3600 miles. That would give North Korea the ability to strike targets throughout Asia and as far away as Alaska.... MR. NELSON stated military experts believe that North Korea intends to put nuclear warheads on its intercontinental missiles or export its missiles to someone who would. North Korea's launch confirmed the conclusion reached by a bipartisan commission headed by former Defense Secretary Donald Rumsfelt: that the United States is now vulnerable to ballistic missile attack and that our nation has no means to defend itself. He summarized by saying the rules of international relations and national defense changed when North Korean launched its missile. Support for SJR 4 indicates Alaska's traditional agreement and commitment to defending Alaska and fellow Americans. SENATOR PHILLIPS moved to amend page 2, line 8, by adding "the Honorable William Cohen, Secretary of Defense," to the list. There being no objection, the motion carried. SENATOR MACKIE moved CSSJR 4(STA) out of committee with individual recommendations. There being no objection, the motion carried. VICE-CHAIR GREEN announced that SB 46 would not be heard during the meeting. SB 43-APPROP: EARNINGS RESERVE TO PERM FUND MARK HODGINS, staff to Senator Ward, sponsor of SB 43, explained SB 43 will transfer an amount, equal to the unappropriated balance of the Earnings Reserve Account on June 30, 1999, into the principal of the Permanent Fund. Number 162 JIM KELLY, Director of Communications for the Alaska Permanent Fund Corporation (APFC), made the following comments. SB 43 would appropriate the funds in the Earnings Reserve, less the dividend and inflation proofing costs, into the principal of the Permanent Fund. SB 43 is similar to past legislation except that the Government Accounting Standards Board (GASB) has adopted Rule 31 which changes the accounting standards applied to the Permanent Fund. The 6/30/98 annual balance sheet for the Permanent Fund was calculated using GASB Rule 31. That rule requires both unrealized and realized gains be considered as income. By including the unrealized gains, the total Earnings Reserve amount is probably higher than the amount the Legislature expects to appropriate. MR. KELLY explained in the past the balance sheet total did not include unrealized earnings, but GASB Rule 31 requires the APFC to mark its funds to market. VICE-CHAIR GREEN asked what the difference was under the previous accounting system. MR. KELLY replied if one looked at the regular projection sheet, the Earnings Reserve for the year ending June 30, 1999, will be about $2.7 billion. The dividends, based on the statutory formula, will reduce that amount by $989 million. Inflation proofing, calculated at 1.54 percent, will reduce it further by $287 million, leaving $695 million in current year income to add to the Earnings Reserve balance. The 1998 cash balance in the Earnings Reserve was about $1.4 billion; the $695 million will increase the cash balance to $2.084 billion. In addition, the Earnings Reserve contains an unrealized cash balance of $3.8 billion. It is unclear whether SB 43 would appropriate $2.084 billion or $5.8 billion according to GASB Rule 31. The APFC has contracted with a legal firm to review the GASB ruling and Alaska statutes to provide an opinion on what "earnings reserves" means. Number 222 SENATOR PHILLIPS noted that his staff contacted Mr. Kelly's office in early January and was told the projected amount for 6/30/99 was $1.9 billion, after inflation proofing and dividend costs were deducted. He questioned why the projection is now over $2 billion. MR. KELLY replied his office was probably basing the earlier projection on the September quarterly report; the latest projection was based on the December quarterly report which wasn't available in early January. SENATOR MACKIE asked Mr. Kelly if he thought SB 43, as written, will appropriate the entire $5.8 billion. MR. KELLY said SB 43 could be interpreted to do so. SENATOR MACKIE asked what the projection for the excess interest earnings is this year. Number 253 MR. KELLY replied $695 million will be left after dividend and inflation proofing costs are deducted. SENATOR ELTON pointed out SB 43 does not mention inflation proofing and asked if that omission will cause a problem. MR. KELLY answered that the same dollars would be put into the Permanent Fund, but not specifically into the inflation proofing segment. The effect, in terms of dollars, would be the same, but the explanation will be more complicated. SENATOR ELTON suggested that the sponsor be informed. Number 267 ROSS KINNEY, Deputy Commissioner of the Department of Revenue, gave the following testimony. He echoed Mr. Kelly's statement that GASB promulgates regulations, and in order to get a "clean" opinion from the auditing firm that audits the Permanent Fund records, GASB guidelines must be adhered to. GASB Rule 31 is unclear, for accounting purposes, about how the Permanent Fund income is recognized. A firm decision needs to be made as to whether the unrealized gains and losses should actually be added to the corpus of the fund. MR. KINNEY stated that during the last few weeks, a tremendous amount of discussion has occurred about Governor Knowles' long range fiscal plan. The plan proposes that approximately $4 billion be transferred from the Earnings Reserve to the Constitutional Budget Reserve (CBR). If SB 43 is enacted as written, that transfer could not occur. Additionally, the Legislature could not appropriate funds from the Earnings Reserve for any other purpose it desires. Once that appropriation is made it cannot be touched because the principal of the Permanent Fund is constitutionally protected. The principal of the Permanent Fund can be increased in three ways: through dedicated oil revenues; through the appropriation of Earnings Reserve or general funds; and through inflation proofing, which has occurred on an annual basis. MR. KINNEY cautioned that one risk the Legislature could incur, if it appropriates the full amount of the Earnings Reserve to the corpus of the Permanent Fund, is that Alaska could find itself in a position where it cannot pay out the total dividend entitlement if it is calculated using the traditional 5 year average and 10+ percent. The state might only be able to pay a dividend amount based on 50 percent of the amount in the Earnings Reserve. That situation could occur if a major market correction took place along with high inflation. The state has never come up against the Earnings Reserve limitation for dividend calculations, but it is not out of the question. Also, the Earnings Reserve limitation comes into play in years 2, 3, and 4, in the Governor's long range plan. At this point in time, the Administration does not support SB 43, pending a thorough review of the Governor's long range plan. VICE-CHAIR GREEN asked for clarification of the GASB changes. MR. KINNEY said the change was to a definition. Alaska statutory language related to the Permanent Fund defines income as interest, dividends, and realized gains. Up until 1997, GASB accepted that definition. However, as the result of the Orange County situation and other factors, the term "mark to market" has come into play. That term means that all financial statements require that the value of assets held have current market values placed upon them based on current market conditions. That changes the definition of income to interest, dividends, realized gains, and unrealized gains and losses. That definition results in an income increase of $4 billion in the Earnings Reserve as compared to the statutory definition, which does not include unrealized gains. The statutory definition is used to calculate the dividend because APFC does not want to pay a dividend based on unrealized gains. VICE-CHAIR GREEN asked for an example of an unrealized gain. MR. KINNEY explained that if a person bought Microsoft stock at $50 per share and that stock increased to $100 per share, the unrealized gain would amount to the $50 increase. If the stock was sold for $100 per share, you would realize a $50 gain. For dividend calculations, that $50 gain is only recognized when the stock is sold. Under GASB's definition, the $50 unrealized paper gain must be recognized as income even though the stock has not been sold. He noted all income from the Permanent Fund goes into the Earnings Reserve. Mr. Kelly's financial statements now show a fourth income component: unrealized gains and losses. That is where the question comes into play. APFC does not know what the interpretation for the Earnings Reserve amount under SB 43 would be. VICE-CHAIR GREEN asked if the bill could be crafted to exclude unrealized gains. MR. KINNEY replied that is the question the APFC has posed to its legal counsel. SENATOR MACKIE maintained an amendment could be offered during the budget process to appropriate a specific amount of dollars to the corpus. MR. KINNEY stated there is no difference as to whether the money is in the Permanent Fund corpus or in the Earnings Reserve from a dividend calculation standpoint. The only difference is that the corpus of the Permanent Fund is not inflation proofed for the amount that sits in the Earnings Reserve but it is still added together when looking at the total assets of the Permanent Fund. SENATOR PHILLIPS asked how the $2 billion in the excess earnings reserve is being invested. MR. KELLY replied for investment purposes, all of the money is co- mingled; he could not determine which investments were from the principal and which were from the Earnings Reserve. SENATOR MACKIE asked if it is earning at the same rate as the Permanent Fund. MR. KELLY said that it is. SENATOR PHILLIPS asked if the CBR is being invested using the same principles as the Permanent Fund. MR. KELLY replied this year the Permanent Fund is earning about an 8.83 percent total rate of return, a little higher than the CBR. VICE-CHAIR announced SB 43 would be held in committee for consideration at a later date. SB 36-YEAR 2000 COMPLIANCE REQUIREMENT VICE-CHAIR GREEN noted SB 36 was heard in committee during the previous week, but was held in order to get an opinion on a question posed by a committee member. MR. HODGINS explained SB 36 will require any new State of Alaska government computer hardware or software purchases to be Y2K compatible. He noted Senator Elton questioned whether the language on page 1, line 11, could be interpreted to mean that a contractor, who was hired to produce a brochure or publication, would have to certify that he/she was Y2K compatible if his/her publisher was not. According to the Division of Legal Services, if the state was to become the owner of the software then it would have to be Y2K compatible under SB 43, but if the product to be delivered was the brochure, it would not. SENATOR ELTON clarified that he was concerned that some professional service contracts require that the product be a disk that contains an advertisement to be published in a newspaper. He questioned whether the contractor would have to prove his/her equipment was Y2K compatible. The Division of Legal Services determined that the deliverable product is the published advertisement, therefore the contractor does not have to use Y2K compatible equipment. He stated he no longer had any concerns with that language in the bill. Number 418 There being no further questions or testimony, SENATOR MACKIE moved SB 36 out of committee with individual recommendations. There being no objection, the motion carried. There being no further business to come before the committee, VICE- CHAIR GREEN adjourned the meeting at 4:01 p.m.