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We Build Alaska

Brad Keithley’s Chart of the Week: What’s going on with the Earnings Reserve Account

Monthly following the publication by the Permanent Fund Corporation (PFC) of its Financial Statement and History and Projections, we publish four charts that follow the state’s two main investment funds: the Permanent Fund and the Alaska Retirement Fund.

The first chart follows the combined amounts over time of the Permanent and the defined benefit (state obligation) portion of the Retirement Funds. The second provides a breakdown of the amounts specifically in the Permanent Fund’s Earnings Reserve account (ERA) over time. The third follows the projections made by the PFC of future amounts in various of its accounts, and based on the third, the fourth provides projections of the amount of Permanent Fund Dividends (PFDs) under various approaches.

Our most recent charts from earlier this month are here. While readers may be interested in all four charts, this column specifically focuses on the information analyzed in the second chart related to the ERA.

Here is the most recent chart that focuses specifically on historical information related to the ERA.

The red and gold portions of the chart represent the portions of the ERA at any given time that are uncommitted. The amount in gold is the unrealized portion – paper profits on investments still held by the Permanent Fund – and the red is the realized portion, the portion of the ERA that is spendable.

Beginning in FY 2018, the Permanent Fund Corporation also started accounting for a portion of the ERA as “committed” for distribution, either to the state as its annual percent of market value (POMV) draw from the ERA or back to the corpus of the fund for “inflation proofing.”

What struck us when we looked at the most recent chart – and what this column examines – is the, by historical standards, extremely low amount (less than $1 billion) held in the ERA as realized uncommitted (spendable) as of the end of July.

To be fair, that compares a month-ending amount – and an early month at that – to previous end-of-year amounts. But even when comparing apples-to-apples, month-ending July amounts to each other, the most recent amount remains extremely low historically.

Looking back over the past eight years, the previous low for July in realized uncommitted (spendable) reserves was FY2023’s $3.47 billion; this July’s (FY2024) is 15% of that.

Some will likely view this as an affirmation of concerns about the ERA raised in recent Permanent Fund Board meetings and in the press. But it’s not; there’s something different going on here.

The Board briefings and press articles are based on speculative concerns about repeated shortfalls in Permanent Fund earnings over time. While last year’s Permanent Fund earnings did fall short of covering the annual percent of market value (POMV) draw plus the amount contributed as inflation-proofing, it does not explain the precipitous drop in the realized uncommitted level in the earnings reserve since FY2022.

As shown in the chart at the top of this column, at year-end FY2022, the realized uncommitted level in the ERA was $10.5 billion. As of the end of July – just 13 short months later – the level is $0.54 billion, roughly $10 billion less.

On the other hand, as shown in the chart above, the difference in FY2023 between the amount of Statutory Net Income (SNI) and the POMV draw plus inflation-proofing was only $1.9 billion. If the problem was the shortfall in Permanent Fund earnings, the realized uncommitted level in the ERA should only have dropped to roughly $8.6 billion by the end of FY2023, and certainly not to the current level of $0.5 billion – an additional $8.1 billion less – only one month after.

Here’s what the Permanent Fund’s July 2023 Financial Statement suggests is going on. Starting with a total end-of-month ERA (realized and unrealized) of $6.84 billion (which already reflects a previous deduction for the $3.53 billion appropriated for the full FY2024 POMV draw), the July report deducts $1.23 billion as unrealized uncommitted funds, then a reserve of $1.41 billion for the full year of FY2024 inflation proofing, then another reserve of $3.66 billion for the anticipated, but not yet appropriated, full-year FY2025 POMV draw.

The remainder is the historically low $0.54 billion in realized uncommitted funds.

At first blush, we would think that the reserve for the FY2025 POMV draw should be deferred, at least until the amount is appropriated by the Legislature, if not, as with the reserve for inflation proofing, until the year to which it applies. But even if including an unappropriated reserve for a future year’s POMV draw is appropriate from the outset of the previous year, we still have two problems with using this approach to provide clear insight into the current status of the ERA.

The first relates to timing. The approach reduces the amount of realized uncommitted earnings for a full year’s worth of charges for both inflation-proofing and both the current and year-ahead POMV draw but only reflects the year-to-date portion – in the case of July, only one month’s share – of FY2024 Permanent Fund earnings.

The result is the same as including a year-plus worth of expenses on an income statement compared to only the year-to-date portion of revenue. Rather than matching the two, it shows a continual, artificial shortfall in profits until the final month, when revenues are finally stated on the same timing basis as the expenses. It’s misleading to those looking for an apples-to-apples, annualized number.

The second relates to the remaining portion of the prepayments previously made into the Permanent Fund corpus for inflation proofing. As we discussed in a previous column, the l\Legislature made two ad hoc contributions in FY2020 and FY2022 of $4 billion each from the ERA to the corpus of the Permanent Fund. The first was made explicitly “to forward fund inflation proofing.” We have treated the second the same way for the reasons we explained in our previous column.

While the Legislature chose not to do so for FY2024, the unused balance of the prepayments remains available to use as an offset to inflation proofing – in other words, as a way of rebuilding realized uncommitted earnings – in subsequent years. We believe the amount of that non-cash asset should also be included to fully reflect the remaining balance of realized uncommitted earnings at any given point in time.

Adjusting for both raises the current balance of the ERA from the $.054 billion reflected in the PFC’s July 2023 Financial Statement to $6.75 billion. Reversing the $3.66 billion not yet appropriated reserve for the FY2025 POMV draw increases the amount to $10.41 billion.

Clearly, the PFC’s accounting approach – which stops halfway through the chart above – produces a very low number conveniently consistent with its – and other’s – political objective of merging the ERA and Permanent Fund corpus into a single account. As a result, we don’t anticipate the PFC changing its presentations.

Going forward, however, we will include the additional adjustments discussed above as part of the charts we publish following the Corporation’s monthly updates. As adjusted, we believe those charts will provide a much better look at where the realized uncommitted (spendable) balances stand on an annualized basis than the raw monthly data produced by the PFC.

Brad Keithley is the Managing Director of Alaskans for Sustainable Budgets, a project focused on developing and advocating for economically robust and durable state fiscal policies. You can follow the work of the project on its website, at @AK4SB on Twitter, on its Facebook page or by subscribing to its weekly podcast on Substack.

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