3. Regulatory Background
The major issues in this proceeding involve Cal Water's compliance with Commission decisions issued in the early 1990s that addressed Financial Accounting Standard (FAS) 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. Cal Water's PBOP consist primarily of medical benefits provided to retired employees.
FAS 106 requires the use of accrual accounting for PBOP costs for financial reporting purposes. Prior to FAS 106, most companies reported PBOP costs on a pay-as-you-go (PayGo) basis, i.e., when retirees received benefits. The accrual basis requires companies to recognize PBOP costs over the service lives of employees and not when the employees receive the benefits during retirement.
The Commission instituted Investigation (I.) 90-07-037 to analyze the use of FAS 106 for ratemaking purposes. The two main decisions in I.90-07-037 were Decision (D.) 91-07-006 and D.92-12-015. In D.91-07-006, the Commission evaluated different methods for funding PBOP costs, including PayGo, the use of Internal Revenue Code (IRC) Section 401(h) accounts (401(h) accounts), and the use of IRC Section 501(c)(9) Voluntary Employee Benefit Associations (VEBAs). These funding methods are summarized below:
PayGo: The PayGo method funds PBOP costs as the benefits are used by retirees. This method was used to set utility rates for PBOP costs in the decades prior to I.90-07-037.
401(h) account: This is a subaccount within a pension trust. IRC Section 401(h) permits employers with a "qualified" pension plan to provide PBOP from the pension trust as long as the contributions to the 401(h) account do not exceed 1/3rd of the pension contributions. There are no income taxes on the earnings from the assets held in the 401(h) account. Under this method, utility rates for PBOP costs would equal their tax-deductible contributions to 401(h) accounts.
VEBAs: VEBAs are tax-exempt trusts used to provide employee benefits, including PBOP. In general, there are no income taxes on the earnings from the assets held by VEBA trusts. Under this method, utility rates for PBOP costs would equal their tax-deductible contributions to VEBA trusts.
In D.91-07-006, the Commission authorized, but did not require, utilities to recover their tax-deductible contributions to 401(h) accounts and VEBAs, subject to the condition that utilities use independent trusts for the receipt, investment, administration, and disposition of funds.1 Cal Water did not participate.
In D.92-12-015, the Commission ordered Cal Water and other cost-of-service utilities to use FAS 106 for regulatory accounting and ratemaking purposes. These utilities were authorized to recover their FAS 106 costs to the extent of their tax-deductible contributions to independent trusts. FAS 106 costs in excess of tax-deductible contributions were to be recorded as a regulatory asset and recovered in future years when tax-deductible contributions exceeded FAS 106 costs.2
The Commission first addressed FAS 106 costs for Cal Water in D.93-08-033. In that Decision, the Commission adopted a settlement agreement between Cal Water and DRA that resolved the general rate case (GRC) applications that Cal Water had filed for seven of its 21 districts (Settlement Agreement or Settlement).3 The Settlement allowed Cal Water to recover its FAS 106 costs if it complied with several specified conditions.
Cal Water filed Advice Letter (AL) 1341 on February 24, 1994, to recover its FAS 106 costs pursuant to D.92-12-015 and the conditions of the Settlement Agreement. The Advice Letter stated that (1) Cal Water had established a PBOP trust account4; (2) Cal Water's FAS 106 costs in 1993 were $717,000; (3) the maximum tax-deductible contribution to the trust account for 1993 was $480,000, which Cal Water had deposited in September 1993; (4) Cal Water's initial PBOP regulatory asset was $237,000 ($717,000 - $480,000), and (5) Cal Water's incremental revenue requirement to fund its tax-deductible contributions was $214,700.5 AL 1341 requested authority to recover the $214,700 via a 12-month surcharge. The Commission Advisory and Compliance Division (CACD) accepted AL 1341 in a letter to Cal Water dated June 10, 1994.6
In the years since CACD's acceptance of AL 1341, Cal Water has funded its FAS 106 costs by making the maximum tax-deductible contribution to its 401(h) account, with minor exceptions.7 Cal Water's FAS 106 expense has exceeded its tax-deductible contributions every year since 1993. The FAS 106 costs in excess of contributions were recorded as a PBOP regulatory asset. As of December 31, 2006, Cal Water had a regulatory asset of $9.87 million, and its 401(h) account had $5.5 million of assets to pay for future PBOP costs.
1 D.91-07-006, Ordering Paragraph (OP) 4, 40 CPUC 2d 638, 664.
2 D.92-12-015, OPs 1, 2, and 4, 46 CPUC 2d 499, 532-33.
3 Cal Water had 21 rate districts in 1994. It now has 24 districts.
4 AL 1341 does not state whether the trust account is a 401(h) account or a VEBA trust. However, the actuarial reports that were attached to AL 1341 plainly indicate that Cal Water had established a 401(h) account. (Cal Water Exhibit 3, Attachments.)
5 Cal Water's PayGo costs at the time were 265,300 (480,000 - 214,700).
6 CACD's letter was erroneously dated as June 10, 1993. AL 1341 and CACD's acceptance letter are attached to A.06-12-025 as Exhibit 2.
7 From 1993 through 2005, Cal Water's maximum tax-deductible funding for its 401(h) account was $10,660,162. Cal Water contributed $10,440,436, a difference of $219,726. The difference was due primarily to a private letter ruling (PLR 2005-500443), which retroactively allowed higher tax-deductible funding in 2004 by $205,952.
