8. General Office Issues

As noted earlier, Cal Water is organized into 24 districts, the rates for 15 of which are at issue in this proceeding. These rates charged to customers reflect costs incurred both at the district level and at Cal Water's general office. The general office provides accounting, engineering, water quality control, purchasing/stores, and customer billing. The districts provide all other services. All costs incurred at the district level are assigned to the specific district. Similarly, all costs incurred in the general office for the benefit of a particular district are directly allocated to the particular district.

On the other hand, expenses incurred for the benefit of all districts are called "indirect" costs and are allocated to all districts. Virtually all general office expenses are indirect and, thus, recovered from ratepayers via the allocation methodology.⁵

General Office expenses are comprised of five major categories: (1) operation and maintenance, (2) A&G, (3) miscellaneous, (4) taxes, and (5) depreciation. Of these five categories, A&G expenses are the highest.

The Joint Recommendation supports a $3 million (or 10% over test year 2000) increase in general office expenses to be allocated among the districts. Aglet challenges this increase, contending that Cal Water has not met its burden particularly with respect to the A&G category of expenses at the General Office. In its testimony, Cal Water did not describe how it arrived at its General Office A&G forecast. Aglet, however, provided for the record, as part of its work papers, a copy of a Cal Water data response setting out the process for forecasting A&G expenses.

Cal Water's data response states that its general approach for forecasting test and attrition year A&G expense is to take the average of recorded data and apply inflation factors. On the topics with which Aglet takes issue, however, Cal Water deviated from this general approach and used alternative forecasting methods. Cal Water offered vague rationales for these deviations; to the extent it offered any explanation at all. Each of those areas is discussed in detail below.

Prior to discussing the specific areas, we address a flaw identified by ORA in the overall allocation methodology that has not been adequately resolved by the Joint Recommendation. This flaw, the inadequate allocation of general office costs to non-regulated operations, results in significant misallocation of expenses and capital costs to ratepayers. We require Cal Water to make a detailed showing on this issue in its next general rate case.

8.1 Allocation of General Office Costs to Out-of-State and Affiliate Operations

In its general office, Cal Water incurs costs for providing services to: (1) the 15 districts at issue in this proceeding, (2) the 9 excluded districts, (3) out-of-state utility operations, and (4) unregulated corporate affiliates. Cal Water must allocate each group its fair share of general office costs. The record in this proceeding shows careful attention to the four-factor allocation to both included and excluded districts. Cal Water has not, however, presented evidence it has applied a similar level of attention to allocations to out-of-state utility and corporate affiliates.

In its testimony, ORA noted that Cal Water does not include out-of-state⁶ operations in its allocation of indirect general office expenses. However, according to ORA, Cal Water had agreed that $2,803,050 of the total $26,044,358 indirect general office expenses should be allocated to out-of-state operations, as well as the districts. Specifically, Cal Water reviewed each general office department, estimated the share of overall department time spent on activities that included the out-of-state operations, and then used the four-factor test to allocate that share among the out-of-state operations and the districts. Application of this test still leaves the districts bearing almost all of these expenses. Cal Water determined that .35% should be allocated to Washington and .08% to New Mexico, for a total out-of-state allocation of .43% of the total general office costs.

While we will accept the Joint Recommendation on out-of-state allocation of general office expenses,⁷ that allocation does not follow sound billing and accounting practices, as discussed in many Commission decisions. Notably, in D.97-12-011, we approved Cal Water's application for a holding company structure. Cal Water and the Commission's Water Division had submitted a settlement that set out the conditions under which Cal Water could operate in a holding company structure. Under the section entitled "Allocation of Common Costs," the parties agreed that the Commission's underlying philosophy of allocating common costs between regulated and unregulated (in this case, out-of-state) operations was that: "ratepayers of the utility should not subsidize affiliates of the utility." This requirement has not changed. In practical terms, we require that all costs attributable to any non-utility function be allocated directly to non-utility accounts. To the extent that direct cost allocation is not feasible, then a cost allocation methodology must be employed to fairly assess indirect costs. To do otherwise will result in ratepayers paying such costs through rates which would fail to meet the just and reasonable requirement.

The evidence does not show that Cal Water's methodology for determining the costs to be allocated to out-of-state operations is based on direct billing where feasible. All costs for all general office departments are allocated as if the costs were indirects. For example, one line item, "HR," which we assume to be human resources, shows total costs of slightly less than $1 million. Cal Water believes that only one half of this department's costs should be subject to allocation to out-of-state operations. Thus, only .43% of the approximately half million dollars is actually allocated to out-of-state operations and not recovered from California ratepayers. Costs directly attributable to human resources work for the out-of-state operations should be directly billed, and the out-of-state share of joint projects determined on a project-by-project basis and recorded. Such detailed cost allocation is necessary to ensure that California ratepayers are not subsidizing out-of-state operations.

A related topic not addressed at all in the record is any allocation of general office expenses to in-state non-regulated operations.⁸ Our policy as stated in the settlement approved in D.97-12-011 requires that non-regulated operations conducted by affiliates be allocated a share of indirect costs. To exempt affiliate operations from sharing in these costs would result in ratepayers subsidizing non-regulated operations. The record in this proceeding shows no allocation of indirect costs to California affiliate operations. As but one example of potential cross-subsidization, we note that the Cal Water web site, discussed in more detail below, contains information on Cal Water's affiliate, CWS Utility Services (CWS). The telephone number listed to contact CWS, however, is the main telephone number for Cal Water's headquarters office. If the office space, telephone equipment, and receptionist's salary are allocated solely to Cal Water's ratepayers, then ratepayers are subsidizing CWS in violation of D.97-12-011. Where a regulated utility with a Commission-approved holding company structure nevertheless chooses to co-locate with its affiliates, the utility must maintain scrupulous records and cost accounting to demonstrate convincingly that ratepayers are not subsidizing affiliate operations. Such records are necessary to show compliance with the settlement approved in D.97-12-011, where Cal Water agreed to "establish procedures for prompt and fair compensation or reimbursement for all assets, goods, and services transferred between the utility and its affiliates." The record in this proceeding does not clearly demonstrate that Cal Water has complied. In addition to the co-located offices and apparently shared telephone service, the record does not show any management policies or service agreements between Cal Water and its affiliates to provide for separation and accounting to ensure that ratepayers do not subsidize affiliates.

In sum, the record shows no methodology for allocating indirect general office costs to affiliates. Similarly, the record does not show that Cal Water has a practice of maintaining strict physical or accounting separation between the water utility and affiliates. Under these circumstances, an allocation to affiliates is absolutely required.

While we believe that the record could support a variety of interim allocation factors, we will not adopt an explicit factor. We reach this conclusion because elsewhere in today's decision we make significant disallowances of general office expenses provided for in the Joint Recommendation. One of our primary reasons for these disallowances is the relationship of the subject expenses to affiliate and other non-regulated operations. In light of those disallowances, we will not devise an interim allocation factor.

We do, however, direct Cal Water to adopt management policies and accounting practices to comply with the letter and spirit of D.97-12-011. Direct billing and complete physical and accounting separation are the best demonstration of cost causation. To the extent Cal Water chooses not to separate its affiliate activities from its regulated assets and employees, maintaining our commitment to ensure that ratepayers do not subsidize affiliate activities will require detailed, verifiable accounting records, subject to thorough scrutiny and auditing by ORA. Office and facility inspections should also be used as needed.

To the extent separation and direct billing are not accomplished, we order Cal Water to develop an allocation methodology that convincingly demonstrates that ratepayers are not subsidizing affiliate operations. All doubts or uncertainties should be resolved in favor of the ratepayers. In preparing its allocation methodology for affiliates and other non-regulated operations, Cal Water shall comply with our recent decision setting out the standards for allocating costs to affiliate operations.

In Roseville Telephone Company, 2001 Cal PUC LEXIS 604 (D.01-06-077), we rejected Roseville's three-factor allocation methodology for common general and administrative costs. The three factors used in Roseville were gross plant, expenses, and employee headcount. We found that this formula "over-allocates costs" to the regulated utility. In reaching this determination, we found that "the use of accumulated assets as a significant factor in allocating common costs . . . does not provide a reasonable approximation of the extent to which affiliates caused common costs to be incurred." D.01-06-077, mimeo. at 57-8. We concluded that "use of an allocator-such as [the] three-factor formula - that emphasizes past asset accumulation would `consistently understate' usage by unregulated affiliates." Id. at 60. Instead of the three-factor formula, we adopted an allocation factor based only on expenses.

In developing an allocation methodology, we direct Cal Water, where feasible, to rely on a cost-causation based factor to allocate common expenses, costs, or plant.⁹ For example, for billing services, it would be meaningful to allocate expenses by the number of bills sent out or by the hours the employees and equipment were used for regulated and non-regulated services. Another example, if regulated and non-regulated activities are conducted in the same building, the rent, utilities, and repairs, may be allocated by the space occupied by the different groups of employees, or if the same employees worked on both, then by their work hours on the different activities, or if that is not available, by the revenues generated, or a combination of the three. We expect Cal Water to develop and supply supporting rationale for a comprehensive cost allocation methodology.

Under the Joint Recommendation, Cal Water will conduct a six-month timekeeping study "to evaluate the proper allocation of management time to non-regulated CPUC activities which are not subject to D.00-07-018."¹⁰ This component of the Joint Recommendation is a solid beginning but does not go far enough to the address the serious cost allocation issues raised by ORA.

Fundamentally, Cal Water management and employees should directly bill all non-utility work to affiliates. Direct billing, with thorough accounting records, is the best means of demonstrating that ratepayers are not subsidizing non-utility operations. We expect direct billing to include management time.

The Joint Recommendation also excludes management time spent on projects subject to D.00-07-018. Management time spent on utility non-tariffed products and services is an incremental cost of the non-tariffed product or service. As we stated in D.00-07-018: "This mechanism allows new non-tariffed products and services, with shareholders absorbing all incremental costs and taxes, and shareholders and ratepayers sharing in any revenues." Consequently, all utility management and employee time and expenses for projects pursuant to D.00-07-018 must be carefully accounted for and allocated solely to shareholders. We, therefore, reject the component of the Joint Recommendation exempting Cal Water's utility projects subject to D.00-07-018 from direct billing and the timekeeping study.

8.2 Allocation of Capital Costs to Unregulated Operations

Notably missing from the discussion of general office capital costs is any discussion of allocating a portion of these costs to non-regulated operations. However, the rate base tables in Cal Water's testimony show an adjustment of 4.595% for "Nonregulated plant adjustment." ORA's testimony shows a similar adjustment but for 7%. In the Joint Recommendation, a line item for "non-regulated plant adjustment" is shown which reflects a 7% disallowance.

In a supplement to the Joint Recommendation, the parties noted, first, that Cal Water's work papers included a 4.595% allocation of General Office rate base to unregulated operations. Cal Water provided no data, calculations, or explanation for this allocation percentage. Cal Water stated that the purpose was "to give credit to ratepayers for general office service contracts made prior to D.00-07-018." Cal Water also stated that contracts made under the rules of D.00-07-018 will not lead to such an adjustment. Second, ORA determined that Cal Water had not allocated any general office rate base to its out-of-state operations. ORA's preliminary calculations showed that the allocation should be about 3%. In the Joint Recommendation, ORA and Cal Water apparently intended to add the two components but inexplicably came up with 7%.¹¹ Both parties recognized that this was an interim amount that will be scrutinized in the next rate case.

Properly calculating a rate base adjustment for non-regulated operations is vital because Cal Water and its corporate affiliates engage in significant non-regulated operations that may rely on regulated assets. Ratepayers should not be allocated 100% of the capital costs for any regulated asset also used for non-regulated purposes.

ORA expressed continued concerns about the impact on ratepayers of Cal Water's contract to provide billing services to the City of Stockton. Information provided by Cal Water to the Director of the Water Division, and copied to all parties to this case, shows that, in addition to the City of Stockton contract, Cal Water has existing billing service contracts with other entities. Cal Water's annual report to shareholders confirms that Cal Water has significant non-regulated operations, with 106,100 unregulated customers and 430,600 regulated California customers.¹² The annual report also identifies six billing contracts in California, as well as four operations and maintenance contracts, one meter reading contract, and two operating or service contracts.

As a matter of general ratemaking requirements, all costs, including indirect common costs, must be allocated between regulated and non-regulated operations. See, e.g., Roseville Telephone Company, D.01-06-077, 2001 Cal. PUC LEXIS 604, *55-*64. Non-regulated operations undertaken by affiliates should also be accounted for in the test years to the extent regulated assets or employees are used.

The record shows that Cal Water's general office expenses have increased substantially, with the greatest increases in the area of customer billing and information services. For general office capital costs, a similar result has occurred. The Joint Recommendation provides for $516,000 of capital additions related to billing and customer information in 2002 and $630,400 in 2003.

For water companies, such as Cal Water, that sell non-tariffed services, the Commission established a sharing mechanism for gross revenues in D.00-07-018. Shareholders receive the bulk of the revenue, either 90% or 70% depending on the type of project, but must also bear all costs. The Commission required that the shareholders absorb all incremental costs of the non-tariffed offering, and left to "future rate cases to consider the issue of whether or to what extent rates should reflect investments made and costs incurred for labor and capital jointly used for tariffed and nontariffed products and services." D.00-07-018 mimeo at p.16. The Commission also required an annual report for each utility¹³ engaging in non-tariffed endeavors. Id.

To the extent a water utility has known contracts for the test year period to sell non-tariffed services that rely on assets included in the utility's revenue requirement, those contracts must be included in all cost allocations related to those assets. Failure to do so would result in ratepayers subsidizing non-tariffed endeavors.

A slightly different result will occur for non-tariffed services sold to a utility's corporate affiliate. In that instance, the corporate affiliate must contract for services from the utility. As set out in Cal Water's holding company decision, the utility must be compensated at the higher of actual cost or fair market value for these services. This revenue is a credit to the utility's revenue requirement, but the plant costs are included in rate base. In this way, ratepayers are compensated for services provided to the affiliate, and the affiliate retains all revenue fro

The Commission must undertake a thorough review of all capital costs and expenses in areas where substantial non-tariffed revenue is being generated from non-regulated utility customers as well intercompany sales to affiliates. For this reason, it is essential that water utilities present a compelling case for capital costs and expenses associated with operational areas with significant non-tariffed operations.

For purposes of today's decision, we will modify and accept as modified the Joint Recommendation to reduce rate base by 8% to account for non-regulated use of these assets. As with the allocation of indirect general office expenses, we accept this interim factor due, in part, to the substantial disallowances for specific costs that we adopt elsewhere in today's decision.

8.3 Payroll

General office payroll consists of both A&G payroll and operations and maintenance (O&M) payroll. Total payroll and associated general office pensions and benefits comprise about 2/3 of all general office costs. To arrive at its forecast for payroll, Cal Water began with recorded 2000 data, and then added new employees hired in 2001 and a 3% inflation factor to arrive at an estimate for 2001. Building off the 2001 estimate, Cal Water added new hires during 2001 and a 3% inflation factor to get a forecast for 2002. Similarly, the 2002 forecast is escalated for new hires and a 3% inflation factor, resulting in the 2003 forecast. ORA explained in its report that Cal Water then distributes the total general office payroll among A&G, operations, and maintenance accounts based on the historic ratio of each account's payroll to total payroll.

According to ORA's report, Cal Water included hiring 40 new employees over the three-year period from 2001 to 2003. Neither Cal Water's report on General Office nor any other record document offered by Cal Water identified these positions or the year of hiring, much less presented any justification for adding them. Apparently through the discovery process or review of Cal Water's work papers, which are not included in the record, ORA came to understand that 15 of these positions had already been filled or related to capital projects ORA supported. In its report, ORA also supported four additional positions for a total of 19 new positions over the course of 2001 to 2003.

The Joint Recommendation allowed for 23 new positions and three upgrades. The Joint Recommendation started with the 19 positions that ORA supported and added four additional positions and upgraded three positions. Cal Water stated that three of the four new positions are engineering related - an electrical engineer and technician in 2002, and a production engineer in 2003 - and that the majority of the costs of the positions will be related to capital projects and thus included in the districts' capital budgets. The fourth position is for a senior web developer to upgrade Cal Water's web site, which is addressed

below, but we note here that this portion of the Joint Recommendation is not approved. Cal Water stated that the Joint Recommendation would result in a payroll increase of approximately 10% from authorized 2000 levels to test year 2002.

Aglet challenged Cal Water's overall payroll increase. Aglet criticizes Cal Water's 3% inflation factor as unreasonable because (1) Cal Water's union contract does not currently provide for such an increase in 2003, and (2) this factor far exceeds the rate of new customers, .9%, or inflation, 1.5%. Aglet recommended that the Commission use an average, judgment, or some other reasonable estimation method.

We agree with Aglet that Cal Water's case for the proposed 10% increase in payroll expenses is vaguely supported at best. Cal Water has not presented any record rationale to support the new employees. The Joint Recommendation also supported using a 3% factor for overall cost of living increases for all personnel for 2001, 2002, and 2003. This amount is based on the increase provided for in Cal Water's contract with its union for 2001 and 2002. As Aglet pointed out, the increase, if any, for 2003 has not yet been set.

We note that ORA's labor inflation factors were 5.9% for 2001¹⁴, 3.4% for 2002, and 3.6% for 2003. The Joint Recommendation payroll increase is less than the increase ORA's labor inflation factors would indicate; we will therefore find it reasonable.

Included in the Joint Recommendation is one rate analyst position. Cal Water continued to request an additional rate analyst because Commission filing requirements have increased substantially. ORA disagreed. In agreeing to add one rates analyst, the Joint Recommendation allows for a 33% increase in the number of analysts. A second analyst would increase the staff by 50%. While Cal Water has not made a persuasive showing that its Commission-imposed workload has increased by 50%, the numerous deficiencies in the filing and litigation of these consolidated GRC's persuasively demonstrate that Cal Water's regulatory operations require additional attention. We will, therefore, grant Cal Water's request for a second rate analyst.

Cal Water also sought to add an electro-mechanical technician to the general office payroll. ORA objected because the technician will provide service only for the proposed Bakersfield treatment plant, and the Bakersfield district is not part of this proceeding. Cal Water agreed to remove these costs if they can be included in the labor component of advice letters submitted pursuant to D.01-08-039. We agree with ORA and will exclude the costs of this position from this proceeding. Cal Water may seek recovery of these costs in any otherwise appropriate proceeding it chooses.

8.4 Office Expenses

The Joint Recommendation supports a forecast $ 3,054,300 for Test Year 2002 and $ 3,360,600 for Test Year 2003 for office expenses. Cal Water stated that these amounts reflect a 30% (or $ 700,000) increase over Test Year 2000 assumptions and that the increase is due to expenses "of new hardware and software to manage customer information, bill customers, and provide accounting and human resources services." The 2002 Joint Recommendation amount is $50,000 more than ORA's estimate and $130,600 less than Cal Water's.

Aglet criticized this recommendation, as based solely on extrapolation from Cal Water's historic costs. Aglet characterizes such forecasting as an "an observation, not an explanation," and concludes that Cal Water's showing lacks sufficient evidence to support the reasonableness of the Joint Recommendation on this point. Aglet recommended using inflation plus customer growth of .9% to escalate office expenses.

We find on this record that a 30% increase in office expenses over two years is unreasonable. ORA's non-labor inflation rates are: .1% for 2001, a decrease of .2% for 2002, and 1.2% for 2003. Cal Water's non-labor inflation rates are .6% for 2001, .9% for 2002, and 1.2% for 2003. In the context of these low inflation rates, Cal Water's forecasted 30% increase in office expenses over two years requires far more explanation than Cal Water has provided.

Cal Water's explanation is that $700,000 is needed for software and hardware to manage customer information and billing, and accounting and human resource information. This explanation is at odds with basis upon which Cal Water determined its forecast - a linear trend of historic expenditures. Missing is any evidence to suggest that the inflation rate for office supplies has been about 15% per year for the last two years. A specific contemplated expenditure for the test year does little to support the escalation rate Cal Water and ORA advocate. Nor does Cal Water's statement in its data response to Aglet that it "believe[s] there is an upward trend in this category of expense" do much to explain why ratepayers should see office expenses increase by more than an order of magnitude higher than what would be suggested by ORA's or Cal Water's non-labor inflation factors or even Aglet's more generous factor comprised of customer growth plus inflation.

We note also that at the time this general rate case was pending, Cal Water entered into a contract with the City of Stockton to provide billing for the City's wastewater, stormwater, garden refuse, and garbage services. ORA discussed this contract in its testimony. In that same testimony, ORA also pointed out that Cal Water's allocation methodology for its non-utility operations failed to properly allocate a share of general office costs to non-utility operations. In the context of increasing costs for non-utility customer billing and a flawed cost allocation methodology for non-utility operations, the extreme office expense increase Cal Water sought requires particularly careful studies showing which costs are incurred for which activities. Cal Water has not provided such studies.

According to ORA, Cal Water agreed to use ORA's inflation factors because ORA's factors represented more recent estimates. For this reason, we will rely on ORA's non-labor annual inflation rates to escalate office expenses. We will also follow Aglet's suggestion and add on an annual factor reflecting Cal Water's historic customer growth of .9%. The sum of these two rates results in office expense increases of 1.0% for 2001, .7% for 2002, and 2.1% for 2003.

8.5 Outside Services

Cal Water forecasts $2,171,100 in outside services for Test Year 2002 and $2,223,200 in Test Year 2003.¹⁵ Cal Water arrived at this forecast by averaging its recorded expenses for 1998, 1999, and 2000. ORA took issue with certain of the costs included in the average, mostly due to the Dominguez merger. ORA's forecast is $1,853,600 in Test Year 2002 and $1,877,800 in Test Year 2003. According to Cal Water, the Joint Recommendation includes general office outside services expense of $1,934,000 in Test Year 2002 and $1,959,900 in Test Year 2003.¹⁶

Aglet opposed the Joint Recommendation on outside services expenses, and Aglet recommends using a five-year historic average, as in Cal Water's previous general rate case. Aglet asserts that Cal Water has previously justified increases in this account by the need to use information services consultants, but at the same time and thus reduce the need for outside consultant services. Aglet alleges that using historic consultant costs to forecast future costs while simultaneously replacing some of those consultants with employees leads to double counting of these expenses.

In response to this allegation, Cal Water stated that the combined revenue requirement for the four employees that will be replacing consultants is approximately $500,000, and that this amount is more than offset by the $900,000 difference between recorded 2000 total outside services and forecasted Test Year 2002 expenses.

Cal Water's Exhibit 80 shows Cal Water's recorded outside services expenses disaggregated into legal expenses, auditing fees, information services consultants, and other consultants for 1998, 1999, and 2000. The information services and other consultant categories are combined for years 1996 and 1997. Exhibit 80 shows that legal expenses alternated from increasing to decreasing on an annual basis. Overall, the amount increased but irregularly. Auditing fees, with a minor exception, increased each year, as did other consultants. Information services consultants, on the other hand, were $195,200 in 1998, decreased slightly to $129,800, and then leapt to $1,327,300 in 2000, an increase of over an order of magnitude. No other outside services cost increased nearly so dramatically. Consequently, this single increase will substantially affect the average cost increase for this account during 1998-2000, which Cal Water used to forecast test year 2002 expenses.

The record shows the following forecasts for outside services expense:

	Cal Water	ORA	Jt. Recomm.	Aglet
Test Year 2002	2,159,500	1,853,600	1,934,000	1,707,000
Test Year 2003	2,211,400	1,877,800	1,959,900	1,748,000

In Southern California Gas Co., 35 CPUC 2d 80, 125-8 (D.90-01-016), we expressed our frustration with the "seemingly endless increases requested by the utilities for A&G expenses." For want of a better guide to evaluating the reasonableness of A&G escalation, we adopted the rate of customer growth, not as an absolute cap but as a level above which the utility must overcome a heavy burden to demonstrate reasonableness. Id. at 126. We found this standard especially apt for accounts, such as outside services, that are catch-all accounts for expenses that have no specific identification. Id.

In D.01-08-039 for Cal Water and D.00-10-027 for Dominguez, the Commission adopted a combined estimate for outside services of $1,422, 100 for 2000. Comparing that number to the Joint Recommendation reveals a 36%

increase over two years. To support this steep increase, Cal Water and ORA relied on a three-year average derived from Cal Water's recorded expense levels for this account. As discussed above, the data upon which the average is calculated are substantially affected by a single year increase. In addition, new employees will perform some undetermined portion of the work formerly performed by outside service providers. These facts call into question the reliability of a simple average.

Given the steep increase in this account and the new employees, a budget-based methodology for forecasting outside services could have better supported Cal Water's request. A budget-based methodology would use a recorded year as a base for test year expenses and then would adjust the amount to remove non-recurring expenses as well as expected new expenses.¹⁷ In this way, the utility can show what Aglet terms "real world expectations"¹⁸ and provide the Commission some information with which to evaluate the reasonableness of the forecasted expense level.

A budget-based methodology for outside services is also particularly appropriate due to Cal Water's and its affiliates' non-regulated sales of billing services. Because most outside expenses are for information service consultants related to customer billing and accounting, a budget-based approach to forecasting outside services expense would allow Cal Water to demonstrate that all costs directly associated with non-regulated services and a share of joint costs are being properly charged to non-regulated operations.

Cal Water bears the burden of justifying its request for this steep increase in outside services costs. A simple average with no analysis of the underlying data to remove nonrecurring costs, particularly in the context of additional employees and closely related non-regulated operations, is insufficient to meet this burden. The ORA and Aglet recommendations, however, are also based on averages and thus susceptible to the same criticisms.

For office expenses, Aglet suggested that the non-labor inflation rate plus customer growth could provide a reasonable escalation. As noted above, we have previously used customer growth as a means to guide cost increases. Given the lack of any justification for a higher rate of cost increases, we will rely on ORA's non-labor annual inflation rates plus customer growth of .9% to escalate adopted 2000 outside services expenses to Test Year 2002 and 2003. Therefore, we reject the Joint Recommendation on outside services, and adopt increases of 1.0%,.7%, and 2.1% for 2001, 2002, and 2003, respectively.

8.6 Expenses for the Board of Directors of the California Water Service Group

ORA recommended disallowing all expenses allocated to Cal Water from its holding company, California Water Services Group. ORA contends that the Board of Directors oversee company operations on behalf of shareholders and that there is no evidence that the Board of Directors considers the interest of ratepayers.

Cal Water countered that a Board of Directors is essential to every public corporation, and that public corporations have access to competitive capital markets that non-public corporations do not. Boards also perform vital management oversight, and review and monitor company programs and

policies. Moreover, Cal Water stated that Commission precedent allows reasonable board of director costs.

We are not persuaded that the Board of Directors provide no benefits to ratepayers, and for that reason we deny ORA's request to disallow all Board costs. Consistent with our discussion throughout today's decision, we encourage ORA in Cal Water's next General Office rate case to conduct a thorough review of the allocation methodology for these and other holding company costs.

8.7 General Office Capital Items

In its General Report on Results of Operations, Cal Water proposed to incorporate in general office rate base gross additions of $3,935,000 in 2001, $6,696,000 in 2002, and $3,377,300 in 2003. These additions, less retirements and adjustments, would result in weighted average rate base increasing from $30,967,800 in 2001 to $40,319,900 in 2003, or a 30% increase in general office rate base in two years. Cal Water developed these proposed additions based on a construction budget, which was reviewed and approved by management. To the extent specific projects were not identifiable, Cal Water used blanket estimates based upon past experience to arrive at an estimate for nonspecific capital items.

ORA recommended smaller additions, as follows: $3,388,500 in 2001, $2,981,800 in 2002, and $3,239,800 in 2003. ORA arrived at these estimates by deferring some Cal Water proposed projects and rejecting others.

In the Joint Recommendation, the parties agree to additions of $3,813,00 in 2002 and $3,940,200 in 2003. The Joint Recommendation reflects may deferrals of projects from one year to the next. As Aglet explained in its brief, the

rate base additions adopted for Test Years 2002 and 2003 are also used as a proxy for rate base additions in the Attrition Years, 2004 and 2005. Because these estimates are used twice, Aglet recommends that the Commission carefully review these estimates. The Joint Recommendation provides for general office rate base to increase by 7.5% in Attrition Year 2004, by 7% in Attrition Year 2005, and cumulatively by 30% over the four-year test/attrition period.

Aglet objects to the magnitude of the requested plant additions. Aglet calculated that from 1996 to 2000 Cal Water's average annual general office net plant additions were $1,484,700; in comparison, the average of Cal Water's proposed additions for 2001 to 2003 is $4,015,200. Aglet supports all of ORA's initial project rejections.

We find this level of general office rate base increases is cause for concern. Aglet, however, has not provided us with a detailed analysis identifying unneeded projects. The Joint Recommendation includes general office rate base additions that are substantially less than sought by Cal Water. The Joint Recommendation contains recommendations on a project-specific basis, from which we infer that ORA reviewed each project.

For example, ORA rejected the costs of upgrading to PeopleSoft Version 8, which is a computer program for maintaining financial, accounting, human resources, and billing records. Cal Water currently uses an older version. ORA noted that the version used by Cal Water was installed in 1999 and was not known to have problems. ORA also reviewed the limited cost estimates presented by Cal Water and found charges for "high cost consultants." ORA objected to the proposed $648,000 upgrade because Cal Water had supplied incomplete cost data and had been unable to present convincing evidence of need.

In the Joint Recommendation, the parties stated that Cal Water had provided ORA with additional information on the project, and had reduced the amount of outside consulting services. Cal Water also agreed to spread the project over three years. As a result, the Joint Recommendation provides for $192,000 in 2002 and $272,000 in 2003, a total of $464,000.

We remain concerned, however, with the proposed level of general office rate base additions. These capital addition budget forecasts are doubly important as they are used as a proxy for capital additions in the attrition years. As noted throughout today's decision, general office costs are rising at rates that greatly exceed inflation, and Cal Water has significant non-regulated operations in the general office.

Thus, we must make all reasonable corrections to obtain the best available forecast. Cal Water presented testimony (Exh. 90) showing that over the ten-year period 1991 to 2001, its budgeted capital expenditures exceeded actual expenditures by an average of 3.1%. This testimony demonstrates that Cal Water's capital budgets, which are the basis for additions level provided in the Joint Recommendation, tend to be overstated by 3.1%. Therefore, we will reduce the general office capital additions for each test and attrition year by 3.1%. With this minor modification, we find the Joint Recommendation on general office rate base is reasonable and should be approved.

8.8 Cal Water Web Site

ORA rejected Cal Water's proposal to add an internet server for its website at a cost of $54,000 in addition to spending $216,000 (for a total of $270,000) to redesign the website to meet Commission requirements. ORA particularly objected to a consultant fee of $175,000. ORA stated Cal Water's website required only minor modifications to implement new Commission tariff publication requirements, work that could easily be performed by Cal Water's employees.

ORA did not, however, offer any explicit testimony regarding what portion of the costs of the current Cal Water Group web site has been allocated to the non-regulated affiliates. In reviewing the web site,¹⁹ we note that the home page is for Cal Water's holding company, California Water Services Group (Cal Water Group). The home page lists all four affiliated companies, along with their business offerings and links to a more detailed page for each. The logos of all the affiliated companies appear and disappear in turn in the upper left-hand corner. Of the six substantive links also found under the changing logos, only one presents any information remotely helpful to California utility customers. The first listed line is "Investor Relations and News," where extensive financial and investor information is available with provision for email alerts, live broadcasts of earnings information, current stock price look-ups, frequently asked questions, and an interactive investment calculator.

The second link is for "Customer Information." In contrast to the audio, interactive, and up-to-date investor portion of the website, the "customer information" link takes one to a simple text page that describes all three regulated operations of the Cal Water Group. In addition to California, the Cal Water Group has regulated utility operations in Washington state and New Mexico. All are listed in the customer information page. Clicking on the California Water link brings one to a page that lists all the districts and provides links to pages with additional information about some districts. Tariff information is also available.

The third listed line is "How We Help Cities and other Companies." Clicking on that link brings one to a page that describes Cal Water's affiliate CWS and states:

CWS Utility Services offers agencies, municipalities and water companies a complete range of utility services, including:

· Meter Reading

· Billing

· Leak Detection

· Engineering Services

· Water Treatment

· Water Testing

· Recycled Water Operations and Design

· Wastewater Operations

Staffed and managed by the same talented and skilled personnel who work for Cal Water, CWS provides services which are exempt from utility commission oversight. Clients receive the same high-quality services which they've come to expect from Cal Water. However, CWS delivers them in ways that can better meet clients' needs in today's increasingly demanding regulatory environment.

Clearly, this portion of the Cal Water Group web site provides no benefits to regulated California customers. Moreover, as discussed above, all forecasted expenses and capital costs associated with providing these unregulated services must be allocated to unregulated operations. To do

otherwise would require that ratepayers subsidize Cal Water's affiliate operations, in violation of long-standing Commission requirements and the Public Utilities Code. The record in this proceeding contains no evidence that such allocations have been performed.

In addition, the tone and representations contained in this portion of the Cal Water Group's web page are deeply troubling. Services provided by Cal Water employees with Cal Water assets are not "exempt" from Commission oversight. Cal Water acknowledged the Commission's continuing authority in the holding company settlement agreement which we approved in California Water Service Company, 77 CPUC 2d 53, 59 (D.97-12-011). For example, the Commission retains access to all records and books of account of the holding company and all affiliates (see settlement agreement at section III); the Commission also has continuing authority to review cost allocation methodologies to ensure compliance with Commission requirements (settlement agreement at section XI).

We are particularly concerned about the obvious attempts to link services provided by the affiliate with that of utility. The "same talented and skilled personnel who work for Cal Water" provide "[c]lients . . . the same high-quality services which they've come to expect from Cal Water." As an initial matter, utility employees providing services to affiliate customers is at odds with Cal Water's holding company decision, 77 CPUC2d 53, 59, where Cal Water agreed to transfer unregulated operations and employees to perform those services to the affiliates. More significantly, these statements attempt to link the affiliates' services with those provided by the utility in such a way as to capitalize on the reputation and goodwill associated with the utility. These statements could even be read to suggest that the affiliate has the authority to

control and direct employees of the utility. In sum, these portions of the Cal Water Group web page provide no benefits to Cal Water's customers and contain representations that are at odds with statutes and the Commission precedent.

The remaining portions of the Cal Water Group Web site list employment opportunities, benefits information for employees, and telephone numbers and addresses for all Cal Water districts, New Mexico and Washington offices.

In addition to excluding the web site costs associated with non-regulated affiliate operations, we must also scrutinize the contents of the Cal Water Group web site that relate to Cal Water's California regulated operations to determine whether those components represent institutional or goodwill advertising. The cost of such advertising is not recoverable from ratepayers. In Roseville Telephone Company, 70 CPUC 2d 88, 135-6 (D.96-12-074), we determined that the defining feature of ratepayer funded advertising is benefit to the ratepayers. Here, the Cal Water Group web site contains very little information that benefits ratepayers. The tariffs and district offices' addresses and telephone numbers are the only pieces of information that might assist ratepayers. These components form a small portion of the Cal Water Group web site related to Cal Water's California operations. Moreover, each of the pages displaying this customer information also displays the logos of all Cal Water Groups affiliates. We have previously held that displaying affiliate logos renders the entire advertising to be institutional or goodwill advertising. Roseville Telephone Company, D.01-06-077, 2001 Cal. PUC LEXIS 604, *44-*45.

In the Joint Recommendation, the parties support $170,000 in general office plant for software, hardware, and site development to enable the website www.calwater.com to meet Commission requirements and provide

greater customer benefits. In testimony, witnesses for Cal Water and ORA stated that in addition to these capital expenditures, one of the new employees funded in the general office would perform some tasks otherwise performed by outside consultants.

The record shows no allocation of the costs of the Cal Water Group web site among the regulated and non-regulated affiliates, and we infer that no such allocation has taken place. Similarly, the record shows no disallowance for institutional or goodwill advertising. Consequently, we are unable to approve the portion of the Joint Recommendation that includes web site costs. In addition to those costs explicitly addressed in the Joint Recommendation, we infer that other costs of the Cal Water Group web site may be reflected in current expenses as well as in capital plant accounts. These costs must be excluded from Cal Water's revenue requirement as well.

Our resolution of this issue should not be misinterpreted as being anti-web site. We remain fully committed to using new technology and services to better inform ratepayers. We see substantial value in providing customers useful information and services via the World Wide Web, and we have devoted substantial resources to designing and continuously improving our own web site. We will not, however, allow our commitment to this medium to alter or diminish our commitment to Commission policies and precedents regarding ratepayer protection and oversight of transactions involving a utility and its affiliates.

We direct Cal Water to revise its entire presence on the web to clearly separate regulated operations from non-regulated, and to provide useful information and services to ratepayers. As one step, we require Cal Water to change the page associated with www.calwater.com to that of the regulated

California Water, not the holding company, California Water Services Group. A link to the holding company page would be acceptable. This revised web site should present useful information and interactive features for customers regarding service, rates, and other customer oriented information. No information regarding service offerings by non-regulated affiliates should be present. The only logo should be that of the regulated company. Of course, only costs associated the regulated web site will be included in revenue requirement.

Therefore, we reject all components of the Joint Recommendation allocating to ratepayers any capital costs or expenses of the web site www.calwater.com. Pending the web site revisions outlined above, we direct that all capital costs and expenses associated with the web site be excluded from revenue requirement.

8.9 Small Mains

ORA contested Cal Water's proposed small main replacement program. ORA's study of Cal Water's past main replacement budgets and actual installations in each district showed that Cal Water actually completed only about 11% of budgeted main replacements in 2001 for certain districts. From this evidence, ORA concluded that Cal Water could not keep up with its replacement budgets, so ORA advocated deferring small main replacement projects to later years, with the result that about 37% of Cal Water `s requested small main replacements would be deferred outside the test period.

In rebuttal, Cal Water claimed that ORA's analysis did not properly reflect capital projects that were budgeted in one year but completed in another year. Cal Water explained that deferred projects retain their original budget year for accounting purposes and are not included in another year. In this way, the projects are accomplished in order, but not necessarily in the original budget year. Moreover, Cal Water explained that to the extent the actual expenditures are less than budgeted the Commission's step and attrition year formulae rely on actual plant balances, not forecasts.

Cal Water's Vice President - Engineering and Water Quality, testified that Cal Water manages its capital expenditures by budgeting to the Commission-approved total amount for the year. Cal Water management then uses engineering and financial judgment to determine which specific projects to fund. Should an unanticipated project arise that has immediate urgency, typically due to water quality or the likelihood of a very severe short-term impact on customers, then the urgent project will be funded and another less urgent capital project deferred. Consequently, capital budgets are not necessarily directly translated into capital expenditures.

On its small main replacement program in each district, Cal Water stated that the goal is to replace all undersized and bare steel mains in the next 50 years. As some of these mains currently have been in service for 50 years, the mains may be up to 100 years old when replaced. Undersized mains are those that have a diameter of less than six inches; replacing these small mains with mains that are a minimum of six inches in diameter enhances flows and water pressure, which also improves fire protection. Many of these smaller mains also suffer from internal corrosion that can obstruct water flow in the main, in some cases by half. These obstructions can also cause water quality problems by becoming sites for bacteria colonies.

In addition to the undersized mains, Cal Water is also replacing steel mains six inches and larger. These mains are being replaced to reduce leaks. Cal Water's engineer testified that many of the steel mains are over 40 years old and are apt to randomly develop leaks. Cal Water tracks the leak repair records and

uses this information to select mains for replacement. Cal Water also compiles all leak information. Cal Water's witness presented charts showing that Cal Water's total system leaks as well as leaks per 100 miles of pipe are increasing over time. From these data, the witness concluded that Cal Water's replacement program should be increasing, not decreasing.

Cal Water also explained that currently it has 4.5 million feet of pipe that meet the criteria for replacement. To accomplish this task in the next 50 years will require Cal Water to install 90,000 feet of mains per year, as is proposed in the application. Cal Water also noted that at a rate 90,000 feet per year of mains, it would take Cal Water 307 years to replace all 27.6 million feet of mains in its system. Cal Water concluded that a 300-year replacement schedule was not aggressive and that as the system continues to age, leaks and catastrophic failures will increase. Cal Water's witness also presented a table showing that Cal Water's budgeted capital projects exceed actual expenditures by about 3.1% on average over a 10-year period.

Aglet supported ORA's recommendations. Aglet observed that the magnitude of Cal Water's overall plant additions is "unprecedented." In looking at Cal Water's main replacement program, Aglet noted that Cal Water is seeking a 60% increase in replacement footage from 50,000 in 2001 (actual) to 82,000 (requested) in 2002, and even more in 2003. Aglet also explained that these high levels of plant additions could subject ratepayers to "bloated" attrition increases two years later.

Cal Water has met its burden (albeit through rebuttal testimony rather than its direct) of demonstrating that its proposed main replacement program is necessary to provide adequate service to its customers. In fact, Cal Water's rebuttal testimony showed that prudent long-term planning could

support an even higher level of main replacement. Cal Water plans to replace its mains over a 300-year period. Commission Standard Practice U-4, Determination of Straight-line Remaining Life Depreciation Accruals, Revised January 3, 1961, states that the longest projected actual service life for any type of main is 100 years. These facts would suggest that Cal Water should be replacing more small mains, not less.

ORA's and Aglet's testimony, however, do not directly challenge the program itself but rather Cal Water's implementation history. The testimony showed that Cal Water used its Commission-approved capital budget as the starting point for considering actual capital expenditures; however, should a more "pressing" project arise, Cal Water will instead spend the capital on the more pressing project. As a consequence, capital budgets may not be implemented exactly as planned. Overall, actual capital expenditures lag budgets by about three percent. Therefore, as discussed in relation to general office capital budgets, to the extent Cal Water has relied on budgets to support its request for capital projects, those budgets should be decreased by three percent.

Having determined that Cal Water's small main replacement program is necessary, ORA's analysis and Cal Water's admitted process for modifying capital budgets cause us concern. This necessary program should not be systematically slighted in implementation. Capital budgets where only 11% of budgeted costs actually occur in the budget year strongly suggest, at the very least, that the budgeting process fails to represent "real world expectations." We will, therefore, require that Cal Water submit a report in each of its future district general rate case filings showing budgeted capital projects and actual expenditures. We expect these reports to compare the budgeted capital projects to actual expenditures, and to explain each deviation and deferral, with revised

in-service dates for the deferrals. We will use this historic analysis to guide our evaluation of any proposed capital projects. Overall, we suggest that Cal Water direct more of its corporate attention to similar long-term infrastructure issues. These facilities are vital for continued service to ratepayers. Relying on infrastructure to provide service two and three times longer than its projected service life could be a plan for catastrophic failures, emergency repairs, and resulting sharp rate increases. Such an outcome is not in the best interests of the ratepayers.

8.10 Postage

The Joint Recommendation provided that ORA's estimates for postage should be increased to reflect the postal rate increase of 2.3 cents per bill, which became effective on July 1, 2002. Aglet opposed this component of the Joint Recommendation.

Aglet noted that Cal Water did not include in its application or updated tables the costs of the postage rate increase. Aglet also pointed out that Cal Water's work papers do not list an amount for postage, but Aglet estimated it to be about $840,000. Because the postage rate escalation will occur mid-way through the test year, Aglet opposed reflecting it in Cal Water's expenses. Aglet points out that all other costs are evaluated on a full year basis, not in half-year increments. Aglet also noted that this component of the Joint Recommendation violates the rate case plan.

To evaluate this issue, we turn to the Rate Case Plan, which resolves the issue of updates in the future test year ratemaking process. Updates to future projections used in a rate case are potentially endless. To enable the orderly processing of rate case applications, the Commission has determined that the utility may file one update to its application 30 days after filing. The utility may also request permission from the ALJ to file an update. Re Schedule for Processing Rate Case Applications by Water Utilities, 37 CPUC 2d 175, 191 (D.90-08-045).

Here, Cal Water requested no such permission, and it had plenty of notice that postal rates were likely to increase. We note that the United States Postal Service web site ( www.usps.com) shows press releases indicating that the July 8, 2002, rate increase was the result of the R2001-1 Rate Case filed by the Postal Service before the Unites States Postal Rates Commission (PRC) in September 2001. The PRC recommended the July increases to the Governors of the Postal Service in March 2002, and the Governors approved the increase in April 2002.

We are also concerned that the Joint Recommendation provided for updating postage costs but does not undertake a comprehensive update to account for other cost changes. Other cost estimates may well have declined in such a way as to offset, in whole or in part, the increase in postal costs. These types of concerns form the basis for the rule strictly limiting updates cited above. Because the postage rate update provided in the Joint Recommendation is not consistent with our rules for updates, we do not approve this component of the Joint Recommendation.

8.11 ¾" Meters

ORA notes that Cal Water does not offer all its customers the option of having a ¾ inch meter. This size meter is in between the two meter sizes offered by Cal Water - 5/8 inch meter or 1 inch meter. ORA stated that the standard flow rate for 5/8 inch meter is 20 gallons/minute, but that current meters typically provide actual flow rates of about 25 gallons/minute. In comparison, the standard flow rate for a ¾ inch meter is 30 gallons/minute, and current meters typically provide actual flows of about 35 gallons/minute. ORA recommended that Cal Water provide its customers with the option of a ¾ inch meter, as do other California water companies.

Cal Water opposed ORA's request and provided a witness to testify that the customers are unlikely to be interested in the slightly higher flow rates available with a ¾ inch meter due to the higher monthly service charge. The service charge for the larger meter is 50% higher than that for the 5/8 inch meter. Cal Water also notes that the larger meters cost it $45.10, while the 5/8 inch meters cost only $24.08.

This issue is about offering customers choices. Some customers may choose to pay the 50% increase in service charge to obtain the 10 gallon/hour difference between the flow rate offered by the 5/8 inch meter and the ¾ inch meter (a 40% increase in flow). Cal Water has not presented any valid reason why customers, fully informed of their options, who desire and are willing to pay for this increase in flow rate should be denied the opportunity to take service through a ¾ inch meter. We, therefore, order Cal Water to begin offering ¾ inch meter service in all its districts.

8.12 Low-Income Rate Assistance Program

In each of its 15 applications, Cal Water requested Commission authorization to institute a low-income rate assistance program that would be available to all Cal Water customers who meet the requirements for energy utility rate assistance programs. Eligible customers would receive a discount of $5 per month on their bill. The discount would be funded by a surcharge of $0.25 per month on bills for all customers not eligible for the program. Cal Water provided no testimony on this topic.

ORA agreed that a low-income rate assistance program should be available for eligible customers. However, due to the lack of experience with funding this program, ORA suggested that the surcharge revenues and discounts be recorded in a balancing account for true-up in next general rate case for each specific district. The Joint Recommendation adopted ORA's position.

Aglet supports low-income assistance in general but considers this proposal "half-baked at best" because it lacks any analysis of the likely customer use rate, program budget, or staffing estimate. Aglet also recommends that the balancing account be replaced with a memorandum account.

We find that Aglet's characterization of Cal Water's proposal is overly generous; this proposal is not half-baked, the ingredients are not even identified. Cal Water offered no testimony on this issue, no draft tariff language, no draft customer information, and no evidentiary support whatsoever for the rate design. Cal Water's entire presentation is eight lines in its applications. This meager showing fails to demonstrate that the proposal meets our standards for low-income programs.

We have a long history of supporting programs that result in reduced rates for low-income customers of California's public utilities. See, e.g., Re Universal Service and Compliance with the Mandates of Assembly Bill 3643, 68 CPUC 2d 524 (D.96-10-066). Such support, however, is tempered by requirements that the programs be carefully constructed to meet clearly identified needs in an efficient and equitable manner. We find, based on the record in this proceeding, that Cal Water has failed to demonstrate that this low-income discount program would be compatible with our conservation goals, and that the discount would fairly reach all low-income persons in Cal Water's 15 districts.

As noted above, Cal Water presented no testimony on this issue. Cal Water did not articulate the objective of the proposal or state a rationale for selecting the proposed rate design over alternatives. The Legislature has directed us to "consider . . . programs to provide rate relief to low-income ratepayers." (§ 739.8.) Therefore, despite the meager record, we will consider Cal Water's proposal.

In D.02-01-034, we approved a lifeline rate proposal by Southern California Water Company that provided for a 15% reduction in all components of each eligible customer's water bill. We approved this proposal rather than ORA's alternative rate design that waived the entire monthly service charge. ORA contended that the overall 15% rate reduction was contrary to our conservation goals. ORA pointed to our decision for California-American Water Company's Monterey District,²⁰ as supporting the concept of reducing monthly service charges rather than discounts on all components of service. We rejected this comparison, noting that the Monterey District had a "carefully developed, inverted block rate structure that ties higher consumption levels to higher rates. All residential customers, not merely the low-income subset, pay higher rates for higher usage." D.02-01-034, 2002 Cal. PUC LEXIS 35, at page *16. Although approving the Southern California Water Company's lifeline rate, we noted that we did not adopt it as a model for low-income rate relief in all Commission-regulated water companies.

Also in D.02-01-034, we addressed the issue of mobile home parks that provide master-metered water service to their tenants. We concluded that otherwise eligible mobile home park residents should not be excluded from the benefits of the proposed low-income program.

Turning now to Cal Water's proposal, we find several components to be at odds with D.02-01-034 and our standards for low-income programs. First, Cal Water chose a rate design that focuses on reducing the overall bill, which is similar to the design approved in D.02-01-034, but rather than a percentage, Cal Water uses a set amount, $5. Cal Water did not explain its rationale for selecting a set amount rather than a percentage or for setting the amount at $5.

Second, Cal Water has not explained how low-income residents who are not direct water customers, e.g., apartment dwellers or submetered mobile home park residents, would be able to receive the proposed discount. Absent such an explanation, we are unable to conclude that the proposed program would be equitably offered to low-income persons.

In sum, we agree with and fully support the concept of rate relief for low-income customers. Such rate relief, however, must be accomplished through a well-thought-out and even-handed program with specific identification of need, consideration of alternative means to address that need, justification for the selected components of the program, and a plan to assess, evaluate, and modify the program as necessary. At this point, Cal Water's proposal does not meet these standards. Until these standards are met, we are constrained to reject Cal Water's proposal. We will, however, order Cal Water to file a revised low-income rate proposal.

8.13 Rate of Return

The capital structure, cost of debt and equity, and rate of return on rate base as set in the Joint Recommendation:

Cost of Capital

	Test Years 2002, 2003, Attrition Years 2004, 2005
	Capital Structure	Cost	Weighted Cost
Debt	48.0 %	8.09%	3.88%
Preferred Stock	.5%	4.19%	.02%
Common Equity	51.5	9.7%	5.0%
Total	100.00 %		8.9%

ORA recommended a rate of return for Cal Water of 8.56%, 8.55%, 8.57%, and 8.57% for the years 2002-2005. Cal Water requested 9.59%, 9.66%, 9.72%, and 9.78% for the same years. ORA recommended 9.10% for return on equity and Cal Water requested 11.5%. For debt, ORA recommended 8.14%, 8.09%, 8.09%, and 8.05%, while Cal Water requested 8.06% for 2002, 8.04% for 2003, and 8.04% for the remaining years.

The Joint Recommendation provided for a rate of return and return on equity that represent a compromise of the parties' positions. Aglet here supports the Joint Recommendation:

[T]he recommended overall rate of return of 8.9% is lower than the present weighted average rate of return of 9.21% for all 15 districts. The joint recommendation is a reasonable compromise of the positions of the parties and will result in lower costs for the majority of Cal Water customers.

We agree with Aglet and approve the Joint Recommendation on rate of return.

⁷ In the Joint Recommendation, the parties agreed that Cal Water would conduct a six-month timekeeping study to evaluate the proper allocation of management time to out-of-state activities that are not subject to D.00-07-018. We discuss this component of the Joint Recommendation below.