2. History of LIEE Performance Award Mechanism

Since 1990, the Commission has experimented with performance award mechanisms designed to encourage the utility to offer energy efficiency information and direct assistance equitably and without discrimination. As a result, the Commission has encouraged the utilities to expand LIEE services by authorizing funding for these programs and by rewarding utilities in modest amounts for their efforts.⁴ Performance adder mechanisms were put in place by D.90-08-068 to apply to programs funded primarily for equity reasons, such as LIEE, or in which the link between programs and savings is difficult to measure. Performance adder mechanisms are similar to a "management fee" incentive. They generally calculate earnings by multiplying the amount of recorded program expenditures by some percentage, usually a fixed five percent. Historically, the level of incentives for LIEE programs has averaged approximately $2 million per year for the four utilities combined. However, the performance adder mechanism applied to these programs has been modified over the years, as described below.

2.1 Pre-PY1995 LIEE Performance Award Mechanism

Before PY1995, utility earnings were based exclusively on program expenditures, subject to a minimum performance standard (MPS). The MPS was linked to program accomplishments in installing the "Big Six" mandatory measures, i.e., those that were required by Public Utilities Code Section 2790 at the time: (1) attic insulation, (2) caulking, (3) weatherstripping, (4) low-flow showerheads, (5) water heater blankets and (6) door and building envelope repairs which reduce infiltration. After achieving a certain MPS, the utilities would receive 5% of actual expenditures on all "non-mandatory" measures, e.g., appliance replacement and energy education, in a single installment. Before PY1995, the MPS varied among utilities, both in terms of the unit of measurement used to establish the program goal for mandatory measures (e.g., number of measures installed, savings achieved) and the minimum threshold that had to be achieved before being eligible for incentives on non-mandatory measures. The utilities were not allowed to earn on expenditures on Big Six measures or to shift funds from these mandatory measures to non-mandatory measures during this period.

2.2 PY1995-PY1999 LIEE Shareholder Incentive Mechanism

By D.94-10-059, the Commission further refined the performance-based adder mechanism for LIEE by standardizing the MPS across utilities and adding an additional link to improve productivity. Specifically, the MPS was established at 75% of forecasted first-year energy savings from the mandatory measures under the program, with a true-up in the following AEAP to reflect actual program participation levels. If the utilities achieved this MPS, earnings would be calculated as 5% of expenditures on non-mandatory measures, adjusted by a factor based on the ability of the utility to reduce average costs relative to the previous year.

Under the shareholder incentive mechanism adopted in D.94-10-059, utility earnings for LIEE were paid out in four installments over 10 years, based on first-year verification of program participation and expenditures. By D.00-09-038, the Commission approved a joint agreement among the parties to authorized recovery of the utilities' PY1998 LIEE earnings claims in two annual installments: 50% of the utilities' earnings claim was authorized in that decision and 50% was to be authorized after the completion of the load impact study in the 2000 AEAP. As part of that agreement, ORA reserved the right to verify program participation for PY1998 and, based on the results of the verification, recommend adjustments to the second earnings claim.

2.3 PY2000 LIEE Shareholder Incentive Mechanism

Parties to the 1999 AEAP proposed an alternate performance adder mechanism in response to the passage of Assembly Bill 1393, which was signed by the Governor in October 1999. Among other things, this bill modified Public Utilities Code Section 2790 by removing the distinction between mandatory and non-mandatory measures. ORA, the utilities and other interested parties developed a joint recommendation to replace the current incentive mechanism with one that would provide incentives for all measures, as opposed to non-mandatory measures only. That joint recommendation was adopted by the Commission in the 1999 AEAP, by D.00-09-038.

The trial PY2000 shareholder incentive mechanism modified the performance adder mechanism approved in D.94-10-059 to reflect the actual installations of measures. For measures that produced no energy savings, or produced energy savings that were difficult to measure ("non-saving measures"), earnings were based on a fixed percentage of expenditures on these measures similar to the pre-1995 performance adder mechanism. Non-savings measures included energy education, furnace repair and replacements, and weatherization measures. LIEE measures that produced measurable savings, referred to as "savings measures," were assigned a monetary incentive reward based on their relative contribution to life cycle energy savings. These savings measures include weatherization (e.g., insulation, caulking) and appliance replacements. For these measures, utility earnings were equal to the actual number of savings measures installed, multiplied by the incentive per measure.⁵

Under the PY2000 mechanism, recovery of the first 50% of shareholder incentives was to occur in the AEAP proceeding after PY2000 in which the Commission addressed such claims. The remaining 50% of the earnings claim was to be authorized for recovery in the AEAP proceeding following completion of the LIEE load impact evaluation for PY2000. Consistent with the joint recommendation, the Commission specified that the amount of the earnings claim would not be further modified by the results of the load impact evaluation.⁶

2.4 Post-2000 LIEE Shareholder Incentive Mechanism

In approving the joint recommendation for LIEE incentives, the Commission stated: "This is recommended as a trial mechanism...for PY2000 only. For PY2001 and beyond, parties will work on and recommend a longer-term performance incentive mechanism."⁷

On November 6, 2000, the utilities filed LIEE program applications that, among other things, proposed to retain the incentive mechanism adopted for PY2000 using updated information to calculate the lifecycle savings for PY2001.⁸ By D.01-06-082, the Commission evaluated the PY2000 LIEE mechanism on its merits, and determined that it should not be continued for the following reasons:

"In considering the utilities' proposal for PY2001 incentives, we therefore have to evaluate whether or not the PY2000 incentive mechanism is workable under the rapid deployment strategy adopted in D.01-05-033. We conclude that it is not. As described above, the derivation of per measure incentive factors requires the development of life-cycle savings for all of the measures offered under the program. The relative contribution of each measure to life cycle savings is a key determinant of the incentive factor per measure, and yet that information for the new measures is not on the record and may not even be available for these measures on a reliable basis at this time. [Footnote omitted.] Even if we wanted to continue the PY2000 incentive mechanism through 2001, we could not do so without further evaluation of life cycle savings for the new

measures adopted by D.01-05-033, and a recalculation of all of the incentive factors proposed by the utilities in their filings, based on that evaluation.

In addition, we believe that the PY2000 experimental mechanism is overly complicated and administratively burdensome to implement during a rapid deployment period, where many different entities will be mobilized to deploy these measures, very quickly, throughout the utilities' service territories. Moreover, to overlay this effort with an incentive mechanism that places a different monetary value on each particular measure installed is likely to work at cross-purposes to our goals for rapid deployment. In negotiating contracts with LIHEAP providers to best leverage resources, we do not want the utility motivated by the particular incentive factor in determining which measures to purchase in bulk to leverage LIHEAP resources, for example. Nor do we want these monetary factors to influence utility decisions on whether the LIHEAP program should provide the basic weatherization services in a particular area, and use the LIEE program to supplement with additional measures not provided under LIHEAP (or vice versa). However, such considerations are unavoidable with an incentive structure that produces differential incentives for each measure installed under LIEE."⁹

Without further Commission action, the performance adder mechanism that was in place for PY1999 would become the default for PY2001. In
D.01-06-082, the Commission determined that this mechanism would not make sense during rapid deployment for the following reason:

"During periods when program design is relatively stable, it makes sense to tie financial incentives to a reduction in average costs from one year to the next. However, such an adjustment does not make sense when program design radically shifts in size or design, as is currently the case."¹⁰

Accordingly, the Commission reverted to a performance adder mechanism that did not include such an adjustment, similar to the one in effect prior to 1995. More specifically, the PY2001 LIEE shareholder incentive mechanism required a MPS of 100% of the PY2001 savings goals presented by the utilities in their program planning applications. This threshold of performance, as in the past, applied to the first-year savings achieved from Big Six measures, as verified with actual program participation levels in the AEAP. Once this level was achieved, the utilities would be eligible for performance adder incentives. Those incentives consisted of a 2% management fee applied to total LIEE program expenditures, not including shareholder incentives. In D.01-06-082, the Commission continued the practice of authorizing recovery of LIEE incentives over two equal installments, with the first installment based on an assessment of actual program participation levels and expenditures for PY2001, and the second installation contingent upon completion of a PY2001 load impact study.

The Commission authorized the mechanism described above beginning with PY2001 and "until further order of the Commission."¹¹ In doing so, the Commission stated its intent to revisit the issue in future years:

"... we expect the issue of shareholder incentives for LIEE programs to be revisited in the future, either in the post-2001 program planning process, AEAP or other procedural forum, as deemed appropriate by the Assigned Commissioner. Until that time, the performance adder mechanism adopted today will apply to the utility's LIEE programs."¹²

By ruling dated May 6, 2003, the Assigned Commissioners in this proceeding and our generic low-income assistance proceeding (R.01-08-027) issued a joint ruling requesting comments on the issue of whether, in addition to full recovery of administrative costs, the utilities should continue to be authorized shareholder incentives in the future. This issue will be addressed in a subsequent decision.