Alaska politicians could use the Permanent Fund to fix the deficit. But will that put PFDs at risk?

JUNEAU — A plan like those pushed by lawmakers to spend part of the $65 billion Permanent Fund on government services could fail after 10 years, leaving no money to pay Alaskans' annual dividends, according to a new analysis commissioned by the fund's managers.

There's a one-in-five chance that happens, according to the analysis. And there's a 30 percent chance the plan depletes $13 billion from the fund's investment earnings account over the same time frame.

The results show the risks posed by the deficit-reduction plan that lawmakers have advanced to help pay for basic government services like schools and snowplowing while preserving a decades-old cash benefit.

If the fund's available cash runs out, it could force politicians to levy taxes and make steep spending cuts to fill the resulting budget gap.

"There's going to come a day in the next 10 years that we may not have the money to transfer," said Angela Rodell, the fund's chief executive. "And what happens then? And what does the state look like then? We don't know."

The big question facing the Legislature for the past two years has been if, not how, it would turn to the fund to fill the state's massive budget deficit.

But with lawmakers increasingly coalescing around that idea, they now face more, equally vexing questions about how, exactly, the fund should be managed — and how much cash it can sustainably generate.

The amount of cash available from the fund will help dictate the mix of other measures, like taxes and spending cuts, that will also be needed to fix Alaska's deficit — which is projected to be $2.5 billion on the state's $5.4 billion budget.

The new analysis, from Connecticut-based investment firm Bridgewater, complicates the argument that the deficit can be cured solely with spending cuts and earnings from the Permanent Fund. If lawmakers decide the fund can't actually sustain the 5 percent annual draws set out by their proposals, the remaining budget hole could be hundreds of millions of dollars larger.

The leader of the state House's largely-Democratic majority, which supports a new income tax to help shrink the deficit, called the report "sobering" and questioned whether the fund's annual investment returns can hit their target.

[Without action by lawmakers, Alaska's main savings account will soon be empty. What will they do?]

One leader of the Republican-led Senate majority, which staunchly opposes taxes, said he disagrees with portions of the analysis and pointed to last year's investment returns, which exceeded 12 percent. The fund's earnings account,

which was $13 billion at the time of the study, now contains $2 billion more.

"We had a phenomenal year," said Soldotna Republican Sen. Peter Micciche, the majority leader. The plan, he added, could be revised if returns fail to meet expectations.

One point of agreement between the two groups is that the issue needs more discussion in the Legislature. Senate President Pete Kelly, R-Fairbanks, said Rodell would be meeting with members of his chamber's finance committee, "no question about that — because this needs to be addressed."

House Speaker Bryce Edgmon, D-Dillingham, said the dilemma of how to manage the fund is, in many respects, "the major decision of this Legislature."

Rodell, the fund's chief executive, is scheduled to appear before both chambers' finance committees this week.

Bridgewater presented its "stress test" to the Permanent Fund's board of trustees last month — one of whom said the results left them "in shock," the Juneau Empire reported.

There are different versions of the plan for the fund favored by the House, Senate and Gov. Bill Walker. But generally speaking, each would manage the assets like an endowment, taking about 5 percent of the fund's value every year and splitting the money between dividends and government services.

Volatile markets

The plan parallels the fund's 10-year forecast of 6.5 percent annual growth. (The discrepancy between the 6.5 percent target and 5 percent draw is to insulate the fund from the effects of inflation.)

But investment markets are volatile: Even if there's a decades-long upward trend, there can be ups and downs over the course of weeks, months or years. In the market crash a decade ago, the fund fell $9 billion in two-and-a-half months.

"If you have a year where the draw's 5.25 percent, and you lose 20 percent of the fund like you did in 2007, you've now taken out a bunch of money and you've lost a bunch of money," said Rodell.

[Alaska Gov. Walker, in State of the State speech, urges Legislature to act on budget deficit]

That's a problem because of the way the fund is managed: The Alaska Constitution only gives lawmakers access to its investment earnings, not its principal. If the fund's investments experience a prolonged downturn, or merely slower-than-expected growth, its earnings account could run out.

Bridgewater examined possible effects of the plan on roughly $20 billion in the fund that it describes as "economic surplus." That includes $13 billion in investment earnings available to the Legislature, plus another $7 billion in investment gains on the fund's principal that could also be converted into cash.

To avoid losing all $20 billion at the end of 10 years, the fund needs to make an average of 3.3 percent a year, Bridgewater says, and there's a roughly one-in-five chance that doesn't happen.

While the plan calls for spending a projected $31.5 billion over that time frame, the fund falls at least $6 billion short in 20 percent of the cases modeled by Bridgewater.

There's a 30 percent chance, meanwhile, that the fund fails to hit a 4.5 percent benchmark, which over 10 years would use up the $13 billion that was in the investment earnings account at the time the analysis was done.

Only in half the cases did the fund make the 6.3 percent-a-year it needs to maintain, or grow, its surplus earnings while making planned payments and accounting for inflation, according to Bridgewater's analysis.

[Opinion: Permanent Fund Dividend: What we gain, what we lose]

What's the lesson from the analysis? It's not that the Legislature should keep from touching the fund entirely, according to Rodell.

"That's not the issue," Rodell said. "The issue is to do it in a thoughtful, agreed-upon manner and to take care of the fund and the corporation."

Constitutional amendment?

One option for addressing the risks raised by the stress test is, simply, taking less money out of the Permanent Fund each year. Walker, in an interview earlier this month, said he's comfortable drawing roughly 5 percent annually, though he added that "if there needs to be an adjustment, I'm pretty conservative when it comes to that."

"The goal is to make sure that we don't over-rely on the earnings and always assume it's going to be an up year," he said. "You look at 2008, we lost billions of dollars in the stock market."

Another option is to eliminate the fund's accounting distinctions set out in the Alaska Constitution, which would allow lawmakers to access all $65 billion in the fund instead of restricting them to investment earnings.

Sitka Republican Sen. Bert Stedman has proposed a constitutional amendment to do that, paired with a conservative management plan that caps annual withdrawals at 4.5 percent — lower than the plans currently under consideration in the House and Senate.

Lawmakers should be setting Permanent Fund policy based on best practices, not based on the demands of the state budget, Stedman said in an interview.

"Is the Permanent Fund a milk cow? Or is it an asset for future generations that can help with the problem?" Stedman said. "The current financial condition of the state is irrelevant."