7. Disputed Issues
The Commission regulates water service provided by Class A water utilities pursuant to Article XII of the California Constitution and the Public Utilities Code.20 For Class A water utilities, Pub. Util. Code § 455.2, as implemented in D.04-06-018 and updated in D.07-05-062, provides for a general rate case proceeding every three years. Cal-Am is a Class A water company with six districts: Larkfield District, Los Angeles County District, Monterey County District, Sacramento District, San Diego County District and Ventura County District.
7.1. Monterey District Plant
Cal-Am seeks to include $1,955,400 in rate base for construction of the Toro arsenic treatment facility. The facility became operational in March 2010 and included the installation of the Pureflow coagulation/filtration system. DRA argues that only $685,000 should be included in rate base as it is the amount included in the settlement agreement adopted by D.09-07-021. The $685,000 settlement was based on the Siemens filtration system bid. That bid was ultimately rejected by Cal-Am in favor of the Pureflow system. DRA claims Cal-Am did not exercise sound engineering practices or business principles in installing the Pureflow system and rejecting the lower cost Siemens bid.
Cal-Am cites multiple reasons for not selecting the Siemens filtration system such as permitting difficulties which could have delayed the project and the incompatibility of the Siemens technology with the water quality at Toro. DRA counters that the project was not completed until March 2010, two years later than anticipated, providing Cal-Am sufficient time to deal with any permitting delays. DRA also claims that unlike the Pureflow bid, the Siemens bid was based on a filtration system tailored to the Toro system water conditions.
Both the Pureflow and Siemens filtration systems bring the Toro water quality to acceptable levels. Thus, the crux of the issue here is which system's combined capital and ongoing operation and maintenance costs results in a lower annual revenue requirement for ratepayers.
Cal-Am claims that even though the initial capital cost for the Pureflow system is higher at $1,955,400, its overall annual operations and maintenance cost is lower. Cal-Am claims the Siemens filtration system needs to be changed out 4 times per year at a cost of $85,000 per change out. In addition, there is a back flush requirement every 1 to 3 months at a cost of $3,000 per back flush.
DRA and Cal-Am provide conflicting data supporting their respective positions on the frequency of the Siemens system filtration media change out. DRA relies on the Siemens' bid information stating that the filtration media lasts 395 days, essentially 13 months, before a change out is required. Cal-Am provides data based on higher levels of contamination than that present in the Toro system to support its position that the Siemens system is incompatible. The table below illustrates the cost difference between the Pureflow system installed by Cal-Am and the Siemens system recommended by DRA.
Table 7
Although not considered in the cost comparison above, all capital projects added to rate base receive a return on equity based on a company's approved rate of return. Here, Cal-Am sought to include a $1,955,400 capital project in rate base, an almost $1.3 million increase over the previously approved project cost of $685,000. If included in rate base, the $1.3 million would be subject to rate of return and the revenue requirement borne by Cal-Am ratepayers would be increased accordingly.
We do not find Cal-Am's installation of the Pureflow system reasonable given that its annual costs are higher to achieve the same result as the Siemens system. Therefore, only $685,000 should be included in rate base and the actual annual operation and maintenance costs for the Pureflow system, $18,660, should be included in the revenue requirement.
Cal-Am requests $1,953,000 for improvements to the SCADA system in its Monterey District. Cal-Am states the improvements include standardizing the software, updating remote site hardware and adding SCADA to sites that currently have no SCADA coverage. Cal-Am also states that the current SCADA software was installed in 1998 and since the life expectancy of SCADA software is five years, an upgrade is long overdue. Cal-Am supports its claim for the improvements with a record of 400-500 monthly SCADA alarms, many of which Cal-Am claims are caused by communication errors and transmitter failures. Cal-Am asserts that the amount of non-revenue water will be decreased since transmitters may currently fail open, causing overflows.
DRA recommends that the Commission deny Cal-Am's request as unmerited. DRA asserts that there is no documented system failure requiring a new system. DRA analyzed the 400-500 monthly SCADA alarms and states that at least half of the alarms required little or no action as they were confirmations or advisory messages that are the result of a properly functioning system. DRA also claims that the remaining five to ten alarms per day might require an operator action or field visit, but states that five to ten alarms per day does not seem excessive given the size and complexity of the system. DRA also notes that the software standardization has already occurred, so the entire SCADA system is currently using the same software. DRA points out that it has also recommended approval of $320,000 in recurring SCADA system improvement projects and upgrades through 2014.
Although Cal-Am claims the new SCADA system would reduce non-revenue water, its testimony provided no breakdown of how many alarms relate to overflows due to transmitter failures. This information would have been useful in evaluating Cal-Am's request for this expenditure in a district with extremely high rates and high non-revenue water.
Cal-Am states that 57% of the budget proposed for this project is to address the current need for replacement and upgrades of existing equipment and adding SCADA capabilities to sites that currently do not have SCADA coverage.23 We find Cal-Am's request to provide SCADA coverage for areas not currently covered is reasonable. Therefore, Cal-Am will receive 57% of its request, reduced by the $320,000 that DRA has already agreed to for SCADA improvements and upgrades for 2009 through 2014. Cal-Am will receive $793,21024 for SCADA system improvements and upgrades.
7.1.3. Special Request #32 - Monterey Billing System Modification Costs
Cal-Am seeks authorization to include as plant in service $960,000 for modifications to its Monterey billing system to calculate and track usage allotments by account for residential, nonresidential and dedicated irrigation customers. Cal-Am claims that the amount includes $400,000 that it was authorized to track in a memorandum account and an additional $560,000 it incurred to make further billing system changes.
DRA opposes Cal-Am's request on several counts. DRA claims that Cal-Am did not track the costs in a memorandum account that would allow recovery in this proceeding. DRA also asserts that the costs are administrative and general, not project costs to be capitalized. Finally, DRA states that Cal-Am already had its opportunity to forecast administrative and general expenses due to rate design changes in the last general rate case and the Commission already ruled on those matters, including billing system modifications, in D.09-07-021. DRA points out that Cal-Am's petition to modify D.09-07-021 seeking authorization to recover $945,720 in billing system modification expenses via advice letter was denied.
Cal-Am asserts that although D.10-11-006 denied its petition to modify D.09-07-021, the decision did not address the reasonableness of the billing system modification costs or the merits of the request. Rather, D.10-11-006 denied the petition to modify because "The Commission does not implicitly and unilaterally impose additional terms on settlement agreements."25 Cal-Am claims that nothing in D.10-11-006 bars it from seeking recovery here.
We disagree. It is clear from Cal-Am's petition to modify D.09-07-021 that Cal-Am was seeking to add to its settlement with DRA to recover additional costs associated with the billing system modification in its settlement with DRA. Although Cal-Am's petition was denied because the Commission cannot unilaterally change the terms of a settlement, the fact remains that the costs and their recovery should have been requested in the last general rate case. Cal-Am's request that the Commission reclassify those costs and allow recovery in this proceeding constitutes retroactive ratemaking. For that reason, Cal-Am's Special Request #32 is denied.
7.2. Income Tax and Related Issues
Cal-Am filed A.10-07-007 on July 1, 2010 claiming taxable income and expenses for the test year including $2,698,590 in California Corporate Franchise Tax and $10,282,710 in Federal Income Tax. Cal-Am's application also originally reflected certain tax deductions that reduce its revenue requirement request.
The Small Business Jobs Act was signed into law on September 27, 2010. The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 was also enacted on December 17, 2010. Both laws affect aspects of Cal-Am's tax calculations. Because Cal-Am filed its application prior to the enactment of the laws, Cal-Am's rebuttal testimony addresses the impacts of the new laws on its tax situation.
Cal-Am claims that it is ineligible for the Domestic Production Activities Deduction (DPAD) because it is in a net operating loss position.26 Cal-Am relies on D.09-03-007, the Suburban Water Company (Suburban) general rate case, in which the Commission found that if a deduction is not used, it should not be considered for ratemaking purposes. Cal-Am also requests approximately $13 million in revenue requirement for California Corporate Franchise Tax and Federal Income Tax. Cal-Am's explanation for this apparent inconsistency is that the Commission requires Cal-Am to calculate income taxes for ratemaking purposes based on a "stand alone" basis and for tax reporting purposes on the American Water Works consolidated income tax return.27
DRA distinguishes the circumstances in this case from those in the Suburban case. Suburban showed an overall loss on its returns. Here, Cal-Am anticipates paying approximately $12 million in California Corporate Franchise Tax and Federal Income Tax in 2012.28
TURN also objects to Cal-Am's explanation. TURN asserts that Cal-Am is asking ratepayers to fund tax obligations in the revenue requirement while also claiming a net operating loss, thus making Cal-Am ineligible to take tax deductions which reduce the revenue requirement for ratepayers. TURN points out that Cal-Am's own witness said that the net operating loss position is directly attributable to Cal-Am's WRAM deferrals and that absent the large deferrals, Cal-Am would have positive taxable income in 2011 and 2012.29
TURN recommends that the Commission remove the California Corporate Franchise Tax and Federal Income Tax request from the revenue requirement.30 However, if the Commission relies on Cal-Am's original filing that assumes taxable income in 2012 for ratemaking purposes, then TURN recommends that the taxable income be reduced consistent with normal ratemaking adjustments such as the DPAD.31
We agree with DRA that the facts in Suburban are distinct from the facts here. Suburban did not include income taxes in its revenue requirement request for ratemaking purposes, and claimed a net operating loss for actual tax reporting purposes. Suburban's tax situation was the same for both ratemaking and actual tax purposes.
We dislike inconsistent treatment of tax positions when the disparate treatment adversely impacts ratepayers, as it does in this case. As noted by TURN, Cal-Am includes the WRAM balances in income for ratemaking purposes, which results in taxable income. However, Cal-Am's calculation of its income for tax reporting purposes excludes the WRAM balances from income, which results in a net operating loss.32
The issue here is which of Cal-Am's tax positions should be used to determine whether the DPAD is applicable. In this case, because Cal-Am's tax position for ratemaking purposes resulted in income tax, it is reasonable to apply the DPAD to reduce the income tax obligation for ratemaking purposes.
In D.10-11-034, the Great Oaks Water Company general rate case, the Commission approved DRA's calculation of the DPAD. DRA uses the same methodology here as in the Great Oaks general rate case. DRA's methodology is supported by TURN. Cal-Am proposed a methodology in its initial application, but its rebuttal testimony claims that it is ineligible for the DPAD. As explained above, we disagree. Therefore we find DRA's DPAD methodology reasonable and we adopt it here.33
7.2.2. Cal-Am Repairs Deduction FIN 4834
This issue is no longer in dispute. In its reply brief, Cal-Am stated that it had inadvertently excluded the FIN 48 in its original application and it will accept its full repairs deduction which will increase deferred taxes.35 On that basis, Cal-Am should remove from rate base the increased accumulated deferred income tax for 2010, 2011 and 2012 associated with its FIN 48 recorded deferred income tax.
Bonus depreciation is a result of the Economic Stimulus Act of 2008 (2008 Act) and the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Act). The Acts permit a company to take deductions for investment in certain property recently purchased or acquired and placed into service. The 2008 Act added section 168(k) to the Internal Revenue Code that allows a company to take a 50% deduction or bonus depreciation of the adjusted basis of qualified property. The 2010 Act extended the 2008 Act and increased the deduction amount to 100%.
According to Internal Revenue Code Section 168(k)(2)(D)(iii), "taxpayers" are entitled to "elect" whether or not to take bonus depreciation at the legal entity level. Additionally, pursuant to Cal. Rev. & Tax Code § 24349, California does not allow bonus depreciation to be claimed on a California State income tax return.
Cal-Am has elected not to take the bonus depreciation for 2011, although it has elected to do so in 2010 and 2012. DRA asserts that there is nothing significantly different between 2011 and the years 2010 and 2012, when Cal-Am says it will take the bonus depreciation and therefore, the Commission should impute the maximum legally allowable amount of bonus depreciation for 2011.36 TURN and DRA assert that Cal-Am's decision not to take the bonus depreciation in 2011 is unsupported.
Cal-Am utilizes accelerated tax depreciation and normalizes its Federal Income taxes consistent with requirements in the Internal Revenue Code. To continue to utilize accelerated tax depreciation, the taxpayer must comply with those normalization requirements. The taxpayer decides whether to elect bonus depreciation. For the Commission to impute bonus depreciation not taken by the taxpayer would be an interference with Cal-Am's normalization of its taxes that could result in Cal-Am losing its ability to use accelerated income tax depreciation. If Cal-Am violates Internal Revenue Code normalization requirements, it would no longer be allowed to use accelerated tax depreciation for federal income tax purposes. There would be no deferred taxes to offset rate base relating to the use of accelerated tax depreciation, resulting in a substantially higher rate base entitled to earn rate of return. Therefore, we will not impute the bonus depreciation for 2011.
7.3. Special Requests
Cal-Am seeks authority to earn its authorized weighted average cost of capital on all deferred balances in excess of its $33 million short-term debt limit. Cal-Am's deferred balances currently earn at the 90-day commercial paper rate. Cal-Am states that this request is supported by Commission precedent. In D.08-05-036 regarding the San Clemente Dam, the Commission looked at the "circumstances at hand and the type of financing being used to fund the project."37 Cal-Am claims the request allows the company the opportunity to recover its actual carrying costs. Cal-Am states that the current carrying costs exceed recovery, currently based on the 90-day commercial paper rate, by millions of dollars each year.
Cal-Am asserts that the 90-day commercial paper rate is only intended to cover items of a short term nature, items that remain on the books for 12 months or less, not items that continue to grow and remain on the balance sheet for multiple years. Cal-Am's application placed its total deferred balances earning the 90-day commercial paper rate at $90 million and estimated the balances would reach $120 million by the end of 2011.38 At the time Cal-Am filed its application, the 90-day commercial paper rate was 0.24%. Cal-Am's current deferred balances represent approximately 20% of its requested rate base of $421 million for 2012.39 Cal-Am asserts that failure to allow recovery at just and reasonable rates is confiscatory.
Both DRA and TURN oppose Cal-Am's request for several reasons. TURN claims that Cal-Am appears to rely on the Commission's decision to authorize rate of return on the San Clemente Dam memorandum account, but fails to recognize the special nature of that situation. TURN asserts that the San Clemente Dam decision merely demonstrated the Commission's discretion to authorize a different rate of recovery. TURN points out that in the San Clemente Dam decision the Commission stated that "we did not intend to establish policy regarding AFUDC40 for all long-term projects."41 Cal-Am also points out that the Commission decided to leave the multi-million dollar Coastal Water Project account at the 90-day commercial paper rate.42
DRA claims that a blanket approval allowing Cal-Am to earn rate of return on all memorandum and balancing accounts denies the Commission the opportunity to evaluate the individual facts of each account, as it did with San Clemente. DRA also points out that after the fact reasonableness review incorrectly places the burden of proof on intervenors to prove that it is unreasonable for a particular account to earn rate of return, rather than placing the burden on Cal-Am to prove that for a particular account, recovery at the 90-day commercial paper rate is insufficient.
Given the number and variety of Cal-Am's deferred balances, we agree with DRA and TURN that a blanket approval for rate of return on all deferred balances is not reasonable. Also, neither Cal-Am's testimony nor it witness was able to say with certainty which accounts would be included in the rate of return treatment, how long the rate of return treatment would be in effect or how the fluctuating balances receiving rate of return treatment would be monitored.43 Therefore, Special Request #4 is not reasonable and is denied.
7.3.2. Special Request #14 Requesting Recovery of Balances on Memorandum and Balancing Accounts
The only one of 37 memorandum and balancing accounts in Special Request #14 that was not part of the settlement agreement between the parties is the Monterey Style WRAM and Monterey Interim Rate True-Up (MIRTU).
Cal-Am filed advice letters 735 and 838 to recover the balances in its Monterey Count District WRAM. DRA protested advice letter 735 and DWA rejected both advice letter 735 and 838. The rejection letters included instructions for Cal-Am to follow prior DWA instructions before submitting another advice letter.44 This issue was included within the scope of this proceeding by an April 14, 2011 Administrative Law Judge Ruling.
Cal-Am seeks to have customer billing adjustments due to leaks, included in the WRAM balances for its Monterey County District. For billing adjustments in the Monterey County District, Cal-Am bills the customer for water usage above historical levels at the second tier of the conservation rate. For billing adjustments in its other districts, Cal-Am adjusts the billed usage to a more normal amount, which results in lower revenues and higher non-revenue water.
Cal-Am asserts that this is a rate issue not a consumption issue, claiming that the lost revenue is due to steeply tiered conservation rates and therefore the lost revenue should be tracked and recovered in the WRAM balance. DRA objects to Cal-Am's request and states that any losses due to billing adjustments should be borne by shareholders.
Neither DRA's nor Cal-Am's recommended resolution of this issue reflects the realities of the situation. Cal-Am claims the losses are a direct result of the steeply tiered conservation rates and therefore capturing the lost revenue in the WRAM is appropriate. We disagree. The losses are not directly attributable to the tiered conservation rates, but to Cal-Am's treatment of billing adjustments. Cal-Am's method creates two distortions - one in the WRAM account, which was not meant to include reduced revenue due to billing adjustments, and a distortion of the actual water loss in the Monterey County District.
DRA's recommended resolution of shareholders bearing the loss is counter to how billing adjustments are dealt with in Cal-Am's other districts and completely unsupported.
We agree with Cal-Am that billing adjustments benefit ratepayers and we agree that Cal-Am should be able to recover the revenue lost due to billing adjustments, but we disagree with Cal-Am's current recovery through the WRAM. Therefore, to recover its WRAM balances, Cal-Am should remove all billing adjustments from its computation of the Monterey County District WRAM and file a Tier 2 advice letter for recovery. Additionally, Cal-Am's advice letter should also comply with any outstanding requests and/or instructions contained in DWA's rejection of Advice Letter 735 and 838.
We will not revisit DWA's approval of Cal-Am Advice Letter 826 regarding the MIRTU. DRA claims there was a mistake in the methodology, but DRA had an opportunity to protest advice letter 826 when it was filed, and it did not.
This special request is no longer in dispute as the Commission issued D.10-10-018 and D.10-12-058 in Order Instituting Rulemaking 09-03-014. Those decisions adopt rules for treatment of contamination proceeds arising from damage awards.
Cal-Am seeks authorization to recover an additional $155,000 related to the acquisition of Toro Water Service (Toro). According to Cal-Am, the $155,000 Cal-Am represents goodwill, or the cost of the acquisition above the book value of the asset.
DRA and Cal-Am entered into a settlement agreement for the purchase of Toro. The settlement agreement provided that Cal-Am would seek and DRA would support recovery of $408,000 in Cal-Am's 2008 general rate case. In D.07-11-034, the Commission approved Cal-Am's acquisition of Toro and the settlement between Cal-Am and DRA on the acquisition.
DRA disputes Cal-Am's claim for additional funds representing Toro acquisition goodwill. DRA maintains that the settlement agreement did not provide for any additional goodwill costs. DRA contends that Cal-Am assumed the risk of any misstatement from Cal-Am's failure to include other costs when it settled on the purchase price of $408,000, which therefore capped goodwill at $105,403.45
Cal-Am states that true-ups and adjustments are common and appropriate46 and nothing in the settlement agreement, or the decision approving it, prohibits Cal-Am from seeking future recovery of other related costs. Cal-Am also states that the settlement does not refer to goodwill and, accordingly, DRA cannot rely on the inferences drawn from the settlement agreement that Toro goodwill was capped at $105,403.
We disagree. Because the $408,000 purchase price included in rate base exceeded the book value of Toro by $105,403, we find it reasonable for DRA to have inferred that the additional amount was goodwill. If Cal-Am wanted to protect its ability to recover the true-ups, adjustments, or other related costs, it could have done so by including such language in the settlement or at least putting DRA on notice that the amounts included in the settlement were estimates. Cal-Am did not do so. To allow recovery of the additional costs now is unreasonable and undermines the settlement process. Therefore we deny Cal-Am's request to recover an additional $155,000 in goodwill related to the acquisition of Toro.
7.3.5. Special Request #34 to Amortize Balancing Accounts in Rates on an Annual Basis
A full review of the WRAM program will occur in Phase 2 of this proceeding, which includes an examination of amortization periods. Until a decision is issued in Phase 2 of this proceeding, the WRAM program, including amortization periods will continue as currently designed.
7.4. General Office Adjustments
Cal-Am's requested labor and labor-related expense of $127,771,286 for the Service Company and $6,883,653 for Cal-Am is based on budgeted positions and assumes no vacancies. DRA has recommended an adjustment to Cal-Am's request based on the number of actual employees on December 31, 2010. Cal-Am claims that its 2010 budgeted labor expenses were within 2% of its actual expenses and demonstrates the accuracy of its budgeting forecast.
Cal-Am argues that the DRA recommendation incorrectly focuses on the employee headcount as of December 31, 2010, a snapshot in time when 68 employees had been recently transferred to the business transformation project and those vacancies had not been backfilled yet. Cal-Am also claims that using the December 31, 2010 headcount is beyond the Rate Case Plan's 100-day update period. Cal-Am is incorrect. The update deadline is for the utility to update its application. However, there is no prohibition against DRA seeking updated information through the data request process or for the Commission considering that updated information.
DRA counters Cal-Am's claim that the 2010 budgeted and actual expenses were within 2% of each other. DRA's calculation results in a 6% gap between the 2010 budgeted and actual expenses. We find that Cal-Am's budget-based expenses and DRA's one-day employee count are extreme positions and neither represents the best basis for determining labor expenses.
The budget-based method includes no allowance for vacancies and there will always be vacancies. Cal-Am provides inconsistent statements regarding vacancies in the company. In support of its budget-based labor expense Cal-Am states that "positions never remain vacant, therefore, there is no ongoing vacancy rate."47 Yet Cal-Am's witness Hobbs states, "...every business - particularly a complex business organization such as the Service Company - always has some level of vacancies in its employee ranks. For example, employees go on leave, get sick or disabled, quit, die or are transferred. So I can comfortably say that the Service Company will continue to have some level of vacancy, as any normal business would."48 We find the latter statement more credible than the former.
While it may be true that most positions do not remain vacant, they are vacant for some period of time. It is impossible to fill 100% of the positions 100% of the time. Cal-Am's testimony on the 68 vacancies in December 2010 stated that as of March 2011, not all the positions had been filled, demonstrating that there continued to be vacancies over a period of time. Even if those vacancies are ultimately filled, other vacancies will occur in another area of the company. Cal-Am's budget-based labor expense calculations ignore this fact, although its witness confirmed it. Some level of turnover is inevitable and to ensure ratepayers are not funding empty positions, there has to be some acknowledgement of this in the labor expense.
Similarly, we do not find that DRA's one-day headcount provides for any fluctuations in vacancies throughout the year. DRA's one-day headcount occurred at a time when the company had just shifted a large number of staff to the business transformation project and therefore skewed the count. DRA's reliance on the adoption of a one-day headcount in D.09-07-021 is misplaced. In D.09-07-021 a one-day headcount was used because Cal-Am failed to support its request. In this general rate case, Cal-Am provides the information that was lacking in the earlier general rate case, but overstates the expense by assuming there will be no vacancies. As the parties were unable to find a middle ground between these two extreme positions, we must fashion one based on other information in the record.
Cal-Am disputed DRA's claim that there is a declining trend of 57 employees per year. Cal-Am calculated the decline trend in employees as 22.49 Therefore, we will adopt Cal-Am's figure and reduce Cal-Am's labor and labor related expense by 22 positions to account for vacancies.
Cal-Am requests pension benefits expenses for Cal-Am employees, which include Cal-Corp employees and the various district employees, and the Cal-Am-allocated pension expense of the Service Company. Cal-Am requests the continuation of calculating the revenue requirement for pension expense based on actuarial projections of FAS 87 (Federal Accounting Standard) for the Service Company and of Employee Retirement Income Security Act (ERISA) for Cal-Am. Cal-Am also asks to track in its pension balancing account the difference between the ERISA expense authorized and actual amount incurred.50
DRA objects to Cal-Am's request because Cal-Am seeks one pension treatment, Generally Accepted Accounting Principles (GAAP), for the Service Company and a different one, ERISA, for Cal-Am. The GAAP treatment results in lower pension contributions for the Service Company than ERISA treatment does for Cal-Am. DRA initially requests that GAAP, rather than ERISA be used to calculate the pension expense for Cal-Am.
Cal-Am responds that it has always based pension expense for the Service Company on FAS 87. For Cal-Am, pension expenses are based on the ERISA minimums authorized in D.10-06-038, the last general rate case that included general office expenses. Upon further reflection, DRA recommends that the Commission continue to authorize "capped" recovery at ERISA minimum funding levels for ratemaking purposes as established in D.10-06-038. DRA had overlooked or forgotten about the settlement achieved with Cal-Am in the last general rate case that allowed pension expenses to be capped at ERISA minimums.
DRA recommends that the Commission adopt the February 201151 updated estimates of pension expense for the Service Company and Cal-Am, which is lower than the April 2010 forecast amount initially sought by Cal-Am. DRA does not dispute the FAS 87 calculations, as those expenses are declining during the rate case period.
We find no reason to discontinue recovery as established in D.10-06-038. The February 2011 updated figures reflect the improvement in the financial markets. Therefore we find the pension expense based on the February 2011 ERISA forecast for the Cal-Am and Cal Corp employees reasonable. We also find the FAS 87 pension expense calculation for the Service Company reasonable. Those amounts are set forth below.
Table 8
Cal-Am and Cal Corp ERISA Forecasts |
American Water Service Company FAS 87 Pension Expenses |
2011 - $93.5 million 2012 - $93.9 million 2013 - $84.5 million 2014 - $50.2 million |
2011 - $61.5 million 2012 - $54.3 million 2013 - $47.9 million 2014 - $41.5 million |
Cal-Am's total expenses are based on its allocation of the Service Company and American Water expenses shown in Table 8.
Cal-Am will continue the capped recovery of pension expense established in D.10-06-038. Therefore, Cal-Am is authorized to continue to track the difference between the level of expense authorized in rates and the actual costs. Cal-Am's recovery for ratemaking purposes shall be capped at the minimum level of Benefit Plan expense calculated according to the ERISA minimum funding levels.
Cal-Am states that group insurance expense includes employee life insurance, medical, dental, prescription drug, vision, accidental death and dismemberment insurance, long-term disability insurance, and short-term managed disability insurance.
Cal-Am requests insurance expense of $4,010,255. This amount represents the cost for all Cal-Am employees as well as expense allocated from American Water Service Company. Cal-Am's increase in group insurance includes a 20.3%52 increase for 2010 to 2011 actual rates plus an 8% escalation factor for 2011 to 2012. Cal-Am claims these increases are necessary in order to cover current and forecast increases in program expenses.
DRA recommends that Cal-Am's group insurance expense be based on 2010 actual costs, adjusted for inflation by applying the labor and labor-related expense escalation rates reflected in D.04-06-018. In the alternative, DRA recommends that if the Commission allows increases above the labor escalation rates in D.04-06-018, that the increase be limited to the utility industry health insurance costs trend rate of 8.2% annually applied to 2010 actual insurance expense.
Cal-Am argues that nothing in D.04-06-018 restricts utilities from proposing alternative escalation factors for general office expenses. Cal-Am also argues that the methods in D.04-06-018 ignore the actual increases in insurance expense over time. Cal-Am points to measures it has taken to keep costs down such as conducting an employee dependent audit in 2007 and ensuring that non-covered expenses are not paid. Cal-Am states that it reduced the number of plan options and, increased employee co-payments, the cap on out of pocket expenses and payroll contributions.
DRA claims that from 2007 to 2010 Cal-Am's insurance expenses have been higher than the industry average except for a 0.1% drop below the industry average for non-Union employees in 2009. DRA points to the fact that Cal-Am employees still pay much less toward their health care costs than the water industry average despite the changes Cal-Am instituted. In 2009 Cal-Am employees were only paying 17% of the gross health care costs while the industry average was 32.2%. Although Cal-Am has since increased its employee contributions to 23%, they are still significantly lower than the 2009 industry average of 32.2%. There is nothing in the record regarding the current industry average, but relying on the 2009 data indicates that Cal-Am ratepayers have been and are being asked to continue subsidizing Cal-Am employee's contributions to health care costs.
Cal-Am admits that its employees contribute less than the industry average for medical benefits. This fact contradicts Cal-Am's claim that its insurance expense is a "cost over which the company has little control."53 Cal-Am certainly has some control over the group insurance benefit package and the amount of insurance expense being passed on to ratepayers.
We find Cal-Am's requested 20.3% increase for 2010 to 2011 and the 8% escalation factor for 2011 to 2012 are not reasonable given that its expenses exceed the industry trend and its employees continue to contribute much less than the industry average toward health care costs.
Therefore we adopt the labor escalation factor as Cal-Am's increase for group insurance expense.
7.4.4. Special Request #11 - Business Transformation Memorandum Account
Cal-Am's business transformation project was implemented to automate, update and modernize all aspects of the information technology platforms and business processes used by American Water Works and all its operating companies, including Cal-Am.54 The original estimate for the project was $280 million with Cal-Am's portion set at $14 million. An updated estimate is set at $317 million with Cal-Am's allocation increasing proportionately.
Cal-Am proposes that: 1) the revenue requirement on Cal-Am's allocated portion of the full $280 million originally requested for the business transformation project be included in rate base; 2) that Cal-Am be authorized to earn a return on and recovery of those business transformation project capital expenditures; and either that 3) Cal-Am track in a memorandum account the revenue requirement of all additional business transformation project costs as well as any cost savings generated by the project and that the memorandum account be the subject of review by all parties and the Commission pursuant to a Tier 3 advice letter filing in May 2015, or (in the alternative) 4) the revenue requirement on the updated $317 million budgeted for the business transformation project be included in rate base.55
Cal-Am's position regarding how the business transformation project costs should be recovered has evolved over the course of this proceeding. In Special Request #11, Cal-Am originally sought to include its estimated business transformation project costs in revenue requirement and requested a balancing account to track differences between the estimated and actual project costs. Special Request #11 also requested that the balancing account earn interest at Cal-Am's authorized rate of return.
In its opening brief, Cal-Am requests a memorandum account rather than a balancing account to track project costs, but still seeks to earn rate of return. And, for the first time in its reply brief, Cal-Am seeks to track the savings generated by the business transformation project in the memorandum account.
DRA agrees that the business transformation project costs should be allowed in revenue requirement, but only under three conditions.56 First, DRA recommends that the Commission adopt only Cal-Am's original estimated costs of the project. Second, DRA requests that the Commission impute a 5.3% reduction in the costs to Cal-Am in recognition of the benefits of the business transformation project that inure to the parent company's unregulated affiliates. Third, DRA proposes that the Commission reduce the revenue requirement by savings that have been identified in a confidential document prepared by American Water Works and presented to its board of directors in May 2010.
DRA points out that the Commission already rejected a Cal-Am request for a balancing account to track all costs of the business transformation project because it was determined that the program costs were within the control of Cal-Am's parent company, American Water Works, the costs were not exceptional in nature and were more like standard operating expenses that could be reasonably forecast.57
TURN objects to Cal-Am's request for memorandum account treatment since the costs are within the company's control. TURN, like DRA asks that the Commission recognize the cost savings identified in the document presented to American Water Work's board of directors and reduce the revenue requirement accordingly.
Cal-Am claims that capitalizing rather than expensing the project costs is the proper regulatory treatment and the Commission should reject both DRA's and TURN's recommendation. Cal-Am justifies the need for memorandum account treatment stating that even if memorandum account treatment is approved, there will still be substantial under-recovery of costs because a return on the costs incurred prior to authorization will never be recovered. Cal-Am points out that ratepayer interests are protected because a Tier 3 advice letter is subject to review by all parties and the Commission prior to recovery.
Cal-Am states that the alleged savings identified in the confidential document are only estimates and that both DRA's and TURN's recommendations ask the Commission to recognize savings without recognizing the costs that are necessary to produce the savings. Although Cal-Am agrees that there will likely be savings in reduced personnel costs over time, the ability to measure those savings today is a matter of timing. Cal-Am states that attempts to estimate savings before system implementation would be very preliminary and of limited predictive value and therefore should not be imputed.
We agree with DRA and TURN that the estimated benefit or savings identified by Cal-Am should inure to ratepayers during this rate case cycle. Cal-Am states that the estimates are preliminary and of limited predictive value. We understand Cal-Am's concern regarding the accuracy of estimates, but general rate cases are fundamentally based on estimates of future expenses. Also, the estimates were provided to American Water Work's board of directors, the people who use the information to make decisions affecting the company. We assume that the accuracy of a presentation for the board of directors is at least the same as that of a general rate case filing. And, as Cal-Am's witness stated, there have been no revisions to the estimates of savings since that information was presented to the American Water Work's board of directors in May 2010.58
Therefore, we will adopt Cal-Am's estimated savings for 2012, 2013 and 2014, as presented to the American Water Work's board of directors and entered into the record of this general rate case by DRA. The estimated savings are calculated using figures from the confidential document; however, the figures here do not compromise the confidentiality of that document.
As with most estimates in a general rate case, if Cal-Am realizes greater savings than those identified, Cal-Am retains the savings. If project costs exceed the amount authorized, Cal-Am absorbs them. This equilibrium provides the incentive for Cal-Am to estimate projects accurately, which benefits ratepayers, and reduces costs, which benefits Cal-Am.
We do not approve Cal-Am's request for a memorandum account to track the difference between the estimated costs of the business transformation project and the actual costs of the project. We have confidence in Cal-Am's estimates and assurances by its witness that the project will be brought in on-time and within the budget.
However, Cal-Am is authorized to file a Tier 2 advice letter to move project costs into rate base when each phase of the business transformation project is complete, used and useful. Total recovery for the business transformation project will be capped at $14 million, reduced by 5.3% in recognition of the benefits of the business transformation project that inure to the parent company's unregulated affiliates. Cal-Am's initial Tier 2 advice letter to move costs associated with the first live phase of Enterprise Resource Planning will include the savings of $111,066 as an expense offset to the rate base addition requested in the initial Tier 2 Advice Letter. The projected savings for 2013 of $998,037 and 2014 of $1,777,056 attributable to Enterprise Resource Planning will be included in the advice letter filing for the attrition years as expense offsets. Cal-Am's Tier 2 advice letter to move costs associated with the first live phase of Customer Information Systems, which is scheduled for 2014, will include the savings of $873,996, attributable to the Customer Information Systems as an expense offset. We will not impute the project savings until the project costs have been added to rate base.
Additional estimated savings from the business transformation project that Cal-Am projects to occur after this rate case cycle should be recovered in the next general rate case.
20 A Class A utility is defined as an investor-owned water utility with over 10,000 service connections.
21 12/13 of $85,000 = $78,461 in annual expense based on the 395 day life of the filtration media. $18,000 represents six back flushes per year, the mid range of every one to three months at $3000 per back flush. Therefore, 78,461 + 18,000 = $96,461 in annual operations and maintenance expense.
22 D.10-11-006 modified D.09-07-021 and adopted $96,100 as the annual operation and maintenance cost of the Siemens system. In its cost comparison testimony, DRA uses $96,100 as the annual operation and maintenance costs for the Pureflow System, however, the Pureflow system's annual operation and maintenance costs are $18,660.
23 Cal-Am Opening Brief at 8.
24 57% of $1,953,000 = $1,113,210; $1,113,210 - $320,000 = $793,210.
25 D.10-11-006 at 4.
26 Exhibit CAW-45 at 2.
27 Cal-Am Reply Brief at 14.
28 Reporter's Transcript at 1145:22-27.
29 Reporter's Transcript at 1120:10-19.
30 TURN Opening Brief at 7.
31 TURN Opening Brief at 14.
32 TURN Opening Brief at 12.
33 We note there is a pending application for rehearing of D.10-11-034. Today's decision does not and is not intended to prejudge the issues in the rehearing application, which will be addressed in a subsequent Commission Decision.
34 FIN stands for Federal Accounting Standards Board Interpretation Number.
35 Cal-Am Opening Brief at 19.
36 DRA Opening Brief at 17.
37 D.08-10-019 at 8.
38 Exhibit CAW-43 at 2, 4.
39 A.10-07-007, Exhibit A, Chapter 2.
40 AFUDC - Allowance for Funds Used During Construction.
41 D.08-10-019 at 8.
42 D.08-05-036 at 10.
43 Reporter's Transcript at 550-552.
44 Exhibit DRA-14, Appendices 10 and 11 contain DWA's rejections of Cal-Am's Advice Letters 735 and 838, with instructions for refilling.
45 Exhibit DRA-13 at 4-5.
46 Exhibit CAW-40 at 5.
47 Exhibit CAW-55 at 6.
48 Reporter's Transcript 795:3-12 and 796:3-9.
49 Cal-Am Reply Brief at 55.
50 Cal-Am characterizes the balancing account authorized in the last decision as tracking the difference between the amounts authorized in the decision and the actual pension expense. Cal-Am's recovery is capped at actual ERISA minimums.
51 Calculated by Cal-Am's actuary.
52 Cal-Am's original request sought $4,388,096, a 30% increase from 2010 rates. Cal-Am stated that its original request was amended in response to changing circumstances and forecasts.
53 Exhibit CAW-27 at 106-107.
54 Exhibit CAW-27 at 54.
55 Cal-Am's Reply Brief at 70.
56 DRA does not comment on Cal-Am's requested rate base treatment of the business transformation project expenses.
57 Exhibit DRA-13 at 2.2-2.3.
58 Reporter's Transcript 890:3-13.
