7. General Office and Centralized Operations Support

7.1. Costs Associated with Vacant Positions and DRA's Request for $45,000 Penalty

Golden State included vacant positions in its labor expense calculations stating that "extraordinary circumstances" allow the inclusion. DRA asks the Commission to impose a $45,000 penalty for Golden State's failure to follow a past Commission order and to exclude $1,471,247 representing vacant positions from Golden State's test year labor expense estimate.

7.1.1. Positions of the Parties

Golden State contends that expenses for vacancies were included in its labor expenses projections because its Human Capital Management Department has taken a proactive approach to filling vacancies and that constitutes "extraordinary circumstances." The proactive approach includes accessing more targeted career websites, developing more detailed job descriptions and advertisements, providing interview preparation and support to the hiring manager, providing quicker turn-around in reviewing applications by using a collaborative team approach, and participating in career fairs. (Golden State Ex. 19 at 4-5.)

DRA counters that the steps Golden State has taken do not constitute "extraordinary circumstances," but are the normal steps DRA would expect all utilities to take when filling vacancies. DRA cites D.05-07-044 which states:

Most utilities will at some point have position vacancies caused by, e.g., separations, retirements or intentionally holding a position open for cost savings. To the extent there were vacancies in the recorded year, we should assume there will also be comparable vacancy savings in the test and escalation years.

DRA requests that the Commission fine Golden State $45,000 for failing to follow D.08-01-043, a past Commission order to exclude vacant positions for its test year labor expense estimate. D.08-01-043 states:

In all future rate cases we direct Golden State to present its labor expense projections consistent with our finding in
D.05-07-044. In that decision, we found that San Gabriel's proposed estimating method for labor expenses included expenses for vacant positions. We decided there, absent a showing of extraordinary circumstances, that to the extent there were vacancies in the recorded year, we should assume that there would also be comparable vacancy savings in the test and escalation years.

Golden State asserts that even if the Commission finds its actions do not constitute "extraordinary circumstances," Golden State's actions were in good faith and therefore do not warrant a penalty.

7.1.2. Discussion

We agree with DRA's position that Golden State's aggressive, proactive recruiting practices do not constitute "extraordinary circumstances." Rather, Golden State employed methods every utility should utilize, taking all necessary steps to recruit from the broadest pool of qualified candidates possible to fill vacancies.

We also agree with Golden State that there is no evidence that Golden State acted in bad faith and that absent a clear directive regarding what constitutes "extraordinary circumstances," companies are left to draw their own conclusions, however tortured the result. The Commission's goal is to ensure that labor expense forecasts used in rate cases are as accurate as possible. To that end, as noted in D.05-07-044, the Commission expects that a certain level of vacancies will always exist, no matter how proactive and aggressive recruiting efforts are.

Some clarity regarding "extraordinary circumstances" is called for. An example of "extraordinary circumstances" might be an unusually high number of vacancies, occurring for various reasons, and a demonstration that denying the utility the ability to fill some of the vacancies could adversely impact service to ratepayers. Tracking vacancies is a normal function of any human resources department. If abnormally high vacancies occur at some period in time, very little effort is required to make such a showing. This is by no means the only possible example of "extraordinary circumstances," but it provides some guidance.

While Golden State's interpretation of "extraordinary circumstances" as the basis for including vacant positions in its labor expense is not persuasive, there is no evidence of bad faith on Golden State's part. Although bad faith is not an element of Pub. Util. Code § 2107,⁸ it is the basis upon which we determine if Golden State's failed claim of "extraordinary circumstances" for including vacant positions in its labor expense rises to the level of
non-compliance with a Commission order. We find it does not. For that reason, we do not impose the $45,000 fine recommended by DRA, but grant DRA's request that the salaries of 24 vacant positions totaling $1,471,247 be removed from Golden State's labor expense.

7.2. Cost Allocation

The purpose of the four-factor cost allocation methodology is to allocate the costs of general office expense between Golden State and its affiliates based on a cost-causation approach. First, the costs that can be directly assigned to one entity or another are separated from the rest of the general office expenses. Next, the remaining indirect general office expenses are totaled and the total is allocated among all the entities based on a set of allocation factors. The methodology and four allocation factors were set forth in the Commission's 1956 Memorandum (Memo). The four factors used in allocating general office expense are (1) direct operating expense (excluding uncollectibles, general expense, depreciation, and taxes), (2) gross plant, (3) number of employees (using direct operating payroll and excluding general office payroll), and
(4) number of customers.

7.2.1. Positions of the Parties

Golden State requests a single-factor cost allocation for certain costs and a four-factor allocation for the remaining costs. Golden State proposes customer billing, customer call center, and human resources for single-factor allocation treatment. According to Golden State's request, the general office cost for billing would be directly allocated to the entities based on the number of customers billed for each entity. Golden State recommends general office customer service costs be allocated in the same manner. Golden State would have customer service costs allocated based on the number of calls to the customer service center received from customers of each entity. Golden State cites the Commission's 1956 Memo as support for its single-allocation factor treatment of certain expenses. The 1956 Memo states:

Indirect general expenses which have a significant relationship to a particular factor, such as pension expense to payroll, should be segregated and prorated on the basis of an appropriate single factor. The remaining indirect expenses may be so general in nature as to require prorations based on a combination of several pertinent factors.

Golden State also cites D.80207, 73 CPUC 597, as additional support for its position regarding single-factor allocation of certain expenses. The decision states:

Staff Exhibit No.19 states that the difference between applicant's original estimate and the staff's estimate of customer records and collection expense was predominantly due to differences in allocation percentages for payroll. The staff developed four-factor allocation percentages, whereas applicant's general manager testified that applicant spreads these expenses in proportion to the number of customers. For the rendering of bills and maintaining of customers' accounts there appears to be no justification for considering (1) direct operating expenses, (2) number of division employees and
(3) division gross plant, the three additional factors used by staff. Applicant's allocation method more properly relates customer records and collection expense to the numbers of customer accounts and bills rendered.

Golden State asserts that its single-factor treatment for certain indirect expenses is based on Commission precedent and identifies costs that have a significant relationship to a particular factor and allocates those on the basis of that single factor.

DRA objects to Golden State's single-factor treatment of certain items stating that the purpose of a four-factor approach is the reasonable averaging of costs which avoids the otherwise necessary account-by-account review of expense allocation. DRA does, however, accept Golden State's proposal that all of the costs associated with the following cost centers be allocated to Golden State alone as none of the other entities benefit from them:
49a-Non-Capitalized Expenses; 51-Rate Cases; 52-Tariffs and Special Projects; 53-Conservation; and 56-Regulatory BVES. DRA also agreed with Golden State's proposal to allocate: 83-Customer Service Center;
88-Application Support; 91-Customer Service Day Shift; and 92-Customer Service Night Shift to Golden State (including BVES) and Chaparral City Water Company (Chaparral) as American States Utility Service (ASUS) receives no services in these areas.

DRA asserts that using a single-factor method for some cost centers coupled with a four-factor method for others results in too many cost allocations. DRA also states that Golden State's approach negates the purpose of the
four-factor method and results in too many costs allocated to non-regulated operations in some areas and not enough in others.

DRA recommends that the Commission rule in this proceeding as it has in recent decisions and deny Golden State's use of a single-factor allocation methodology. DRA cites D.07-11-037, Golden State's last GRC that included general office expense and where Golden State's single-factor approach was rejected by the Commission in favor of a modified three-factor allocation method.

In addition to its objections to the single-factor allocation, DRA proposes revisions to the four-factor allocation method. First, DRA proposes using the total number of employees rather than payroll expenses in the four-factor allocation. DRA's justification is that Golden State's proposed ASUS payroll expenses figure under-represents ASUS's true payroll expense because it is based on the number of employees as of December 31, 2007. DRA asserts that by June 1, 2008, ASUS had more than tripled its number of employees, going from just 27 to 84. DRA claims that even though it has recommended the use of payroll expense in past cases, in this case the employee number should be used because Golden State's payroll expenses figure represents the expense associated with only 27 employees.

DRA's second recommended modification is associated with the total direct operating expense factor. DRA proposes that the costs of purchased water be removed for Golden State ($44,582,744) and Chaparral ($856,379) because the cost of the water is a flow-through to customers' bills. DRA asserts that the
flow-through costs do not require the general office attention and activities at the level required by produced water.

Countering DRA's argument that purchased water has lower general office costs, Golden State lists multiple accounting functions specifically related to tracking purchased water costs. They are: a separate balancing account to track under- or over-collected balances; tracking production costs by source including purchased water; and, calculating an accrual for purchased water costs at the end of each month.

DRA also proposes using the number of connections (17,788) at the military bases served by ASUS as the customer number rather than counting each base served by ASUS (6) as the number of customers.

Finally, DRA proposes increasing the amount of Golden State's direct plant from $1,184,464 to $226,033,576 (an increase of $224,849,090) to reflect the amount of gross plant owned and operated by ASUS subsidiaries serving military bases. DRA contends that the figure used by Golden State represents only the corporate headquarters and assets for ASUS.

Much of the testimony regarding total plant expense was filed under seal. Except where necessary, we avoid discussing sensitive contract terms. DRA asserts that under its contract with the military bases, ASUS not only provides water and wastewater services, but also acquired the distribution assets to provide services under those contracts. DRA claims the value of the assets being transferred is $226,033,576. DRA contends that this amount includes additions to the military plant and Construction Work in Progress. (DRA Ex. 107-C at 2-15, 16.)

Golden State denies DRA's claims that the military contracts transfer assets. Golden State asserts that since the military has the right to terminate the contracts and take the assets back, there is no transfer. Golden State contends that DRA has provided no proof of its claims regarding the terms of the contracts. Golden State also states that the value of the pipeline and infrastructure used to provide service under the contracts has little if any impact on Golden State's general office costs since ASUS has its own employees to operate the distribution system and ASUS pays them directly.

DRA also asks the Commission to order Golden State to discontinue providing service to several cities and agencies under eight non-regulated operating contracts. DRA claims the level of service varies from city to city and since the last GRC, Golden State has shifted certain non-regulated contracts to the regulated operations of Golden State in violation of D.98-06-068. That decision authorized establishment of a holding company. A prior settlement agreement adopted by the Commission in D.97-12-016 requires that all contracts and unregulated operations shall be transferred to the appropriate affiliate as soon as all requisite consent is obtained.

In 2007, Golden State moved eight city contracts from ASUS to Golden State in violation of D.98-06-068. Golden State acknowledges this action and admits that it did not seek a change in ratepayer rates and asserts its intention to discontinue services under these contracts.

DRA contends that if Golden State continues to provide services under city contracts when the rates from this proceeding go into effect, ratepayers will be subsidizing non-regulated service. The Cities agree with DRA's position regarding using a four-factor approach and stressed the importance of ensuring that ratepayers are not subsidizing unregulated operations.

Because Golden State's contract to provide services to the City of Torrance was extended, the four factor allocation calculation must include the general office costs associated with that contract. As part of the supplement to the settlement agreement, Golden State and DRA agreed to use a separate ASUS category in the allocation, ASUS-City, to reflect the extended contract with the City of Torrance.

7.2.2. Discussion

The four factors identified in the Commission's 1956 Memo are direct operating expenses, gross plant, number of employees, and number of customers. The purpose behind the four-factor methodology is to arrive at a reasonable allocation of costs among entities and avoid the tedious parsing of individual cost centers that Golden State advocates here with its single-factor allocation.

DRA has agreed to allocate costs to Golden State only, or to Golden State, Chaparral and ASUS-City combined, all those cost centers which provide absolutely no services to ASUS-Military. Of the 47 general office cost centers, ASUS-Military benefits from 30. The other 17 cost centers totaling $5,719,902 of general office costs are allocated among Golden State, Chaparral or ASUS-City. Although Golden State cites the 1956 Memo and D.80207 as support for its single-factor methodology, the Commission has not adopted a single-factor methodology in any recent cases. In fact, recent Commission decisions have either approved the use of the traditional four-factor methodology, or fewer than four factors if it can be shown that one or more of the established four factors are inappropriate or would result in distorting the allocation results unreasonably.

Golden State argues that the number of customers for ASUS should be determined by counting each military contract as one customer rather than by counting the number of connections. Under Golden State's proposed method, ASUS has only six customers.

DRA's proposed method, which is the method we adopted in D.07-11-037, would recognize 17,788 customers for ASUS. That method, however, was an interim expedient based on three factors - total labor costs, total expenses and a weighted average number of customers, based upon the number of ultimate connections served and the nature of services provided by the affiliates.⁹ In that decision, the basis for utilizing a weighted average number of customers was driven, in part, by the need to take into consideration the varying levels of service provided by ASUS under military and city contracts. In contrast, with the exception of its contract with the City of Torrance (ASUS-City), ASUS now only has military contracts. Under its contracts with the military, neither Golden State nor ASUS provide direct service to military base residents. Additionally, the cost allocation methodology adopted today considers four factors, and the inclusion of both the total dollar amount of plant involved in the Golden State military contracts and the number of ASUS employees (as opposed to payroll expenses) provide a better means to ensure that the costs for general office expense are properly allocated between Golden State and its affiliates. For these reasons, we agree with ASUS that it has only six customers. Golden State and DRA agree on the number of customers for Golden State (277,819), Chaparral (13,488), and ASUS-City (12,599).

In the allocation calculation, DRA proposes that purchased water costs be deducted from the total expenses for Golden State and Chaparral because it is a flow-through expense that does not require the same level of general office activity as produced water. Golden State argues that some general office functions are related to purchased water. However, neither the quantity nor expense related to purchased water materially impacts the amount of general office activity and including the purchased water costs unreasonably skews the allocation results. Therefore, we exclude the purchased water costs for Golden State and Chaparral in the four-factor allocation.

DRA proposes that the number of customers be substituted for the payroll expense factor in this GRC. We agree that Golden State's payroll expense figure under-represents its actual costs and a more accurate figure is the number of employees.

Golden State objects to DRA using 2008 figures for some factors, such as number of employees, and 2007 figures for other factors, claiming it leads to biased outcomes. On the contrary, using the 2008 figures for number of employees, the most accurate information, ensures the four-factor allocation outcome is as fair as possible. Using out-of-date information skews the outcomes. Golden State does not dispute the fact that ASUS's employee count has tripled since December 2007. As a general matter, it would be preferable to use data from the same year for all factors. However, the Commission favors accurate information that adheres to the objective of the 1956 Memo which seeks to fairly allocate actual indirect general office costs between all entities. For these reasons, Golden State's proposal is not reasonable and we adopt DRA's recommended employee count for Golden State (553), Chaparral (13), ASUS-Military (84), and ASUS-City (2.25),¹⁰ rather than payroll expense as one of the cost allocation factors.

DRA proposes including the total dollar amount of plant involved in Golden State military contracts ($224,859,122) for the plant factor of the allocation methodology. Golden State proposes that only the value of furniture, vehicles, and equipment ($1,184,464) should be used since ASUS does not actually own the water distribution and wastewater collection systems.

As part of the reopened proceeding, Golden State was required to provide the contracts for ASUS operations on military bases. Although the contracts are confidential, a review of the contract terms reveals specific language as to ownership of the water distribution and wastewater collection systems. Each contract contains language such as, "ASUS shall assume ownership, operation and maintenance of water distribution systems and wastewater collection systems..." and "The Government shall transfer such assets as are listed in the Bill of Sale..." (DRA Ex. 133-C, Attachments at 2-8, 10.) There is little doubt as to the intent of the contracts and therefore we adopt DRA's recommendation that Golden State's plant factor for ASUS-Military include the water distribution and wastewater collection systems for a total plant factor of $226,043,586.

The result of our adopted four-actor allocation is illustrated on the table below:

Table 7

*This is the allocation of costs associated with the general office activities that do not apply to the ASUS-Military contracts.

As part of the settlement, Golden State and DRA agree that if for some reason, Golden State's ASUS-City contract (the contract with the City of Torrance) expires prior to December 31, 2012, Golden State may establish a balancing account to track the costs being allocated to ASUS-City.

7.3. 1% Equity Adjustment

Golden State requests a 1% equity adjustment to labor expense forecasts for both its general office and regional labor expenses. The 1% equity adjustment is calculated based on the total forecasted labor expense and produces funds that are used as employee bonuses.

7.3.1. Positions of the Parties

Golden State claims the 1% equity adjustment would provide a pool of funds for the purpose of attracting, retaining, and rewarding experienced,
non-executive employees that perform at or above the level expected for their positions. Golden State asserts that the opportunity to receive
performance-based increases provides an incentive for employees to perform at their highest level. Golden State believes employees who perform at a high level deserve more than just a Consumer Price Index adjustment. Golden State asserts that the equity adjustment is allowed under the rate case plan. Golden State's witness Darney-Lane likened the 1% equity pool to the State's Merit Salary Adjustment that allows employees to progress through their salary grade up to the maximum of the grade. (Golden State Ex. 73 at 7:20-22.)

Golden State asserts that its goal of attracting, developing, and retaining high-performing employees is becoming increasingly difficult because water utilities are facing a "War on Talent" with all water utilities as well as municipally run systems competing for the same employees. (Golden State Ex. 19 at 4:1-2.) Golden State contends that one way to combat this is to compensate high performing employees for their work.

DRA opposes Golden State's request for a 1% equity adjustment to general office and regional labor expenses. DRA asserts that the current wage escalation rate sufficiently addresses the need for salary increases and Golden State has not shown a need for this adjustment over and above wage escalations. (DRA Ex. 102 at 16:20-25.) DRA cites the state's unemployment rate of 11.2%, and rising, as easing Golden State's difficulty in attracting and retaining employees since fewer alternative employment opportunities are available. DRA claims this situation creates an incentive for employees to perform at a high level in order to retain their current positions.

Golden State counters DRA's claim regarding the current high unemployment rate as an incentive for employees to maintain their current employment with statistics demonstrating that the government sector from which Golden State draws its employees has not had significant job losses. Golden State asserts that its main competition for employees is municipal water companies. Golden State cites statistics indicating that the government sector has only lost 0.4% of jobs in the 12-month period of March 2008 to March 2009. (DRA Ex. 114 at 3.)

DRA expresses concern about the 1% equity adjustment becoming part of an employee's base salary so that future escalations are applied to a higher base salary, regardless of whether the employee continues to perform at a high level. And finally, DRA objects to Golden State's expansive view of customer service that includes sections of the company, such as regulatory affairs, that have nothing to do with service to ratepayers, but would be eligible for Golden State's proposed ratepayer-funded equity adjustments. (RT at 452:4-12.)

The Cities state that the 1% equity adjustment is particularly offensive in these economic times and agree with DRA's position opposing the 1% equity adjustment.

7.3.2. Discussion

While Golden State's assertion that the RCP (D.04-06-018)¹¹ allows water utilities to use any methodology to forecast expenses is correct, such forecasts are subject to review and approval by the Commission.

Golden State states that the equity adjustment is essential to attracting and retaining high performing employees, especially in light of the competition among water utilities for the same talented employees. In its supplemental testimony, Golden State listed the criteria used to determine when an employee's performance warrants a bonus. Among the criteria it considers are the employee's knowledge and skills and the expectation that the employee will continue to perform at this higher level. The criteria support the position that awarding bonuses is based on an objective process, and ensures that only the highest performing employees would be awarded bonuses. Further, Golden State explains that since these merit increases reward employees who perform above and beyond normal performance expectations, the amount of merit increases will vary each year.

We cannot agree with DRA that the equity adjustment amounts to an unnecessary and excessive salary increase. Employees are not assured a merit increase every year, but rather must meet certain performance criteria to receive one. Further, Golden State states in its Supplemental Testimony that the merit adjustment recognizes individual employee performance and is available to the majority of employees who are not eligible to receive stock options.

Golden State contends that the merit adjustments are an important component of the company's compensation structure. While it may be true that the current economy may not necessitate such an incentive to attract and retain employees, we do not believe it is appropriate to micro-manage how a company structures the compensation of its employees. Moreover, to the extent this compensation structure allows Golden State to retain qualified and experienced employees, it benefits both the company and its ratepayers.

For the reasons given above, Golden State's request for a 1% equity adjustment in its general office and regional forecasted labor expenses is reasonable and therefore is granted.

7.4. Pension and Benefit-Retiree Medical

Golden State seeks $3,340,800 in 2009, $3,411,000 in 2010, $3,505,000 in 2011, and $3,573,000 in 2012 to expand its post-retirement Voluntary Employee Beneficiary Association (VEBA) benefits.

7.4.1. Positions of the Parties

Golden State proposes to increase pre-65 aged retiree medical benefits to $242 per month, an increase of $90 per month. Golden State proposes to increase the post-65 aged retiree medical benefit to $150 per month, an increase of $65 per month. (Golden State Ex. 10 at 24 of 77 of Attachments.) In addition to the increased post-retirement medical benefits, Golden State is also proposing to offer VEBA benefits to all of its employees. This is the first increase in benefits since Golden State froze its VEBA plan in 1995.

Golden State asserts that the increases in VEBA are necessary in order for the company to stay competitive as it competes with other water utilities and municipal water agencies to attract and retain talented employees from a limited pool of technically skilled candidates. Golden State produced a study performed by its actuary Mercer evaluating which companies in its peer group offer retirement medical benefits to their retirees.¹² The actuary noted that all members of the peer group for which information was available provide a
post-retirement medical plan covering all of its employees.

Golden State claims that the freeze on VEBA has resulted in an issue of equality amongst employees regarding their respective benefits and that in negotiations with its BVES Union, the Union made a demand that all employees be treated the same when it comes to providing medical insurance for retirees.

DRA objects to Golden State's proposal because it amounts to a 45% increase in benefits for pre-65 aged retirees and a 70% increase in benefits for post-65 aged retirees. The expanded and enhanced medical benefits would increase costs to ratepayers by 350%, from $953,000 to a total of $4,364,000 in 2010.

DRA refers to a survey by Towers Perrin and the International Society of Certified Employee Benefit Specialists, dated December 2008, indicating that only 39% of employers are currently offering retiree medical benefits to new hires, that 40% of companies either have changed or will change the cost sharing terms and 20% of companies either have ceased or plan to cease providing post-65 financial support in post-retirement medical plans. DRA asserts that the results of the survey show that Golden State's proposal is contrary to what is happening elsewhere in the country.

DRA claims that Golden State has been unable to demonstrate either that it is not competitive in the marketplace for talent or that it has lost employees due to a lack of retirement medical benefits. DRA also notes that the Mercer study merely compared post-retirement medical benefits, but failed to compare overall compensation structures to provide a complete picture of retirement benefits. DRA also objects to Golden State's basing its request for increased benefits for all employees on the demands made by a Union representing only 16 of Golden State's employees.

Golden State contends that the results of the Towers Perrin survey are of limited use because they do not indicate whether water utilities were included in the survey or whether any of the survey participants were located in California.

The Cities agree with DRA's position and recommend that the Commission reject the request for expanded VEBA.

7.4.2. Discussion

Golden State's Mercer study stops short of a complete and convincing analysis in support of Golden State's requested enhanced and expanded medical benefits. An accurate comparison of employee benefits between companies must include an analysis of the overall compensation package. Without knowing how Golden State's overall compensation package compares to its peer group, it is impossible to reach the conclusion that it is not competitive.

Golden State has provided no evidence that it is not competitive in the marketplace or that it has been unable to attract new employees due to its medical benefits structure. Golden State seeks a substantial increase in employee benefits at a time when many of its customers may be facing personal financial difficulties. Absent a demonstration that without the increased benefits Golden State has been unable to attract qualified employees and that service to its customers has suffered as a result, Golden State's request is not reasonable and therefore the request is denied.

We adopt DRA's recommendation that $948,000 in 2009, $953,000 in 2010, $951,000 in 2011, and $945,000 in 2012, based on the current level of VEBA benefits, be included in rates.

7.5. Pension and Benefit-Balancing Account

Golden State's GRC application originally requested pension cost recovery of $5,062,000 in 2009, $5,115,000 in 2010, $5,191,000 in 2011, and $5,288,000 in 2012. In updated testimony, Golden State submitted an increased pension cost projection of $8,572,000 for 2010 and requested a two-way balancing account to track the difference between the pension amounts included in rates and the actual costs.

7.5.1. Positions of the Parties

Golden State asserts that between its initial filing and its updated filing, the financial markets collapsed and the stock market suffered an unprecedented decline. As a result, Golden State claims that its pension plan costs have increased by 67.5%. Golden State asserts that its original estimated pension costs for 2010 of $5,115,000 have increased to $8,572,000. Golden State seeks a
two-way balancing account because according to its actuary, current economic conditions are likely to cause Golden State to under-recover its pension plan costs from 2010 through 2012.

Golden State and DRA agreed that the estimated pension expense is projected to be $6,870,000 in 2010, $6,664,000 in 2011 and $6,595,000 in 2012 based on the most recent actuarial calculations, which were provided to Golden State from its actuarial firm in correspondence dated February 10, 2010. (DRA Ex. 133 at 45 and GSWC Ex. 212, Attachments A and C.)

Golden State cites the Joint Ruling to Modify the Scope of Phase 2 to Consider the Impacts of the On-going Financial Market upheaval issued by ALJ Long and Commissioner Bohn in A.08-05-001 as recognizing the impact of the financial crisis on the national and state economy. Golden State also cites Commission decisions establishing balancing accounts for pension and benefits costs of SCE and Pacific Gas and Electric Company (PG&E).¹³ Golden State asserts that a balancing account benefits ratepayers since they fund only the actual pension benefit costs and there is no chance for over-recovery.

Golden State asserts that the current economic crisis goes beyond mere market fluctuations. Golden State claims the influences of the economy, financial market conditions, and changing interest rates on Golden State's pension expenses are as follows:

· Bear market returns have significantly decreased the value of assets held in the pension trust fund. This has led to a significant increase in the under-funded status of the Golden State pension plan resulting in a corresponding increase in annual pension expenses and required cash contributions.

· Low discount rates have resulted in increased pension liability and service costs and therefore, an increase in expense levels.

· Poor asset performance and increase in liability have resulted in actuarial losses that are amortized over the future, working lifetime. Again this results in increased annual expenses. (Golden State Ex. 10.)

DRA objects to Golden State's calculations of the increased pension and benefit costs for years 2010, 2011, and 2012 and its request for a two-way balancing account. DRA asserts that the discounted rate Golden State used to determine the updated pension costs is higher than that used in its initial filing. The change in discount rate results in lower pension costs since the discount rate is inversely related to the costs of the pension plan.

DRA also claims that establishing a two-way balancing account removes the incentive for the company to control costs and that Golden State has benefitted from the current system and only now, when market fluctuations are adversely affecting it, has Golden State sought a change. DRA states that many companies are freezing pension plans or discontinuing defined benefit plans and offering enhanced 401k plans instead to mitigate costs. DRA also claims that market volatility results in both gains and losses over time and therefore Golden State's actuarial assumptions can and should be revised on an annual basis to account for the fluctuations.

DRA points out a distinction between the pension balancing accounts the Commission has authorized for SCE and PG&E and that sought by Golden State. DRA states that the balancing account established for SCE was based on the Employee Retirement Income Security Act (ERISA) minimum funding levels and not the pension expense calculated under Financial Accounting Standards No. 87 (FAS 87) used by Golden State. DRA asserts that ERISA funding levels are almost always lower and sometimes significantly lower. The PG&E case was based on a settlement between DRA and PG&E, authorizing PG&E to establish a balancing account to track the differences between authorized pension contributions and (1) lower contributions or (2) federally mandated higher contributions.

The Cities recommend that the Commission reject Golden State's request for a pension balancing account.

In its supplemental testimony and during oral arguments, Golden State cited instances where the Commission has approved balancing account treatment for water companies. Golden State asserts that because it earns the same return on equity as the water companies that have been granted pension and benefit balancing accounts, Golden state should be given one so that it is facing the same risk.

7.5.2. Discussion

The Commission's current ratemaking treatment for water company pension and post-retirement benefits is based on forecasting the pension obligations and allowing recovery of the forecasted amount through rates. If pension asset earnings exceed expectations, the company retains any surplus funds; if pension asset earnings fall short of expectations, the company contributes the difference to meet the required funding level. Consequently, Golden State currently assumes the risk of under-recovery and enjoys the reward of over-recovery.

Golden State now seeks permission to establish a two-way balancing account to track the difference between the pension expenses it collects in rates and the actual costs it is required to incur for these benefits. It asserts that in the last five years, it has under-recovered through rates and the company contributed the difference. It further notes that during this period, its recorded pension expense required by SFAS 87 exceeded the authorized amounts by almost $6 million. Golden State asserts that significant shortfalls over the course of the past two decades and significant market volatility in recent years warrant establishment of a two-way balancing account.

We find Golden State's arguments persuasive. Establishment of a
two-way balancing account will provide a means for Golden State to control the volatility of its pension costs. Moreover, in recent years, we have approved and adopted pension and benefit balancing accounts for California-American Water Company and San Jose Water Company, as well as PG&E and SCE. We have also recently issued a proposed decision adopting a similar mechanism for California Water Services. Since these utilities all compete in the same market for capital, denying Golden State's request could place it at a disadvantage.

For the reasons stated above, Golden State's request to establish a balancing account is reasonable and is therefore granted. In its supplemental testimony, Golden State states that it would not object to permitting rate recovery of its pension costs only to minimum ERISA funding levels if it were granted a two-way balancing account to track the difference between the actual costs and FAS 87. Since we are granting Golden State's request, pension and benefits expenses shall be $4.136 million in 2010, $6.563 million in 2011, and $6.117 million in 2012. The amount to be tracked in the balancing account shall be the difference between the expenses authorized in rates and the actual costs calculated in accordance with SFAS No. 87.

7.6. General Office Rent Expense

Golden State requests $314,600 in 2009, $326,900 in 2010, $339,600 in 2011, and $352,800 in 2012 for general office rent expense.

7.6.1. Positions of the Parties

DRA's primary objection to Golden State's rental expense request is that the size of Golden State's two facilities exceeds Golden State's needs. Golden State recently leased a new facility down the street from its existing facility.¹⁴ The new facility contains 9,258 square feet of space on two levels. DRA recommends removing half of the rent expense associated with the new facility. DRA's testimony cited vacant offices and workstations, large areas of unused space near the executive offices and a 24% increase in the amount of general office conference and training room space. DRA cites the 29 work stations on the second floor of the new facility where only 14 to 16 customer service representatives are working at any given time as another example of underutilized space. (DRA Ex. 107 at 3-44, 45.)

Golden State counters that all but one office in the existing facility and two offices in the new facility are assigned and otherwise all space is fully utilized and useful. Golden State's witness Garon declares that the large open space next to the executive offices is used to greet visitors and is no larger than it needs to be based on its intended use. Garon states that the training and conference room space is justified because the additional 599 square feet represent only a 24% increase in space, while the number of employees has increased by 30%. (Golden State Ex. 77 at 63.)

Garon states that every customer service representative has an individual work station on the second floor because at least once a quarter all customer service representatives need to report to work on the same day. Garon also claims that sharing work stations would require the time-consuming process of packing and unpacking personal effects and adjusting ergonomic equipment. Finally, Garon emphasizes that sharing work stations and phone equipment would increase the likelihood of spreading germs and illness, therefore each customer service representative is assigned an individual work space for efficiency, morale, and health and safety reasons. (Golden State Ex. 77 at 65.)

The Cities support DRA's position regarding excessive office rent.

7.6.2. Discussion

Golden State's new facility has 9,258 square feet on two floors that, according to Golden State's original testimony, accommodates 42 employees. The lease expense for the new facility is $288,900 for 2009. The first floor of the new facility has 13 offices as well as 599 square feet of conference and training rooms, and a small coffee room. The second floor is occupied by the call center with 29 workstations. Both floors have restrooms.

In its supplemental testimony, Golden State has indicated that 1,734 square feet of the 9,258 square feet in the new general office space is elevators, stairwells, restrooms, and equipment rooms in addition to the 599 square feet of common areas indicated above. Golden State's supplemental testimony has also updated the total number of employees situated at both general office locations as 154 and demonstrated that varied and overlapping work schedules for its call center employees indicate a need for individual cubicles. For the above reasons, Golden State's request for $288,900 for 2010 with escalation factors for subsequent years is granted.

7.7. Executive Labor Adjustment

DRA recommends that salaries for two executive positions be disallowed from Golden State's requested labor expense.

7.7.1. Positions of the Parties

DRA requests that the salaries of two positions, the Chief Executive Officer (CEO) and the Executive Vice President (EVP) be removed from Golden State's forecasted labor expense. DRA does not recommend the elimination of the positions, but a reduction to Golden State's overall labor expense equal to the salaries of the two positions. DRA asserts that because at least one of the positions is vacant and because Golden State overcompensates its executives at the expense of ratepayers, removal of the two positions' salaries will bring Golden State's overall executive labor expenses more in line with its peers.

DRA contends that compensation studies ordered by Golden State show that Golden State overcompensates its executives. DRA also asserts that executive bonuses become part of base salary which are then brought forward and compound the overcompensation.

Golden State claims there are no actual vacancies as the previous CEO, Mr. Wicks, retired on December 31, 2008, and the position was filled when the previous Chief Financial Officer, Mr. Sprowls, became the CEO on January 1, 2009. Golden State asserts that the EVP vacancy will be filled with an executive level employee to oversee the Information Technology department prior to the issuance of a decision in this proceeding. Golden State asserts ongoing vacancies at the executive level are less likely than at other levels within the company and therefore should not be excluded from labor expenses.

Golden State also contends that it does not overcompensate its executives, and salaries are based on the results of contracted compensation studies.

The Cities support DRA's position that executive compensation is excessive.

7.7.2. Discussion

Most of the information regarding executive compensation was filed under seal. To the extent necessary, we have avoided using specific confidential information. Golden State hired Frederick Cook & Company to compare the five highest levels of executive compensation at Golden State to a peer group and make recommendations regarding the appropriate level of executive compensation at Golden State. The resulting study (the Cook Report) includes the years 2006, 2007, and 2008.

Golden State asserts that its five highest executives' salaries fall between the 50^th and 75^th percentile of its peer group's five highest executive salaries.¹⁵ This statement does not paint a completely accurate picture of Golden State's overall executive compensation.

According to the Cook Report, except for the CEO, the total cash compensation at every level is above the 75^th percentile. Golden State's total direct compensation is also near or above the 75^th percentile for all positions except the CEO, which is at the median. (DRA Ex. 117-C at 20-25.)

The CEO salary comparison is skewed because the highest CEO salary in the peer group is almost double that of the second-highest salary. Therefore, although Golden State's CEO's compensation is the fourth highest of the eight companies compared, it falls below the 60^th percentile due to the impact the highest compensation has on the overall comparison. Of the other four companies compared, one is at the median and the other three are clustered around the 25^th percentile.

DRA asserts that Golden State has applied the Cook Report's recommendations to more than just its five highest paid executive positions, compounding the asserted overcompensation by doubling the number of executives that are compensated within the five highest compensation bands.

The Cook Report lists the compensation of the five highest paid positions at Golden State. (DRA Ex. 118-C at 10, 20-25.) The proposed Officer Compensation for 2008 lists two officers at the second-highest grade, one officer at the third-highest grade, four officers at the fourth-highest grade, three officers at the fifth-highest grade, and three officers at the sixth-highest grade. (DRA Ex. 118-C at 1-2.) An analysis of the information in both Exhibit 117-C and Exhibit 118-C demonstrates that all 12 executives or officers, including the three at the sixth-highest compensation level, receive salaries falling high within the percentile ranges recommended by the Cook Report for only the five highest paid executives.

For the reasons stated above, we find that Golden State's executive compensation exceeds what is reasonable. Golden State's compensation for the 11 highest positions, at Vice President and above, is $3,288,965. DRA requests a reduction of approximately $1 million representing the CEO and EVP actual cash compensation or 30.5% of the total executive salary base. DRA's request is denied. However, we find it reasonable to reduce Golden State's executive salary base by $500,000, approximately 15% of the executive salary base and the equivalent of the total direct compensation of the still-vacant EVP position. This reduction will place Golden State's overall executive compensation more in the mid-range of the percentile span recommended by its consultant.

7.8. Management Audit

DRA has requested that the Commission order a management audit before Golden State files its next GRC.

7.8.1. Positions of the Parties

DRA cites the significant internal reorganization that Golden State is undergoing as the basis for its request. In 2007, Golden State created the COPS department. The Asset Management, CSC, and Environmental Quality cost centers now all fall within the purview of COPS. The reorganization clarifies the reporting hierarchy of the various departments and the employees within the department. The Asset Management Department's functions, historically handled at the regional level, are now centralized under COPS.

As a result of the formation of COPS, Golden State requested a 35% increase in employee positions; however, a lesser figure resulted from parties' settlement negotiations in the last Golden State GRC. DRA states that although the centralized functions should result in more efficient operations and ultimately long-term cost reductions, the significance of the change and the cost involved call for a management audit prior to the next general office GRC in May 2011. DRA asserts that a management audit would ensure that the reorganization is effective and results in reduced costs, and would determine whether the Asset Management program is operating efficiently. (DRA Ex. 107 at 5-15.)

Golden State objects to the management audit, calling it premature because the reorganization is not complete and, in part, dependant on the decision in the present proceeding. Golden State asserts that a management audit in the time frame suggested by DRA allows only 17 months between the assumed January 2010 effective date of the decision in this proceeding and the May 2011 filing of the next general office GRC. Additionally, contrary to DRA's claims that the audit would provide several years of actual operational experience, Golden State asserts that less than a year will elapse between full reorganization implementation and the start of the audit in order for it to be finalized by the GRC application deadline. Finally, Golden State states that a premature management audit would impose unnecessary costs on ratepayers.

The Cities recommend that DRA's request for a management audit prior to the next GRC be adopted.

7.8.2. Discussion

It appears that the timing of the management audit may be the real issue between the parties. Golden State does not oppose the management audit outright, but contends that it is premature. As an alternative, Golden State proposes that the Commission defer its decision on whether to order an audit until the next general office GRC.

While we agree with DRA that it is necessary to determine if the significant costs for the reorganization have yielded the expected efficiencies and resulting cost reductions, it is prudent to ensure that the information necessary to make that determination is available. It is unclear how far the reorganization is from full implementation. Proof of its inchoate state is evidenced by the fact that some positions for the centralized COPS functions were requested in this GRC. However, because the reorganization was started in 2007, it is reasonable to assume that some aspects of the centralization are complete.

For the results of a management audit to adequately and accurately represent the impact of the reorganization on Golden State's operations, it is necessary that the reorganization be completely implemented and operating for a sufficient period of time. There are only about 17 months between the issuance of the decision in this proceeding and the filing deadline for Golden State's next general office GRC. The audit would have to be completed within that compressed time frame. Less than 17 months of fully operational experience supplies insufficient information to determine whether a costly reorganization is providing the expected beneficial results. The Commission's goal is to ensure that ratepayer money is spent wisely, both for Golden State's COPS reorganization and the audit to determine its efficacy. A delay more likely to yield quality information is preferable to swift feedback that may be of questionable value. Ordering a management audit prior to Golden State's next general office GRC is premature and the Commission denies DRA's request.

⁸ Pub. Util. Code § 2107 states: Any public utility which violates or fails to comply with any provision of the Constitution of this state or of this part, or which fails or neglects to comply with any part of provision of any order, decision, decree, rule, direction, demand, or requirement of the commission, in a case in which a penalty has not otherwise been provided, is subject to a penalty of not less than five hundred dollars ($500), nor more than twenty thousand dollars ($20,000) for each offense.

⁹ See D.07-11-037 at 35 (slip op.).

¹⁰ The ASUS-City employee count is part of DRA's and Golden State's supplement to the settlement.

¹¹ D.04-06-018 states:

For test year district and general office expenses, excluding water production related expenses, the utilities and ORA may forecast using traditional estimating methodologies (historical averages, trends, and specific test year estimates). In addition to any other methodology the utility may wish to use, the utility shall also present an inflation adjusted, simple five-year average for all administrative, operational, and maintenance expenses, with the exception of off-settable expenses and salaries in its workpapers.

¹² Golden State Ex 10 at 5:15-18. The peer group consists of California Water Service, City of Anaheim, City of Banning, City of Fullerton, City of LaVerne, City of Riverside, City of Sacramento, City of Simi Valley, San Diego Gas & Electric Company (SDG&E), San Jose Water Company, and Southern California Edison Company (SCE). Information was available for all entities except City of Banning.

¹³ D.06-05-016 established a two-way balancing account for SCE and D.06-06-014 established a two-way balancing account for PG&E.

¹⁴ The existing facility is at 630 E. Foothill Boulevard, San Dimas, CA and the new facility is at 460 E. Foothill Boulevard, San Dimas, CA.

¹⁵ The fourth highest paid executive at American State Water (Golden State's parent), works for the unregulated ASUS and is not included here.