8. Remaining Disputed Issues

Three issues raised in San Gabriel's application and opposed by DRA remain unresolved as part of the settlement. These issues are San Gabriel's requests that: 1) the Commission adopt a balancing account for its employee health and dental expenses, 2) expenses contained in San Gabriel's Water Quality Litigation Memorandum Account (WQLMA) be amortized in rates and collected from customers, and 3) annual estimated costs of $166,000 in outside legal costs for defending against contract disputes under a settlement agreement related to water contamination in San Gabriel's Baldwin Park Operables Unit should be included in test year expenses, rather than in the WQLMA. These issues are addressed in Section 8.1, 8.2, and 8.3 below, respectively.

8.1. Balancing Account Treatment for
Employees Health and Dental Expenses

In its application, San Gabriel requests authorization to establish a Health and Dental Expense Balancing Account. San Gabriel explains that the requested balancing account would track changes in San Gabriel's group health and dental insurance premiums, which San Gabriel describes as volatile, unpredictable, and beyond the utility's control. San Gabriel further argues that "the even greater uncertainty and changing conditions created by the ongoing health care debate and new national law" support the company's request for a balancing account by making premium costs less predictable. In addition, San Gabriel estimates that the magnitude of the health and dental premium expenses will be approximately 1.4% of the company's proposed revenue requirement in this application, which it characterizes as a significant cost to the company and its ratepayers.⁵

DRA, on the other hand, argues that creation of a balancing account would limit San Gabriel's incentive to control the health and dental premium expenses for its employees by passing these costs through to ratepayers. DRA specifically argues the costs of health and dental premiums for its employees are within San Gabriel's control, because San Gabriel could adjust the terms of the health insurance it provides for its employees, make employees cover a greater share of the premium costs for the coverage provided, or "comparison-shop" for less expensive insurance if premiums are higher than expected or desired.⁶

San Gabriel and DRA both note that the company covers 100 percent of the premium costs for its employees and 60 percent of the premium costs for employees' dependents. In proposing balancing account treatment for these premium expenses, San Gabriel appears to assume that this level of company contribution, along with the current terms of the health and dental benefits, will continue for the foreseeable future. Based on this assumption, it is understandable that San Gabriel characterizes premium costs as beyond its control, and represents that the company is exposed to volatility in costs for a defined level of coverage, with the costs of that coverage set independently by insurance providers. San Gabriel further notes that two-way balancing accounts, the sort San Gabriel requests, do not solely pass through costs to consumers, but may also pass through savings to customers if costs decrease or are lower than expected.⁷

As DRA notes, however, not all companies provide the same type and level of health or dental insurance to their employees. San Gabriel's commitment to maintaining current benefit levels for its employees is laudable, however the proposal to create a two-way balancing account would require the Commission to perform an after-the-fact reasonableness review of San Gabriel's expenditures to determine whether the Company's ratepayers to should bear the cost of this commitment. San Gabriel is correct in stating that a balancing account does not necessarily result in increased costs to ratepayers, and under certain circumstances may result in decreased costs or even credits to ratepayers. However, despite San Gabriel's argument that it is not requesting a balancing account simply because of an increasing trend in premium expenses, but rather because of unpredictability, volatility, and lack of control,⁸ San Gabriel acknowledges that the current trend for health and dental premiums is one of increasing costs. San Gabriel uses the magnitude of those forecasted increases (and specifically the fact that they are much higher than the escalation factors applied to San Gabriel's costs) to support its request for a balancing account.⁹ This argument tacitly acknowledges that in this case, San Gabriel expects the costs recorded in this requested balancing account to increase, at least in the immediate future. If so, the practical effect of adopting a balancing account would be that San Gabriel would ask to pass through increased costs to ratepayers, reducing the company's incentive to limit these costs. In addition, it is not clear how volatile the health and dental expenses will be in the next few years or the effect on costs (if any) of new state and federal health care laws, making a request to change treatment of these costs on the basis of new laws premature.

For these reasons, we decline to approve San Gabriel's request for balancing account treatment of health and dental insurance premium expenses. We do not necessarily advocate a reduction in employees' benefits or an increase in the employee share of premium costs, as suggested by DRA; however, we note that there are many ways in which San Gabriel (or any company) may act to limit health and dental insurance premium expenses. It is reasonable to maintain the current funding mechanism for these costs, which ensures that San Gabriel has incentives to manage health and dental expenses in a cost-effective manner. The San Gabriel request for balancing account treatment of health and dental insurance premium expenses is denied for these reasons.

8.2. Request to Amortize Cost Balance
from the WQLMA

In this application, San Gabriel requests authority to amortize in rates approximately $3.5 million in costs recorded in the company's WQLMA. San Gabriel argues that, based on Commission policy set in D.10-10-018, the company should be allowed to collect the amounts spent on water quality litigation. San Gabriel states that it should be able to collect from ratepayers both amounts spent as a defendant against customers complaining about water quality (as has been allowed in previous Commission decisions), and as a plaintiff attempting to collect expenses from polluters.¹⁰ San Gabriel further argues that, under the terms of Commission Resolutions W-4089 (approving the creation of the first WQLMA for Southern California Water Company and encouraging other companies to file for their own, similar accounts) and W-4094 (approving San Gabriel Advice Letter 300 and authorizing its WQLMA), the only amounts appropriately included in these accounts are litigation costs relating to water contamination lawsuits.

San Gabriel also suggests that D.10-10-018 supports its request to amortize recorded costs because it provides a mechanism for water companies to periodically collect those costs.¹¹ D.10-10-018 adopts a "combined trigger" default mechanism to allow water companies to avoid major delays in receiving funding for their litigation costs. Under this mechanism, water companies may recover costs recorded in their balancing accounts "which ever of the following occurs first, reaching the monetary threshold of 2% of revenue requirement or the elapsing of three years from the date the memorandum account was established."¹² Because San Gabriel's memorandum account was created by the company's Advice Letter 300, effective January 29, 1998, San Gabriel states that it meets the trigger mechanism criterion that more than three years have elapsed since the account's establishment, and it should be allowed to recover the recorded costs. San Gabriel further notes that in past GRCs, it has been allowed to recover costs related to defending itself against litigation related to water contamination, which the company says establishes a precedent for recovering at least defense-related costs from customers, leaving only the plaintiff-related costs and as-yet-unrecovered defense related costs at issue here. San Gabriel asserts in its briefs that the $11 million credit balance currently in its WQLMA represent proceeds from general damage settlements from polluters and accrued interest, and that "none of those proceeds relate to or result from San Gabriel's defense of toxic tort litigation,"¹³ once again drawing a distinction between plaintiff and defense-related amounts recorded in the account, as well as between expenses incurred through litigation as opposed to through other contamination-related activities.

DRA opposes the request to amortize some or all of the costs, arguing that the same decision cited by San Gabriel, D.10-10-018, requires water companies to subtract costs from the gross proceeds of insurance amounts, settlements, or awards, before collecting any net costs from ratepayers. Based on this interpretation, DRA argues that the approximately $3.5 million in costs recorded in the WQLMA should be offset from the approximately $11 million credit in the WQLMA, in which case no money would need to be collected from ratepayers at this time.

D.10-10-018 deals largely with rules for the sharing between ratepayers and utility shareholders of contamination-related proceeds collected from polluters, government entities, insurance companies, or others. As noted by San Gabriel, that decision does establish an interim method for recovering costs when cost recovery has been delayed. However, in discussing the sharing of proceeds, D.10-10-018 also addresses the issue of cost recovery from ratepayers in its definition of "net proceeds" for the purpose of sharing between ratepayers and shareholders. D.10-10-018 defines net proceeds as:

Gross proceeds received minus all (1) reasonable legal expenses related to litigation, (2) costs of remedying plants, facilities, and resources to bring water supply to a safe and reliable condition..., and (3) all other reasonable costs and expenses that are a direct result and would not have been incurred in the absence of such contamination, including all relevant costs already recovered from ratepayers (for which they have been, or will be, repaid or credited).¹⁴

This definition does not distinguish between defense-related and plaintiff-related costs, and in adopting this definition, the Commission clearly stated that all costs "that are a direct result and would not have been incurred in the absence of such contamination," not only litigation costs, should be subtracted from gross proceeds before sharing of those proceeds. This is consistent with the principle expressed in Resolution W-4089, which allowed the creation of the first WQLMA by Southern California Water Company and allowed other water companies to request similar accounts, which ordered the affected utilities to "use every means possible to maximize insurance proceeds and to seek restitution from the polluters... so as to lessen any possible regulatory burden on... customers."¹⁵ Though Resolutions W-4089 and W-4094 do appear to limit the WQLMAs to litigation costs, San Gabriel has been required to record proceeds from litigation or settlements related to litigation, resulting in the credit balance in that account today.

As exemplified in our past orders, the Commission has consistently provided that, to the extent possible, ratepayers should be shielded from costs stemming from water contamination. Neither the original advice letter and resolutions establishing San Gabriel's WQLMA nor D.10-10-018 distinguish between defense-related and plaintiff related costs for the purposes of cost recovery. The Commission requires that water companies in general (and therefore San Gabriel in particular) are to collect as much as possible from insurers, polluters, and other non-ratepayer sources to cover costs related to contamination, and D.10-10-018 contemplates those proceeds including costs of remediation, litigation, and "all other reasonable costs and expenses that are a direct result and would not have been incurred in the absence of such contamination" being recorded in the utilities' WQLMAs and offset against costs before sharing residual amounts (beyond expenses) between ratepayers and shareholders. D.10-10-018 further requires a utility to share with ratepayers any proceeds in excess of those costs, again without regard to whether those proceeds were collected from litigation in which the company was a plaintiff or a defendant, or from a settlement, insurance claim, or other action related to contamination. In fact, the definition of net proceeds assumes that before sharing between ratepayers and shareholders takes place, costs previously collected from ratepayers would be refunded to consumers. Consistent with the principle that ratepayers should be shielded from bearing contamination-related costs to the extent possible, D.10-10-018 assumes that amounts collected from ratepayers will be refunded to them out of gross proceeds before a determination is made of the net proceeds amount that can be shared between ratepayers and shareholders.

Under D.10-10-018, whether the costs (or credits) reflected in the WQLMA represent plaintiff-related or defense-related activities is not relevant to the determination of how or when they should be recovered from or shared with ratepayers. Similarly, D.10-10-018 provides that all proceeds in WQLMAs, regardless of whether they are labeled as "litigation-related," shall be used to reduce the burden of litigation costs on ratepayers. Given the consistently expressed principle that ratepayers should not be charged for contamination expenses that can be recovered from a more appropriate source, it would not be reasonable to collect from ratepayers any costs recorded in San Gabriel's WQLMA when that account holds a credit balance. Doing so would require ratepayers to cover, at least in the short term, costs that not only can be, but apparently have been, collected from another source.

For these reasons, San Gabriel's request to amortize the expenses recorded in its WQLMA is denied. San Gabriel did not request sharing of the credit balance in its WQLMA in this GRC, and such a determination is not within the scope of this proceeding. In addition, it appears from the information available in the record that San Gabriel continues to be involved in litigation and other activities that may affect the credit or expense balances in this account, which could make such a sharing request premature. As a result, the record in this case does not include sufficient information to determine a "net proceeds" amount for sharing or a sharing allocation between ratepayers and shareholders, so that question is not resolved in this decision. Other issues of cost recovery or sharing of balances in the WQLMA may be included in the scope of a future proceeding, as appropriate.

8.3. Outside Legal Costs Related to
Baldwin Park Operables Unit
Settlement Agreement

San Gabriel asserts that its forecasted annual expenses of $166,000 for outside legal services to defend against contract disputes arising from administration of the Baldwin Park Operable Unit (BPOU) Project Agreement should be included in its test year revenue requirement. San Gabriel included this amount in its original estimate of test year A&G expenses, and notes that foreseeable outside legal services are generally considered a component of a company's A&G expenses for the purposes of determining the test year revenue requirement. In addition, San Gabriel states that these costs are "necessary ongoing costs for implementing a complex contract which is very beneficial to San Gabriel's customers."¹⁶ As a legal expense that is foreseeable, ongoing, beneficial to San Gabriel's customers, and relates to disputes over a contract that is currently in place (not specifically to ongoing litigation that stems from water contamination lawsuits), the company asserts that these costs meet the requirements for inclusion in the test year A&G expenses and therefore in the company's test year revenue requirement.¹⁷

In contrast, DRA suggests that these annual costs should be recorded in San Gabriel's WQLMA, and are not appropriate for inclusion in the test year revenue requirements. DRA explains that the legal services funded by this item relate to disputes over a contract that ultimately stems from a settlement agreement between San Gabriel and various entities accused of contaminating the San Gabriel water supply. The settlement agreement resolves earlier litigation among those parties related to water contamination of the company's Baldwin Park Operables Unit. Because the costs relate to a settlement agreement resolving contamination litigation, the legal costs are "contamination-related legal expenses" that must be handled through the WQLMA. DRA cites D.10-10-018 in support of its position, stating that the decision requires all contamination-related costs to be included in the litigation memorandum account.¹⁸ DRA also states that this is consistent with Resolutions W-4089 and W-4094, which authorize San Gabriel's WQLMA.

The parties characterize their dispute as turning on the question of whether the money at issue is fundamentally a water quality litigation expense and (as such) necessarily handled through the WQLMA, or an ongoing foreseeable expense over a new contract dispute, which is traditionally recovered through rates. These characterizations are not mutually exclusive. As both parties implicitly acknowledge, the amount at issue is an ongoing and foreseeable expense, and that expense ultimately stems from water quality litigation (in this case, a settlement agreement or contract ostensibly resolving that litigation). In this case, the more relevant questions are: should this particular ongoing and foreseeable expense be collected in rates even though the contract stems from water contamination, or should it be included in the WQLMA because it ultimately stems from water contamination, despite the fact that the expense is an ongoing and foreseeable expense that otherwise would be considered in the A&G budget?

Unfortunately, neither D.10-10-018 nor the resolutions establishing San Gabriel's WQLMA explicitly address the treatment of ongoing costs from long-term contracts or other agreements arising from water quality litigation. The resolution that orders San Gabriel to submit an advice letter requesting the WQLMA states that, in addition to including the costs of defending itself against lawsuits related to water contamination, "[r]easonable legal expenses associated with [attempts to collect from insurance companies or polluters] would also be considered appropriate for inclusion in the memorandum account." This stops short of requiring that specific expenses be included in the WQLMA.

However, as discussed in Section 8.2 above, the definition of net proceeds from water quality litigation in D.10-10-018 states that before proceeds may be shared between ratepayers and shareholders, "reasonable costs and expenses that are a direct result and would not have to be incurred in the absence of such contamination" must be subtracted from the total credit amount. This is consistent with the Commission's expectation, also discussed in Section 8.2 above, that ratepayers should be shielded from costs due to contamination, and that (to the extent possible) all costs related to water quality contamination and related litigation should be borne by polluters. In this case, the only way to ensure that those costs are borne by polluters and not ratepayers is to record them in the WQLMA.

Consistent with these principles, the $166,000 annual forecasted cost of outside legal services to defend against contract disputes should not be considered an A&G expense and collected as part of the company's revenue requirement. Instead, any outside legal costs incurred to defend against contract disputes arising from the BPOU agreement should be recorded in the WQLMA, in the same way that other litigation-related expenses are recorded in that account.

⁵ SGVW Reply Brief at 18.

⁶ DRA Reply Brief at 13-14.

⁷ SGVW Reply Brief at 16.

⁸ SGVW Reply Brief at 16.

⁹ SGVW Reply Brief at 17.

¹⁰ SGVW Opening Brief at 6-11.

¹¹ San Gabriel Opening Brief at 9-10.

¹² D.10-10-018 at 54.

¹³ SGVW Reply Brief at 9.

¹⁴ D10-10-018 at 46.

¹⁵ Res. W-4089, OP 2.

¹⁶ SG Reply Brief at 4 and testimony SG-11 at 2-3.