Alaska’s Permanent Fund has a structural problem. Left untended, it could put the Fund in jeopardy.
The Fund’s trustees have warned about this for two decades. The state’s political leaders haven’t paid attention. Preoccupied with the Permanent Fund Dividend, there has been almost no attention paid to the deeper problem.
Here it is, in a nutshell:
The Fund, now $81 billion in value, is really two funds. One is the constitutionally protected principal. The second an earnings reserve account that holds cash income as it is earned, and which is not protected. It can be spent by the Legislature.
This is an odd construct and no other large investment fund is built like this. There are historical reasons why it happened. When the Fund was created it was organized like a trust fund with money invested in very secure fixed-income assets, mainly bonds. Equities like stocks were considered risky. Many types of equity investments are now made for the Permanent Fund.
The 1976 constitutional amendment that created the Fund established the protected principal as the Fund. Income from investments went to a special account in the Fund, as they still do to hold the earnings. This is known as the Fund’s earnings reserve.
What’s important is that funds can be appropriated from the Earnings Reserve. It is unprotected, unlike the principal.
Many people believe the earnings reserve should be part of the protected principle, and this change is included in a proposal this year by Gov. Mike Dunleavy.
The problem now is that unless this is done the principal of the Fund, the protected part, does not grow from the realized, or cash, earnings of its investments. Those go to the earnings reserve in the General Fund.
In contrast with the principal, the earnings account does grow through realized earnings, which are mostly retained. The benefits do not flow to the principal.
Any transfer from the unprotected earnings reserve to the protected principal must be done by the Legislature through an appropriation. This has been done over the years as an annual “inflation-proofing” payment to the principle and sometimes by direct appropriation. But in recent years inflation proofing has not been done, at least not on a regular basis.
Protected principal grows more slowly than earnings reserve
The difficulty this creates is that over time, and particularly in recent years, the protected principle has grown at a much slower rate than the unprotected earnings reserve.
Here’s an illustration: In state Fiscal Year 2016 the principle was valued at $44.2 billion. Over five years, FY 2016 through April 30, FY 2021, the principal value increased to $59.5 billion, a growth of $15.3 billion. Included in this was a transfer of $4 billion from the earnings reserve to the principle by the Legislature in FY 2020. Absent this transfer, the growth of the principal though unrealized gains in market value and ongoing petroleum royalty deposits was $11.3 billion.
In contrast, over the same five years the earnings reserve value increased from $8.6 billion in FY 2016 to $18.3 million in FY 2021, an increase of $9.7 billion.
This doesn’t include $11 billion paid from the earnings for various purposes, mainly the Permanent Fund Dividends and more recently the percent-of-market-value payment to the state General Fund to support the budget.
If these funds earned but paid out are included, the earnings reserve actually increased by $20.7 billion.
What the figures show that the earnings reserve is growing faster than the principal. Unrealized market value growth is reflected in both the earning reserve and the principal because assets are invested equally. What isn’t shared in the principal is the realized income from the periodic sales of assets (stocks or real estate, for example) or income from bond interest and rentals of real estate.
The realized earnings are substantial and are held in the earnings reserve. For that reason, the growth of two funds is unbalanced.
Unless the problem is solved the principal value will lag over time and the earnings reserve will get much larger, and because it can be spent It will be an inviting target for politicians looking for money.
This year, in fact, the Legislature and Gov. Mike Dunleavy are proposing to take $3 billion from the reserve as part of a broad restructuring of state finances, but in effect it is to cover state budget deficits and to pay a higher PFD.
The solution: Merging the two funds
The solution to the problem, the Fund’s trustees have proposed for the last 20 years, is to end the odd construct of the two funds, the principal and earnings reserve, so that all of the money is protected. It could then operate like a large endowment like those of major universities and charitable funds.
The Permanent Fund’s annual payment to help support the state budget, using a percent-of-market-value, is set by statute at 5 percent of the Fund’s total value averaged over five years. Combining the principal and earnings reserve as the Trustees propose wouldn’t affect this, but by protecting the entire fund and not just part of it the annual payment becomes more secure.
A constitutional amendment is required to combine the two funds, however. Governor Dunleavy has proposed this as a part of his plan to also guarantee the PFD in the constitution.
However, putting a spending program in the constitution along with a payment methodology, which is also part of the governor’s proposal, is controversial because it could be seen as giving priority to the PFD over other requirements in the Constitution, such as support for education and public safety.
However, one attractive feature of this is that including the POMV and its annual payout of 5 percent of the Fund’s value effectively caps any payment from the Permanent Fund, which adds more protection against efforts by politicians for large payments, such as for large dividends.
Complicated ballot propositions are risky
Despite the popularity of the PFD voters often reject ballot propositions that are complicated. This one, with its merging of the earnings reserve and the principle and the guarantee of the dividend and its payment methodology, is very complicated.
It may be difficult to explain to voters in the 2022 general election. Experience has also shown that when ballot propositions are complicated voters often say no.
Despite the risk of rejection by voters, the governor and many legislators feel the only way to resolve the political turmoil that has occurred over the size of the PFD (it has dominated recent elections and legislative sessions, distracting from other matters) is to guarantee it.
The only way to do that is to put it into the Constitution, the governor and many others argue. It would lay the annual fight over the PFD to rest.
Tim Bradner is editor and publisher of the Alaska Legislative Digest and Alaska Economic Report
