By Tim Bradner
The times are uncertain, for sure. COVID-19 and its effect has dealt a blow to almost all parts of our economy, from tourism to trade, to oil and gas and potentially fisheries. State revenues are under new pressure as oil prices implode.
There is one thing to be thankful for: Alaska’s Permanent Fund.
Even before COVID-19 the Fund had become an important stabilizer for the state budget because state oil revenues had not recovered from the 2015 oil price collapse before the new one hit.
The Fund now provides about $3 billion a year to support a state general fund budget of about $4.5 billion. Oil revenues were to have provided about $2.2 billion, and non-oil revenues (state insurance, motor fuel, fisheries and minerals taxes) bring in about $500 million. Oil revenues will now be less, so we’ll still have a deficit.
The point, however, is that for the foreseeable future Permanent Fund earnings will likely contribute twice as much as oil to the state general fund. For this we should thank our state’s leaders in adopting Senate Bill 26 two years ago, which established a percent-of-market-value formula in state law to set a maximum draw from earnings of about 5 percent a year.
A “POMV” mechanism for annual payments is common with endowments such as those of big Ivy League universities and large charitable foundations.
When the Fund’s total value is over $60 billion this works out to about $3 billion annually. What’s important is that the actual payment is based on an average Fund value for the five previous years, which keeps the payment steady even if financial markets take a big tumble, which they have. That means we can count on this for at least this year and next.
If financial markets don’t eventually recover the averaging will eventually catch us because if one bad year in five preceding years becomes two years, or three, the 5 percent annual draw will go down.
How far down? State financial analysts are modeling different scenarios, but it could mean a drop of several hundred million dollars in the POMV payment in five or eight years. But that can be planned for, at least.
In the near term we have urgent economic issues in our state that need immediate attention. The federal and state economic aid packages will help, but more will be needed.
Meanwhile, there are some aspects of the current crisis that should concern us in our new dependence on Permanent Fund earnings. We shouldn’t get too comfortable.
For example, under the state Constitution we can only draw on earnings of Fund, not the principal. The earnings are held in a separate Earnings Reserve Account.
As of Feb. 29 the earnings reserve held about $17.8 billion but a $4 billion transfer from the earnings to the principal of the Fund, an additional $700 million for inflation-proofing, both approved by the Legislature last year, and $3.1 billion for the Fiscal Year 2021 POMV are committed to be paid from this. The $4 billion and $700 million transfers to the principal happen on June 30, the end of the fiscal year, unless the Legislature acts before then to reverse these.
But with those accounted for the adjusted value of the earnings reserve would be approximately $10 billion. That’s still a lot, but not as much as $17.9 billion.
But is $10 billion is enough for a little over three years of $3 billion annual POMV draws? Maybe of maybe not, because there’s an additional complication.
State statutes allows only realized, or cash, earnings to be withdrawn. Part of the value of the earnings reserve is in unrealized, or market, gains. If these assets are sold the proceeds are realized gains and can be included in the POMV transfer. But if they are not sold, they cannot be transferred.
In normal times this wasn’t a problem because the only draws on the earnings were transfers from the earnings account to the principal to offset inflation in the principal and to the state General Fund to pay for the annual Permanent Fund dividends, or PFDs. Dividend payments required over a billion dollars annually to be withdrawn from the earnings, depending on the amount of the PFD that year. Last year’s $1,600 PFD required $1.14 billion to be transferred to the state general fund, for example.
Nowadays the $3 billion POMV payment to the general fund must be considered. Currently the PFD payment is included in the $3 billion, so with $1.14 billion taken out for dividends about $1.86 billion is left for the budget this fiscal year.
What’s important about this is that Permanent Fund trustees and its staff must now ensure that there are enough realized (cash) earnings in the till when the cash-call comes for the POMV payment.
As of March 16, there was about $7.9 billion in realized earnings, which seems comfortably enough for two years of $3 billion annual draws and maybe more because there will be more realized earnings coming in. A big portion of the Fund is invested in bonds which make steady interest payments and real estate that brings in rent income, all of which are realized (cash) income. These are not as affected by market volatility as stocks.
A two-year margin and maybe a little more are not enough to be comfortable, and the margin could narrow if the annual 5 percent draw is exceeded, for example to pay larger PFDs as a stimulus to the state’s economy. Some Alaska political leaders are calling for that.
Meanwhile, there are consequences to working with narrower margins. One is that the Fund’s managers now have to be more sensitive to the larger cash draws and will have to manage the asset portfolio with those in mind. It could lead to a more short-term focus for investment strategy, which we have not had to do before.
The Fund has always prided itself on managing for the long term and not worrying about near-term market fluctuations or needs for cash withdrawals. That may be changing now.
Tim Bradner is copublisher of the Alaska Economic Report and Alaska Legislative Digest
