The Legislature’s most significant action this year has received little public notice. It is the transfer of $10.6 billion into the protected principal of the Alaska Permanent Fund from the fund’s earnings reserve, which is unprotected.
Many would see this as just an accounting measure, moving money, though a lot of it, from one part of the Permanent Fund to another. It doesn’t change the overall value of the fund, which was $65.3 billion at the end of April.
But it is still a powerful statement because we’re taking money off the table that politicians can either spend in the budget or give away in larger Permanent Fund dividends and putting it into the part of the fund that can’t be spent under the state constitution.
The transfer does expose us to some risk. It reduces the earnings reserve account, first to about $9 billion, but when the fiscal 2020 percent-of-market-value payment of $2.93 billion is made to the state, under terms of Senate Bill 26 enacted last year, and other Permanent Fund expenses are paid, approximately $5.5 billion will be left on June 30, 2020, according to the Permanent Fund Corp.
Of course, over the next year, realized cash earnings will also be paid into the reserve, so the balance will rise, but the amount of those is unknown.
Including our current state revenues (mostly oil), this is enough to fund the state budget for about two years if the world’s financial system goes into meltdown. The chances of this seem unlikely, but there are omens out there.
The trade-off for us that we reduce short-term financial flexibility by cutting the checking account, but we strengthen long-term security by boosting the protected principal — the locked-down savings account — from $46 billion to almost $57 billion.
One way look at this, long-term, is that it is a rebalancing, so that the protected principal can receive the benefits of gains in realized earnings that now go to the earnings reserve.
Here’s why this is important: Our Permanent Fund has a very unusual structure. It is unlike most other large endowment-type funds. The principal receives only money from a share of petroleum royalties, which are declining, and from legislative appropriations for inflation-proofing, which have been sporadic in recent years. The Legislature has also made large one-time appropriations of surplus funds to the principal in the past.
However, under the fund’s current structure, all realized (or cash) income, such as interest from bonds, rental income and revenue from sales of equities like stocks, go to the earnings reserve account, which is available for appropriation.
There is no mechanism for the protected principal to grow from realized earnings because those go to the reserve account. The result, over time, is that the growth of the principal has lagged and the earnings reserve has ballooned, now to $19 billion.
Another aspect of this is that when there are market losses, the principal absorbs its share of the loss, as does the earnings reserve (funds are invested equally), but when realized income occurs, which can soften a market loss, this goes only to the earnings reserve.
The Legislature has been somewhat inattentive to regular inflation-proofing. Payments were not made for three years after 2015. This is in sharp contrast to legislators’ laser focus on ensuring PFDs. In that regard, the $10.6 billion transfer should be seen as an adjustment for the irregular inflation-proofing, allowing the protected principal to benefit from the realized gains.
The transfer is well worth doing, but we should still think out the implications of having less immediate cash on hand. This is more important now that we’re thinking seriously of locking the Permanent Fund dividend into a “full-funding” formula that, under some circumstances, could expand faster than the fund’s income. If that happens, it would either eat into money available for public services or force a higher withdrawal than is healthy from the earnings reserve to sustain the higher dividend.
Here’s how this could play out:
We now have a percent-of-market-value, or POMV, mechanism, for an annual structured draw from the fund’s earnings reserve to help support the state budget, including the PFD payment. POMVs are commonly used by large endowments, such as those that support universities or major charities.
The annual POMV draw authorized in SB 26 is 5.25 percent of the fund’s market value, dropping to 5 percent yearly after 2021.
Estimates prepared in the spring by the Senate Finance Committee have the POMV draw for state fiscal year 2020, which begins July 1, making $2.933 billion available for the budget and PFD.
What if the painful experience of the 2009 recession repeats itself? The fund lost money that year and the losses, which were big, had to be taken from the earnings reserve (remember, the principal is protected).
The situation was bad, even with five-year averaging. The Permanent Fund did manage to pay a dividend, but it was a scary time.
Having less money in the earnings reserve simply brings these issues into sharper focus — the margins are narrower. The transfer is still worth doing, I believe, but we need to be clear-eyed about the implications.
Tim Bradner is co-publisher of the Alaska Legislative Digest and the Alaska Economic Report.
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