5. Expenses

5.1. Expense Forecasting

Southwest forecasted 2003 test year expenses utilizing recorded expenses for the 12-month period ending August 31, 2001, to establish a base year. Base year expenses were then increased to recognize a 3.25 percent general salary increase effective June 2001, and further augmented by labor and non-labor escalation factors to determine 2002 expenses. The 2002 expenses were then adjusted for within-grade step increases for non-exempt employees, additional incremental billing expense for new customers, a scheduled postage increase in the third-quarter of 2002, and an increase in California Alternative Rates (CARE).¹⁵ Southwest then increased the adjusted 2002 expenses by labor and non-labor escalation factors, and made additional adjustments for new employees and increased safety advertising to arrive at expense estimates for 2003.

ORA rejected Southwest's forecasting methodology, and proposed that expense estimates be based on averages of normalized¹⁶ prior years' recorded expenses. ORA explains that many recorded expense accounts demonstrate wide variations, and that Southwest did not provide justification for using 2001 recorded amounts as a basis for estimating. ORA estimated Administrative and General Expenses (A&G) using a five-year average of recorded expenses between 1997 and 2001; while, Operating and Maintenance Expenses and Customer Account Expenses generally utilize a three-year average. ORA has included many of the adjustments proposed by Southwest including billing expenses for new customers, increased postage expense, new employees, and increased safety advertising. ORA did not include adjustments to annualize labor or to recognize within-step increases for non-exempt employees.

The estimating methodologies used by both Southwest and ORA apply to Northern and Southern California operations, although certain adjustments, such as the district manager and customer representative proposed for Northern California, are specific to each division.

ORA applies the burden of proof standard to Southwest's estimating methodology and concludes that Southwest has failed. In particular, ORA argues that Southwest has not provided clear and convincing evidence that either its 2001 recorded expenses, or its estimates of 2003 test year expenses are reasonable. ORA contends that Southwest's showing estimating test year expenses based on the recorded expenses for the twelve months ending August 31, 2001, is not sufficient, as there is virtually no testimony explaining why recorded expenses are necessarily reasonable for estimating the test year. In response, Southwest argues that ORA failed to demonstrate that the methodology ORA employed is either superior or reasonable. Southwest contends that forecasting test year expenses based on a recorded year is the same methodology used in general rate cases since at least the mid-1980s, although it concedes that other methodologies may be more reliable.

5.1.1. Discussion

We previously addressed the use of recorded costs to establish a base year in A.91-11-024, a San Diego Gas and Electric Company (SDG&E) general rate case (GRC). In that proceeding we stated, "The purpose of a general rate case is to develop and adopt sound, informed estimates of the reasonable costs to be incurred in the test year. We know that our adopted levels of revenues and expenses may be at variance with actual experience. However, we must be sufficiently informed to know that adopting a given estimate makes sense."¹⁷ In this same proceeding, we noted that "SDG&E simply states that `1988 base year recorded costs were adjusted as follows ...' Although this type of explanation might help a reader to understand where the cost figures came from, it does not provide a justification. Why is it appropriate to use a 1988 base year recorded cost for this account? What changes are expected in staffing and operations? Why are the specified adjustments appropriate? How were they calculated? These types of questions should be easily answered by the initial showing."¹⁸

In this proceeding we ask the same questions of Southwest. During cross-examination, Southwest's witness, when questioned about explanations of increases in the recorded base year from the previous year, stated "...we have no explanations as to increases from year to year." Later, he stated that Southwest assumed base year costs were reasonable and the witness believes they are reasonable.¹⁹ This position does not meet Southwest's burden to demonstrate through clear and convincing evidence the justification for its estimates. Simply stated, there must be more.

Southwest argues that ORA has not presented evidence that Southwest's expense estimates are unreasonable,²⁰ and that ORA's reliance on the Roseville decision²¹ is misplaced since Roseville used inflated, estimated budgets, which were unreasonable for estimating test year expenses. Thus, Southwest concludes that the basis for ORA's averaging technique used in this proceeding is not the basis for the averaging used in the Roseville case. Southwest contends that it has presented rebuttal testimony that demonstrates the reasonableness of actual incurred expense levels. (Exhibit 5, Tab K.) However, a review of that rebuttal testimony, and the cross-examination of the rebuttal witness, provide limited insight about increases, or decreases, in prior years' recorded expenses. Southwest argues in rebuttal that ORA's estimates are unreasonable because certain of ORA's 2003 test year estimates are below recorded expenses in 2001 and prior years, and that ORA's methodologies were intended to produce a low revenue requirement in this proceeding.²²

We note that Southwest is expected to justify its estimates for expense levels in its initial testimony and work papers, not through rebuttal testimony. Our adoption of test year 2003 expenses rejects Southwest's forecasting methodology based on increasing 2001 recorded expenses to create test year estimates. Although Southwest contends that the record is replete with evidence of steady upward trends in expenses, it is apparent that while upward trends may exist in some instances, substantial variations also exist. Examples of substantial variations are evident in ORA's Administrative and General (A&G) expenses (Table 6-2)²³ and for other expenses as further discussed. As shown in Table 6-2, after adjustments for inflation, year-to-year recorded expenses show increases exceeding 50% and decreases exceeding 21%. Such annual changes are less reflective of trends and more reflective of wide variations that are generally unexplained by any of the parties.

Conversely, we reject complete adoption of ORA's averaging of recorded amounts. ORA's methodology that forecasts future expenses by averages, whether over a 3-year or a 5-year period, does not answer the question of whether an estimate is reasonable, or whether the estimate reflects the factors affecting the expense. For example, apart from improvements in efficiency, customer related expenses would logically increase over time if the number of customers also increases, as is the case in this proceeding. Therefore, we will adopt expense estimates for each account using methodologies that fit the circumstances including averaging, trending, or other appropriate method, and adjusting for non-recurring expenses, or anticipated cost increases. We will also increase certain expense estimates, such as distribution costs, for estimated increases in customers. Many of our adopted increases in expenses will use the ratio between 2001 customers and 2003 estimated customers, as our expense estimates are based on recorded amounts through 2001. Expenses that are increased for customer growth will be based on the ratio between 2003 customers and 2001 customers, resulting in increases of 5.3% for Southern California, and 5.7% for Northern California.

5.2. Labor Loading (pensions, benefits, and
payroll taxes)

Labor loading is a factor applied to labor estimates to calculate additional expenses due to pensions, benefits, and payroll taxes. Labor loading is defined as the ratio of the cost for all employer provided employee benefit plans and programs divided by total labor payroll excluding leaves (holidays, vacations, and sick leave). Specific elements we adopt to develop the labor loading factor are discussed in A&G expenses (Acct. 926), and in taxes (payroll taxes). Only two labor loading elements, pensions and benefits, and miscellaneous benefits were disputed by ORA. Since we are adopting ORA's estimates for pensions and benefits and miscellaneous benefits, the adopted labor loading factor is ORA's recommended factor 46.09%. Our adopted labor-loading factor of 46.09% is applied to the 2003 test year labor estimate for operating and maintenance, customer accounts, and administrative and general expenses.²⁴

5.3. Four-Factor Cost Allocation

Total company costs are allocated to the Northern and Southern California divisions using a four-factor allocation methodology. The four factors are: (1) direct operating expense; (2) average direct plant in service; (3) direct labor; and (4) average number of customers.

Southwest using a regression calculates four-factor allocation percentages of 1.78% for Northern California, and 8.19% for Southern California. ORA using more recent recorded data, calculates four-factor allocation percentages of 1.53% for Northern California and 8.16% for Southern California. After reviewing Southwest's regression methodology, and considering ORA's more recent data, we will adopt ORA's allocation percentages.

5.4. Labor and Non-Labor Escalation

ORA estimated annual labor escalation using the Consumer Price Index for Urban Customers (CPI-U) forecast for 2003-2006, resulting in an estimated escalation factor of 2.6% rate. Southwest did not object to this escalation rate, and therefore we will adopt it for purposes of increasing labor to 2003 dollars.

Our labor forecasts also reject including any within grade increases, as we expect these amounts will be offset by attrition, and the replacement of existing workers at lower salaries. Furthermore, our adopted forecasting methods rely on recorded expenses, and therefore to the degree that within grade increases are included in these amounts, they are also included in our forecasts.

We will also adopt ORA's forecasts of non-labor escalation of 1.00% for 2002, and 1.019% for 2003. ORA and Southwest both use the same index to develop the non-labor escalation factors, however ORA's estimates are based on later information.

5.5. Operating and Maintenance Expenses²⁵
(Southern and Northern California Divisions)

5.5.1. Gas Distribution Expenses (Southern
California)

Southwest estimated gas distribution expenses using recorded 2001 expenses adjusted and escalated to 2003. ORA estimated distribution accounts using a three-year average of recorded expenses except for Accounts 871, 881, and 893. For Accounts 871 and 893, ORA reviewed and accepted Southwest's estimates. Account 881, Rents, is discussed below.

It is apparent from the recorded information that there have been substantial annual variances in the various gas distribution accounts. For example, between 2000 and 2001, Account 871, Distribution Load Dispatching Expense, declined by over 62%, and between 1998 and 2001, Account 874, Mains Expense declined by over 33%, in constant 2001 dollars.²⁶ Individual account changes are unexplained in the record, although Southwest generally attributes these increases to customer growth, salary and benefit increases, and maintenance of aging pipe.

Although Southwest and ORA argue over their respective estimating methodologies applied to individual accounts, an analysis of the total gas distribution expenses shows that gas distribution expenses for operations and maintenance are consistently trending upward on an annual basis. It is not unexpected that the charges to individual accounts will vary from year to year since service personnel who operate and maintain different portions of the system, will charge accounts differently from year to year. Thus, it is important to view the distribution expenses as a whole.

We will not adopt Southwest's estimates using recorded 2001 expenses adjusted and escalated to test year 2003. The record does not show that the expenses incurred in 2001 are necessarily a correct estimate of costs in 2003; nor did Southwest provide a detailed showing regarding recorded expense variances. We also do not adopt ORA's estimating method that addresses each account separately and averages recorded expenses over different numbers of years. Although ORA's averaging methodology eliminates many of the variances for individual accounts, the overall result does not give sufficient weight to the upward trend of total distribution expenses. Instead, we will adopt an average of the total distribution expenses over the past three years, except for gas supply and rents expenses. Our adopted methodology recognizes that variances in expenses will occur, and averaging will help normalize these variances. Secondly, our adopted decision provides Southwest with a pipeline replacement program that we will expect will reduce future distribution expenses. As Southwest's testimony indicates, the PVC pipe replacement project will reduce the number and severity of pipe leaks that in turn should reduce maintenance costs. We fully expect that the replacement of PVC pipe in Southern California will reduce future maintenance costs, and therefore, should be reflected in our adopted distribution expenses.

5.6. Account 813 Other Gas Supply Expenses
(Southern and Northern California)

Other Gas Supply expenses for both Northern and Southern California were the same for ORA and Southwest except for labor loading. Therefore, we will adopt the labor amount increased by our adopted labor loading factor, plus materials and expenses, escalated to test year 2003 using the labor and non-labor factors.

5.7. Account 881 Rents (Southern and Northern California)

ORA points out that Rents expense declined significantly between 2000 and 2001 as a result of Southwest owning computers rather than leasing computers. ORA argues that given this change it is reasonable to use 2001 recorded rents expense for estimating 2003 Rents expense. Southwest has not provided any information to show that ORA's finding is incorrect. Given this information, we will adopt Southern and Northern California recorded 2001 rents expenses for the 2003 test year.

5.8. Gas Distribution Expenses except Gas Supply and Rents Expenses (Northern California)

ORA estimated Gas Distribution Expenses differently for the Northern California Division than comparable estimates for the Southern California Division. ORA explains that Southwest recently completed an extensive expansion project, initiated in the mid-1990s, to bring a gas distribution system to the City of Truckee and the Donner Lake basin. As a result, recorded gas distribution expenses were unusually high in 1996 and 1997. Total distribution expenses increased by over 140% between 1995 and 1996.²⁷ After 1998, recorded expenses show stability, and annual changes decreased. ORA explains that it would not be reasonable to include the non-recurring expense levels in estimates for the test year. Therefore, ORA generally used a three-year average of expenses between 1999 and 2001, for its test year estimates, except for five accounts (870,881,885,887 and 892). ORA made certain adjustments to these five accounts reflecting a new Truckee district manager (Accounts 870 and 885), and an expected decrease in maintenance of mains and services (Accounts 887 and 892) as a result of reducing the amount of PVC pipe subject to leaks and other problems.

Southwest does not dispute the unusual expenses during the mid-1990s, however Southwest argues that although expenses declined between 1998 and 1999, unexpected customer additions, and costs of an agreement between the City of Truckee and Southwest have caused additional increases in costs. Southwest explains these increases have resulted in overall distribution expenses of $1,594,000 for the twelve months ending June 2002.

After reviewing the significant variations in past distribution expenses, and the current stability in expense levels, and noting the recent expansion of the Northern California service territory, we will adopt Southwest's estimate based on 2001 recorded expenses. We will escalate this amount by our adopted labor loading factor and labor and non-labor escalation factors. Our adopted Northern California distribution expenses do not include Other Gas Supply or Rents expenses that are discussed above. Although we have not adopted ORA's estimate, we agree with ORA that future distribution expenses are likely to reflect lowered costs due to the installation of non-PVC pipe for distribution services.

ORA and Southwest agreed that Accounts 870 and 855 should include the costs for a new manager in Truckee. Therefore, we will also include these costs in our adopted expenses.

5.9. Customer Accounts Expenses - Accounts 901,
902, 903, and 905 (Southern California)

Consistent with its overall forecasting methodology, Southwest's test year customer accounts expenses are based on an annualized 2001 estimate, adjusted for in-grade salary increases, increased billing expense associated with customer growth, and an increase in postage rates.²⁸

ORA forecasted test year expenses using a three-year average of past expenses (1999-2001) in constant 2001 dollars. These amounts were escalated to 2003 for projected inflation. ORA also included adjustments for an increase in postage rates, and increased costs as a result of growth in customers ORA did not include within-grade labor increases. ORA argues that within-grade increases are included in its estimating methodology since these increases are present in the recorded years used in ORA's averages. Furthermore, ORA contends there is no analysis that within-grade increases are not offset due to turnover by higher paid employees leaving or retiring and being replaced by lower paid employees.

Apart from arguments over estimating methodology, Southwest notes that by averaging recorded expenses, ORA has excluded a new customer representative in the new Northern California Division for 2003, although ORA included the manager who will supervise this employee.

5.9.1. Discussion

We do not adopt Southwest's estimates using the recorded 2001 expenses, nor do we adopt ORA's estimating methodology for Customer Accounts expenses. Customer Accounts expenses including meter reading, customer accounts and customer records and collections expenses logically are related to the number of customers served. In order to recognize this relationship, we will estimate customer accounts expenses on a normalized cost per customer basis. ORA and Southwest do agree on including expected increases in postage costs in customer accounts expenses, and thus we have also included these costs.

As shown in Appendix A we will use a three-year historical average of costs per customer in constant 2001 dollars, and multiply this average by the number of estimated customers in 2003. This amount is further increased using adopted escalation factors. As demonstrated by the relatively equal cost per customer in 2001 dollars, this method addresses customer growth, and efficiencies, developed during the recorded years.

5.9.2. Customer Accounts Expenses, Excluding
Account 902, Meter Reading, and
Account 904, Uncollectibles (Northern
California)

Our adopted customer accounts expense estimates for Northern California will be based on the recorded 2001 expenses to reflect the recent customer expansion, except for Accounts 902 and 904. ORA and Southwest agree that expected increases in postage costs should also be included in the estimates of customer accounts expenses, and thus we have also included these costs.

5.9.3. Account 902 - Meter Reading

ORA notes that meter reading labor costs have been trending downward during the past five-years as a result of the use of modern meter reading equipment. This improvement in productivity should be recognized in the adopted estimate for this account. Therefore, we will adopt an estimate based on the recorded amount for labor and non-labor in 2001.

ORA did not provide an explanation why the customer representative in Northern California was excluded for 2003, although ORA included the supervisor for the customer representative in its estimates. Therefore, we will include the costs of the customer service representative in our adopted customer accounts expenses.

5.9.4. Account 904 - Uncollectible Expense

Uncollectible expense represents the amount of billed revenue that cannot be collected from customers. Uncollectible expense is calculated by multiplying an uncollectible rate times the adopted net operating revenues, less revenues from special contracts. ORA reviewed Southwest's proposed uncollectibles rates of 0.1925% for Southern California, and 0.0797% for the Northern California, and found both rates reasonable, but stated that the rates were incorrectly applied to all revenues, including cost of gas revenues. Although, parties agree on the rate of 0.0797% for Northern California, a rate we adopt, ORA and Southwest disagree over the rate for Southern California.

Southwest argues that if an averaging methodology is adopted for other expenses, then a three-year average of the uncollectible rate should also be adopted for Southern California. Southwest calculates that a three-year average of the rates between 1999 and 2001 would result in an uncollectibles rate of 0.418%. In response to this proposal, ORA stated that if an average of past years' uncollectibles were adopted, the average should eliminate the rate in 2001 as abnormal,²⁹ and be based on an average of 1999 and 2000, resulting in a rate of 0.146%.

It appears from the recorded rates that the uncollectibles amount in 2001 is indeed unusual, and likely the result of the extremely high and unprecedented gas prices in 2000 and 2001. However, we will not completely dismiss the 2001 results, since gas prices could again increase resulting in increases in the uncollectibles rate. Therefore, we will adopt Southwest's initial request for an uncollectibles rate of 0.1925% for Southern California.

5.9.5. Customer Service and Information
Expenses (Accounts 908 and 909)

Southwest's application included approximately $306,000 in expenses for Customer Service and Information expenses. Most of these expenses are for the Low Income Energy Efficiency (LIEE) program, and were removed by ORA as result of the April 19, 2002, Joint Assigned ALJ Ruling.³⁰ However, Southwest contends that ORA inadvertently removed $7,602 for accounts 908 through 910 in Southern California, and $40,749 from Accounts 908 through 910 in Northern California related to customer education and energy efficiency. During cross-examination the ORA witness stated ORA had no position on these expenses, and therefore we will include customer education and energy efficiency expenses in the Customer Service and Information expenses for Northern and Southern California.

5.9.6. Implementation of the Public Purpose
Program Surcharge Adjustments
Adopted in D.03-03-007

On September 12, 2003, in compliance with Ordering Paragraph 5 of D.03-03-007, Southwest filed Advice Letter No. 695 to enable CARE program funding through program year 2004 at the same levels authorized for program year 2003, once SB5 monies have been exhausted. In Advice Letter 695, Southwest stated as follows:

If a final decision is rendered in A.02-02-012 prior to implementation of these surcharges, Southwest will amend this filing to reflect the 2004 test year customers, volumes and margin rates authorized by the Commission; as well as to reflect any changes in amounts recorded in the CARE balancing account.

On July 1, 2003, in compliance with Ordering Paragraph 6 of D.03-03-007, Southwest filed an Application to enable LIEE program funding through program year 2004. In its Application, Southwest states as follows:

Southwest will calculate the LIEE Surcharges to recover PY 2004 Commission authorized program expenses using the 2004 Test Year forecast ultimately adopted by the Commission in Application (A.) 02-02-012, Southwest's general rate case application.

Appendix C sets forth the calculation of the CARE and LIEE surcharges utilizing the Test Year 2003 bills, volumes and margin dates adopted in this Decision. Southwest is authorized to implement the public purpose program surcharge adjustments contemplated in D.03-03-007.

5.10. Sales Expenses (Accounts 912 and 913)

Southwest requests $3,016 (2001 dollars) in the Southern California Division, and $204 in the Northern California Division, for Accounts 912 and 913. The Joint Comparison exhibit, Exhibit 12, shows zero dollars for this expense, the amount we adopt for Sales Expenses.

5.11. Administrative and General
Expenses - System Wide

Administrative and General (A&G) system wide expenses include expenses allocable from Southwest's total company operations to the Southern and Northern California Divisions. A&G expenses charged directly to specific A&G accounts in the Southern and Northern California Divisions are discussed following this section. Total A&G expenses are a summary of allocable and direct expense estimates for both divisions. A&G expenses include administrative salaries and expenses, outside services expenses, property insurance, injuries and damages, employee pensions and benefits, and miscellaneous general expenses and rents.

Consistent with its forecasting methodology, Southwest used 12-months recorded A&G expenses as of August 31, 2001, and escalated these amounts to the 2003 test year. Adjustments were made to the following expenses: (a) Account 920, A&G salaries were annualized for a general salary increase of approximately 3.25%, effective June 2001; and $156,000³¹ was included for a Management Incentive Plan (MIP); (b) Account 925 was increased for premiums paid for Directors and Officers (D&O) liability insurance.

ORA argues that recorded A&G expenses have varied significantly from year-to-year, and as a result test year forecasts should reflect an average of past years. ORA forecasted test year A&G expenses using a five-year average of recorded expenses. In addition, ORA excluded expenses for the MIP, and for D&O insurance. ORA also adjusted Account 926, Pensions and Benefits for an underfunding or diversion of Post Retirement Benefits Other Than Pensions (PBOPs). ORA contends it has included a portion of the general salary increase in its forecasting methodology by including 2001 salaries in its average forecasted salary amounts.

Southwest asserts that ORA's averaging technique does not include the general salary increase, and that ORA does not include expenses for employees added since Southwest's last GRC.

Our adopted forecasted expenses reflect methodologies appropriate for each of the various A&G accounts as discussed below.

5.11.1. Account 920 A&G Salaries

In constant 2001 dollars, recorded system-wide A&G salaries increased 0.6% between 1999 and 2000; and then increased over 13% between 2000 and 2001.³² No party analyzed the reasons for these increases, although Southwest testified that increases in A&G expenses are a result of more employees, increased information technology needs, increased litigation that was not merger related, and greater regulatory and business requirements. However, this explanation is very general and certainly does not provide specific instances of cost increases, or reasons for the significant increase between 2000 and 2001. Southwest notes that ORA's recommended expense for A&G salaries is actually less than the recorded amount for 1997. Furthermore, ORA did not provide information indicating those areas in which Southwest can reduce A&G salary expenses. Therefore, we will not adopt ORA's estimate. After review of the recorded A&G salary amounts, and noting a general upward trend in Account 920 expenses, we will adopt the recorded amount for 2000, escalated by 0.6% the percentage increase between 1999 and 2000 as a reasonable estimate for the test year.

We have reviewed Southwest's proposed MIP, and the associated management performance criteria. Although certain of the criteria such as improving customer satisfaction may benefit customers, we conclude that the criterion to improve Southwest's return on equity is not in the interests of customers. Our assessment of the criteria leads us to conclude that the costs of the MIP should be allocated between shareholders and ratepayers. Therefore, we will adopt ORA's recommendation and allow 60% of the MIP in rates.

5.11.2. Account 921 - Office Supplies and Expenses

Office supplies and expenses result from general overhead expenses other than salaries. Unlike A&G salaries, recorded amounts in Account 921 have demonstrated both increases and decreases over the past few years. No party has provided an analysis explaining the reasons for these annual changes. We agree with ORA that an average of past years' expenses, adjusted for inflation, is a reasonable forecast of Account 921 expenses in the test year. Therefore, we will use a five-year average of recorded expenses escalated to the 2003 test year.

5.11.3. Account 922 - A&G Express
Transferred to Capital

This account transfers a percentage of Accounts 920 and 921 to construction costs or non-utility accounts. Although ORA used a five-year average to forecast this account, we will adopt a percentage of our adopted amounts in accounts 920 and 921 for Account 922. We note that the percentages³³ during the last three recorded years (1999, 2000 and 2001)³⁴ have been almost the same (14.8%, 14.4% and 15.2%). Therefore, we will adopt an average of these three years, or 14.8%.

5.11.4. Account 923 - Outside Services

Outside Services expenses include the fees and charges of professional consultants and others for general services not applicable to a particular operating function, or to other accounts. During the past five recorded years, annual changes in these accounts varied between minus 5% and plus 44%.³⁵ Southwest's forecast for Account 923 is $4,730,322 or $144,597 less than ORA's five-year average of $4,874,919 in 2001 dollars. The year-to-year fluctuations are significant, and a forecast of the test year expenses should normalize these fluctuations. Therefore, we adopt ORA's use of a five-year average for Account 923 escalated to 2003.

5.11.5. Account 924 Property Insurance

Account 924 includes the costs of insurance or accruals to protect the utility against losses and damages to owned or leased property used in its utility operations. Recoveries from insurance companies or others for property damages, and dividends, are credited to this account. ORA used a five-year average to estimate Account 924, while Southwest used recorded expenses from August 31, 2001, resulting in an ORA estimate of $172,020 that exceeds Southwest's estimate of $151,733. Recorded property insurance expenses have declined significantly during two of the past five years, before increasing. We conclude that the most recent costs for property insurance best reflect the expected costs in the test year. Therefore, we will adopt an amount of $158,790, the amount recorded for the year 2001.

5.12. Account 925 Injuries and Damages, Liability Insurance and Workers' Compensation

Account 925 includes the cost of insurance and reserve accruals to protect the company against injuries and damages claims of employees or others. The reserve accruals pay expenses for claims not covered by insurance. Reimbursements from insurance companies, or others, for expenses previously charged and insurance dividends or refunds are credited to Account 925.

Southwest estimated Account 925 using recorded amounts for 12-months ending August 31, 2001. ORA based its estimate on a five-year average, after adjusting this account for Director's and Officer's (D&O) liability insurance premiums.³⁶ ORA argues that D&O insurance was used to fund Southwest merger activities, and thus should be charged to shareholders and not ratepayers. ORA explains that D&O insurance premiums were raised as a result of a failed merger with ONEOK, an energy company involved in gas production. In its reply brief, ORA states that at a minimum D&O insurance benefits both shareholders and ratepayers, and there should be an equal sharing of costs.

Southwest contends D&O insurance is a necessary expense in order to attract quality executives and directors, and that D&O insurance protects against litigation and is thus a necessary business expense. Southwest believes that ORA disallowed all D&O insurance in its estimates, and not just a portion of D&O insurance.

It is uncertain from the information provided whether the increase in insurance premiums was a direct result of the failed ONEOK merger. However, D&O insurance protects directors and officers from activities that benefit both shareholders and customers. Therefore, we will adopt an amount for D&O insurance that allocates the cost of D&O insurance equally between shareholders and customers.³⁷

The recorded amounts in constant 2001 dollars during the past five years for Account 925 vary substantially, with increases exceeding 52%, and decreases of 3% on a year-to-year basis. This variability indicates that an average of past years is a reasonable method to forecast the test year expense. Therefore, we will adopt an average of the past five years recorded expenses, including a sharing of the costs for D&O insurance, for Account 925.

5.12.1. Account 926 - Pensions
and Benefits Expenses

Pensions and benefits expenses include pensions, PBOPs, healthcare, relocation reimbursements, school tuition, leaves, and similar benefits. These benefits do not include legally mandated benefits such as unemployment insurance and workers' compensation, or executive and board of director's benefit and retirement plans. Pensions and benefits are a major component in determining a labor loading factor.³⁸

Differences between estimates by Southwest and ORA reflect ORA's PBOPs disallowance for alleged over-collections, a reduction in Southwest's request to reflect regulatory accounting, and the use by ORA of more recent data. ORA also recommends against including expenses associated with company events, employee recognition, and a "wellness" program. ORA contends these miscellaneous expenses are for social, cultural, and charitable activities and should not be paid by customers.

5.12.2. PBOPs

ORA recommends a one-time refund to ratepayers of $8,983,000 for PBOPs over-collections on a total company basis.³⁹ This proposal would allocate refunds of $137,440 to the Northern California Division, and $733,010 to the Southern California Division using the four-factor allocation method.⁴⁰ ORA contends that a refund of past over-collections is appropriate since ORA concludes that Southwest diverted PBOPs' revenue requirements to non-PBOP uses, contrary to D.92-12-015. More specifically, Ordering Paragraph 3 of D.92-12-015 directs that:

To the extent that PBOP trust assets cannot or are not used for PBOP obligations, then those assets shall be returned to ratepayers as allowable by law. Utility rates are hereafter made subject to refund, but only to the extent necessary to allow such a return to ratepayers of any PBOP assets that cannot be used for PBOP expenses or that have been used for other purposes. (46CPUC 2d 455.)

In response, Southwest contends it has never withdrawn any money from the PBOP trust account at any time since its inception, and that it has consistently funded PBOPs at a level equal to or greater than the actuarially determined funding amount. Southwest notes that ORA was unable to show any instance in which Southwest withdrew money from its PBOP trust account.

Responding to other allegations, Southwest argues it is not in violation of Ordering Paragraph 4 (D.92-12-015).⁴¹ Southwest asserts that because there is no difference between regulatory accounting PBOP expense and financial accounting PBOP expense, it could not establish the regulatory asset required by Ordering Paragraph 4.

Southwest also disputes ORA's initial calculation of a refund, since the calculation includes recovery of PBOPs costs before California, Arizona, or Nevada authorized recovery of PBOPs costs. As a result, Southwest contends the ORA witness agreed to a reduction in the refund amount attributed to California of $2,345,000,⁴² and additional amounts attributed to Arizona and Nevada, that would reduce the refund amount by an additional $4,815,000, or a total of $7,160,000 on a total company basis. In response, ORA argues, that Southwest failed to provide any information for the record to confirm its statements regarding authorizations in other jurisdictions.

Finally, Southwest argues that even if ORA's recalculation is considered, the recalculation is in error since (1) it ignores current cash payments to retirees, and (2) understates PBOP funding for California operations. Southwest asserts that including these adjustments in ORA's recalculation reduces the refund to zero.

5.13. Discussion

We do not adopt ORA's recommended refund of PBOP over-collections. ORA does not dispute that Southwest pays its current PBOP obligations for current retirees on a cash basis, and not through the PBOP trust account. However, it appears that ORA's calculations do not include these annual PBOP expenses.⁴³ Thus, ORA's recommended refund amount is overstated. Secondly, it is not possible to determine the dollar effect on ORA's alleged PBOPs over-collections due to the timing differences between jurisdictional authorization, and ORA's assumed dates used in its refund calculations. California did not authorize PBOP recovery until 1995, and other jurisdictions⁴⁴ did not authorize collections of PBOPs revenue requirements until July 1996 and September 1997.⁴⁵ As result of these differences, ORA recognized that certain adjustments were necessary in order to recalculate its proposed refund to adjust for these changes. Although ORA insists that it made no "error" in its calculations, ORA revised its recommended refund calculations and appended the revision to its opening brief.⁴⁶ After consideration of these matters it is not possible to conclude that a PBOP refund is justified. Furthermore, even if a refund could be justified, the information is incomplete in determining the amount of the refund.

Ordering Paragraph 3 (D.92-12-015) states that "to the extent that PBOP trust assets cannot or are not used for PBOP obligations . . . . then those assets shall be returned to ratepayers as allowable by law . . . . " ORA did not find that existing PBOP assets cannot be used, and are not necessary for PBOP obligations in the future; or, that at a future date Southwest would not begin to withdraw amounts from its PBOP trust account. Therefore, there has been no violation of D.92-12-015, Ordering Paragraph 3.

Ordering Paragraph 4 (D.92-12-015) states that the utilities shall establish and maintain regulatory assets pursuant to FASB Statement No. 71. Although ORA argues Southwest failed to establish this regulatory asset, D.92-12-015 provides that utilities with California operations 10% or less of their total utility operations (based on a four-factor allocation) may choose to be exempted from the accrued PBOP requirement for regulatory accounting purposes only.⁴⁷ Based on the adopted four-factor allocation in this opinion, Southwest's California operations are 9.69%, and thus Southwest may be excluded from this requirement. Thus, we do not find that Southwest violated paragraph 4 of D.92-12-015.

Although we find that Southwest has not violated D.92-12-015, we are concerned that the PBOPs trust account will continue to increase without some certainty as to how Southwest plans to use the PBOPs trust account in the future. Therefore, we will require Southwest, in its next GRC, to provide the Commission with a complete, independent audit of all regulatory funding and accounting activity from 1994 through the next base year of PBOPs under California jurisdiction. This audit will be administered under the fiduciary responsibility of the trustees of the PBOP and pension plans, as appropriate.

5.13.1. Pensions and Benefits-Regulatory
Adjustments

ORA takes exception to the accounting mechanisms used by Southwest in forecasting pensions. ORA contends Southwest's "Normal Cost" method for regulatory accounting exceeds the Internal Revenue Code and Employee Retirement Income Security Act (IRS/ERISA) maximum and minimum limits. Southwest argues that its accrual method of accounting, as opposed to the cash method recommended by ORA, results in a more gradual trend, and that the cash method recommended by ORA under IRA/ERISA guidelines may result in volatile pension funding requirements.

We have previously addressed this issue in D.88-03-072, Ordering Paragraph 2, where we rejected FASB 87 for ratemaking or accounting purposes.⁴⁸ Furthermore, ORA points out that the Commission's ratemaking pension policy has been consistently applied for all other energy utilities, and we can find no reason to deviate from that policy. Therefore, we adopt ORA's recommended pension expense.

5.13.2. Miscellaneous Benefits

ORA concluded that certain miscellaneous benefits for a "wellness" program should be excluded from benefits expenses. ORA contends these benefits constitute expenses for employee social, cultural and charitable activities, and therefore should not be borne by ratepayers. In response, Southwest argues that these activities include costs for health forums, and seminars and as health related activities that improve the overall health of employees.

We are not opposed to activities that benefit the health and improve the morale of Southwest's employees. Southwest's wellness program may be useful in promoting better health and provide other benefits for its employees. However, Southwest's employees have generous benefits included in their employment contracts, and costs for these benefits have been included elsewhere in this decision. We are concerned with current economic circumstances and conclude that ratepayers should not have to pay for the wellness program. Southwest may, of course, continue this program using shareholder monies; however, that will be a decision of Southwest management.

5.13.3. Account 930.1 - Safety Advertising

Southwest estimated Account 930.1, Safety Advertising, using the 12-months recorded amount as of August 31, 2001, while ORA used a five-year average. We note that between 1997 and 2000, expenses for this account were relatively unchanged; however, in 2001, expenses increased by approximately 13% in constant 2001 dollars. We believe that safety education is an important issue for customers, and therefore to reflect the greater spending in 2001, we will use a two-year average of 2000 and 2001 for safety advertising expense.

5.13.4. Account 930.2 - Miscellaneous,
Deferred Compensation Directors

Account 930.2, Miscellaneous, Deferred Compensation Directors, includes the cost of labor and other expenses incurred by the general management of Southwest not provided for elsewhere. Apart from the difference in estimating methodology (Southwest used the 12-month recorded expense in August 2001, and ORA used a five-year average) ORA recommends disallowing the cost of interest on deferred compensation for directors, and payments for the lobbying component of dues to the American Gas Association (AGA) and the Western Energy Institute (WEI). ORA contends that the interest on deferred directors compensation at 150% of Moody's Seasoned Corporate Bond Rate⁴⁹ appears excessive, and should not be borne by ratepayers. In response, Southwest contends there is no evidence or testimony that the proposed interest rate is excessive, or that the interest should be paid by shareholders. Southwest explains that this is a necessary business expense, and that the interest compensates directors for the later receipt of board or meeting fees.

In D.96-01-011⁵⁰ interest expenses on Edison's Director Deferred Compensation Plan were removed by Edison in response to arguments from the Federal Executive Agencies. This plan is similar to Southwest's plan, and we see no reason to change our position, and will not charge ratepayers for the interest on Southwest's Directors Deferred Compensation. We will also disallow the lobbying component of payments to AGA and WEI as unnecessary and properly the responsibility of shareholders.

After increasing annually, recorded amounts in Account 930.2 have stabilized in 2000 and 2001. We will adopt a two-year average of these amounts after deduction for the interest on Director's Deferred Compensation.

5.13.5. 931 Rents Expense

Rents expenses include the rents and operating expenses for the property of others used in connection with the operations of Southwest. Rents expenses include both rents that escalate and those that are under fixed cost leases and thus do not escalate. In an effort to apply consistent forecasting methodology, ORA used a five-year average of recorded rents expenses in 2001 dollars escalated to the test year. Southwest's estimates are based on recorded 2001 expenses as of August 2001.

Our review of those rents subject to escalation indicates a wide variance between minus 21% and plus 43% during the past five-years. Therefore, we adopt a five-year average of rents expenses for those expenses subject to escalation. However, for rents that are subject to fixed cost leases, we will adopt the 2001 recorded amount.

5.13.6. Account 935- Maintenance of General
Plant

Account 935, Maintenance of General Plant records costs assignable to customer accounts, sales and A&G expense functions incurred in the maintenance of general plant. The difference between Southwest and ORA estimates for this account are a result of their different forecasting methodologies. A review of the recorded amounts shows significant year-to-year changes that vary between minus 17% and plus 52% in constant 2001 dollars. Due to these substantial and unexplained variances, we adopt ORA's use of a five-year average to forecast Account 935 in the test year.