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1 DOCKET NO. APPLICATION OF SOUTHWESTERN PUBLIC SERVICE COMPANY FOR AUTHORITY TO CHANGE RATES PUBLIC UTILITY COMMISSION OF TEXAS DIRECT TESTIMONY of RICHARD R. SCHRUBBE on behalf of SOUTHWESTERN PUBLIC SERVICE COMPANY (Filename: SchrubbeRRDirect.doc) Table of Contents GLOSSARY OF ACRONYMS AND DEFINED TERMS... LIST OF ATTACHMENTS... I. WITNESS IDENTIFICATION AND QUALIFICATIONS... II. ASSIGNMENT AND SUMMARY OF TESTIMONY AND RECOMMENDATIONS... III. PENSION AND BENEFITS OVERVIEW... IV. RECOVERY OF CURRENT PENSION AND OTHER POST- EMPLOYMENT AND RETIREMENT BENEFITS EXPENSE... A. QUALIFIED PENSION... B. RETIREE MEDICAL... C. SELF-INSURED LONG-TERM DISABILITY... D. REASONABLENESS OF SPS S PENSION AND OTHER POST- EMPLOYMENT AND RETIREMENT BENEFITS EXPENSE... 0 V. HEALTH AND WELFARE COSTS... A. ACTIVE HEALTH CARE... B. THIRD-PARTY-INSURED LONG-TERM DISABILITY... C. LIFE INSURANCE... D. MISCELLANEOUS BENEFITS... E. REASONABLENESS OF HEALTH AND WELFARE COSTS... VI. WORKERS COMPENSATION COSTS... A. SELF-INSURED WORKERS COMPENSATION... B. THIRD-PARTY-INSURED WORKERS COMPENSATION... C. REASONABLENESS OF WORKERS COMPENSATION BENEFIT COSTS... Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

2 VII. OTHER BENEFIT COSTS... A. 0(K) MATCH... B. MISCELLANEOUS RETIREMENT-RELATED COSTS... C. REASONABLENESS OF OTHER BENEFIT COSTS... VIII. PENSION AND OPEB RESERVE ACCOUNT... IX. SPS S PREPAID PENSION ASSET... X. PENSION AND BENEFIT COST TRENDS... AFFIDAVIT... Schrubbe Direct Revenue Requirement Page RR - Page 0 of 0 0

3 GLOSSARY OF ACRONYMS AND DEFINED TERMS Acronym/Defined Term ADIT CAGR Commission CWIP ERISA EROA FAS FERC GAAP HSA HR IRC IBNR LTD NCE O&M OPEB Operating Companies PBGC PBO Meaning Accumulated Deferred Income Tax Compound Annual Growth Rate Public Utility Commission of Texas Construction Work in Progress Employees Retirement Income Security Act Expected Return on Assets Statement of Financial Accounting Standard Federal Energy Regulatory Commission Generally Accepted Accounting Principles Health Savings Account Human Resources Internal Revenue Code Incurred But Not Reported Long-Term Disability New Century Energies Operation and Maintenance Other Post-Employment Benefits Northern States Power Company, a Minnesota corporation; Northern States Power Company, a Wisconsin corporation; Public Service Company of Colorado, a Colorado corporation; and SPS Pension Benefit Guaranty Corporation Projected Benefit Obligation Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

4 Acronym/Defined Term PURA RFP SPS Meaning Public Utility Regulatory Act Rate Filing Package Southwestern Public Service Company, a New Mexico corporation Test Year October, 0 through September 0, 0 Update Period October, 0 through December, 0 WACC Xcel Energy XES Weighted Average Cost of Capital Xcel Energy Inc. Xcel Energy Services Inc. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

5 LIST OF ATTACHMENTS Attachment RRS-RR- RRS-RR- RRS-RR- RRS-RR- RRS-RR- RRS-RR- RRS-RR- RRS-RR- Description Calculation of Pension, OPEB, Non-Qualified Pension, FAS Long-Term Disability and Workers Compensation Costs (Filename: RRS-RR-.xlsx) 0 Actuarial Report (Non-native format) 0 Actuarial Report (Non-native format) Calculation of Health and Welfare Costs (Filename: RRS-RR-.xlsx) Calculation of Deferred Pension and OPEB Balances (Filename: RRS-RR-.xlsx) Calculation of Test Year Prepaid Pension Asset (Filename: RRS-RR-.xlsx) Cumulative Prepaid Pension Asset Balance Since the Adoption of FAS (Filename: RRS-RR-.xlsx) Year-over-Year Changes in Pension and Benefit Costs (Filename: RRS-RR-.xlsx) Schrubbe Direct Revenue Requirement Page RR - Page of 0 00

6 DIRECT TESTIMONY OF RICHARD R. SCHRUBBE 0 I. WITNESS IDENTIFICATION AND QUALIFICATIONS Q. Please state your name and business address. A. My name is Richard R. Schrubbe. My business address is Nicollet Mall, Minneapolis, Minnesota 0. Q. On whose behalf are you testifying in this proceeding? A. I am filing testimony on behalf of Southwestern Public Service Company, a New Mexico corporation ( SPS ) and wholly-owned electric utility subsidiary of Xcel Energy Inc. ( Xcel Energy ). Xcel Energy is a utility holding company that owns several electric and natural gas utility operating companies, a regulated natural gas pipeline company, and three electric transmission companies. Q. By whom are you employed and in what position? A. I am employed by Xcel Energy Services Inc. ( XES ), the service company subsidiary of Xcel Energy, as Director of Corporate and Benefits Accounting. Q. Please briefly outline your responsibilities as Director of Corporate and Benefits Accounting. A. I am responsible for accounting for all employee benefits programs, playing a liaison role with the Human Resources ( HR ) department, external actuaries, and Xcel Energy is the parent company of four utility operating companies: Northern States Power Company, a Minnesota corporation; Northern States Power Company, a Wisconsin corporation; Public Service Company of Colorado, a Colorado corporation; and SPS (collectively, Operating Companies ). Xcel Energy s natural gas pipeline company is WestGas InterState, Inc. Through a subsidiary, Xcel Energy Transmission Holding Company, LLC, Xcel Energy also owns three transmission-only operating companies: Xcel Energy Transmission Development Company, LLC; and Xcel Energy West Transmission Company, LLC; all of which either are are regulated by the Federal Energy Regulatory Commission ( FERC ) or are expected to be regulated by FERC. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

7 senior management with benefit fiduciary roles. As part of my job responsibilities, I have become familiar with the applicable laws, regulatory rules, and ratemaking practices regarding the Operating Companies recovery of pension and benefits costs and assets. In addition, I am responsible for: 0 Xcel Energy s corporate accounting, including four core utility business unit accounting groups and multiple Xcel Energy subsidiaries; the oversight of the XES accounting, billing, allocations, policies and procedures, service agreements, internal audits, external audits, and external reporting to state and federal regulatory agencies; the publication of cost assignment and allocation manuals in each jurisdiction, where required; and the updating and maintenance of system processes for utility allocations, work order allocations, non-operation and maintenance allocations, and non-regulated business activity allocations for all four of Xcel Energy s Operating Companies where such allocations are necessary. 0 Q. Please describe your educational background. A. I received a Bachelor of Science degree, with a major in finance, from Marquette University in. Q. Please describe your professional experience. A. From 000 to 00, I was employed by the DoALL Company, first as a Staff Accountant, later as Assistant Controller, and then as Corporate Controller. From 00 to 00, I was employed by Wilsons Leather as a Financial Analyst. In 00, I joined Xcel Energy as a Consultant. I became the Manager of Corporate Accounting in 00 and the Director of Corporate and Benefits Accounting in 0. Additionally, in 0, I was assigned responsibilities associated with the oversight of the administration of XES, including accounting, billing, allocations, policies and procedures, service agreements, internal audits, external audits, and external reporting to state and federal regulatory agencies. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

8 0 Q. Have you testified or filed testimony previously before any regulatory authorities? A. Yes. I testified before the Public Utility Commission of Texas ( Commission ) in SPS s last base rate case, Docket No., on pension and other postemployment benefit expenses, active health care expenses, and the proper treatment of a prepaid pension asset, among other issues. In addition, have submitted pre-filed testimony to the Commission on SPS s behalf regarding SPS s agreements with affiliates in Docket No.. I have also testified before the Colorado Public Utilities Commission and the Minnesota Public Utilities Commission on pension and benefit issues. Further, I have submitted pre-filed direct testimony on SPS s behalf on those issues, and on affiliate service agreements, to the New Mexico Public Regulation Commission. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

9 II. ASSIGNMENT AND SUMMARY OF TESTIMONY AND RECOMMENDATIONS Q. What is your assignment in this proceeding? A. My testimony addresses seven topics related to SPS s employee pensions and other non-cash benefits:. I support SPS s request to recover its reasonable and necessary expenses for qualified pension calculated under Statement of Financial Accounting Standard ( FAS ), retiree medical costs calculated under FAS 0, and self-insured long-term disability ( LTD ) costs calculated under FAS ;. I support SPS s request to recover its active health and welfare costs, which include costs incurred for active health care, miscellaneous benefits, life insurance, and third-party-insured LTD benefits;. I support SPS s request to recover the reasonable and necessary costs incurred for workers compensation benefits;. I support SPS s request to recover other reasonable and necessary benefits, such as the 0(k) match, certain benefit-related consulting costs, and deferred compensation;. I quantify the amount of pension and other post-employment benefit ( OPEB ) expense to be used as the baseline on a going-forward basis for purposes of the tracker established under section.0 of the Public Utility Regulatory Act ( PURA ), and I quantify the current deferred balance to be amortized;. I quantify SPS s prepaid pension asset and support the request to continue to include that prepaid pension asset in rate base; and. I explain that SPS s pension and benefit cost trends in recent years are reasonable, and I describe the factors that render it difficult to make a meaningful comparison between different utilities pension and benefit costs. In addition, I sponsor or co-sponsor the following schedules in SPS s Rate Filing Package ( RFP ): Schedules B-, B-., G-.0, G-., G-., and G-.. PURA is codified in Title II of the Texas Utilities Code. See Tex. Utils. Code Ann (Vernon 00 and Supp. 0). Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

10 Schedule B- lists the monthly balance of each accumulated provision account (i.e., injuries and damages, property insurance, etc.), the amount accrued each month, and the amount charged off each month during the Test Year. In 0 0 addition, Schedule B- provides the same information on an annual basis for the prior three years. B-. provides the information requested on Schedule B- on a Texas retail basis only. I co-sponsor these schedules with SPS witness Arthur P. Freitas. The G- series of Schedules provides general employee benefit information with specific information on pension expense provided in Schedule G-., postretirement benefits other than pension expense provided in Schedule G-., and administration fees provided in Schedule G-.. I co-sponsor Schedule G- with SPS witness Jill H. Reed. The RFP requires that each of these schedules be updated days after the initial filing. I also support the portions of the Executive Summary that contain information from these Schedules. Q. Please summarize your testimony and recommendations. A. I support SPS s request for recovery of pension and other post-employment and retirement benefits expense in the Test Year, and I recommend that SPS be authorized to recover $,,00 of pension and other post-employment and retirement benefits expense on a total company basis. That amount is composed of $,0, of qualified pension expense, $(0,) of FAS 0 retiree medical expense, and $,00 of FAS self-insured LTD expense. SPS is not requesting recovery of non-qualified pension expense. The Test Year is the twelve-month period from October, 0 through September 0, 0. Schrubbe Direct Revenue Requirement Page 0 RR - Page of 0 0

11 0 0 I also support SPS s request to recover its reasonable and necessary active health and welfare costs. I recommend that SPS be authorized to recover $,,0 (total company) for active health and welfare costs. That amount is composed of $,,0 of active health care costs, $,0 of life insurance costs, $, of miscellaneous benefit costs, and $,0 of third-partyinsured LTD costs. I further support SPS s request to recover third-party-insured workers compensation costs. I recommend that SPS be authorized to recover $0, (total company) of third-party-insured workers compensation costs. I further recommend that SPS be authorized to recover $,, (total company) of other pension and benefit-related costs, which include 0(k) matching expense, consulting expense, and deferred compensation. I next support SPS s request to establish a baseline for pension and OPEB expense on a going-forward basis under PURA.0, and I recommend that the Commission set that baseline at $,,, which is a Texas retail number. I further recommend that SPS continue to be allowed to include its prepaid pension asset in rate base in accordance with the standard ratemaking treatment of prepayments and Commission precedent. Customers earn a return on the prepaid pension asset in the form of reduced annual pension cost, and therefore it is appropriate for SPS to earn a return on the asset as well. SPS s thirteen-month average net prepaid pension asset balance as of December, 0 was $,, on a total company basis. SPS s request to include the prepaid The total company amount is $,,0. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

12 0 0 pension asset in rate base is discussed in further detail in Section IX of my testimony. Finally, I explain that the trends in SPS s overall pension and benefit costs over the last several years have been reasonable. Although SPS s pension and benefit costs appear at first glance to be increasing year-over-year, those costs have actually been declining in recent years. They only appear to be increasing because of the accounting treatment that flows from the tracking mechanism provided in PURA.0. Moreover, the percentage increases in the early years of the comparison are misleading because of the very low baseline from which the measurements were made. Furthermore, it is not possible to make meaningful comparisons among utilities pension and benefit costs without information about each utility s funding strategy, or about the regulatory treatment that may affect the recorded pension amounts. Q. Will your testimony be updated for actual costs incurred in the three months following the Test Year, October through December 0? A. As discussed by SPS witness Evan D. Evans, SPS will file an update days after SPS filed this application. That update will include actual costs incurred to replace the estimates provided in the application for the time period of October, 0 through December, 0, referred to as the Update Period. The Update Period costs that include certain affiliate Operation and Maintenance ( O&M ) labor overheads will be addressed in the case update filings made by Ms. Reed, Mr. Freitas and me. Additionally, I will provide updated G- The Update Period is the three-month period from October, 0 through December, 0. Schrubbe Direct Revenue Requirement Page RR - Page 0 of 0 0

13 0 schedules that incorporate updates to the estimates that I have presented in my direct testimony, as well as the most current information available to SPS but not provided in the direct filing. Q. Were Attachments RRS-RR- and Attachments RRS-RR- through RRS-RR- prepared by you or under your direct supervision and control? A. Yes. Q. Are Attachments RRS-RR- and RRS-RR- true and correct copies of the documents that you have represented them to be? A. Yes. Q. Were the portions of the RFP Schedules and Executive Summary you sponsor or co-sponsor prepared by you or under your supervision and control? A. Yes. Q. Do you incorporate the portions of SPS s RFP Schedules and Executive Summary sponsored or co-sponsored by you into this testimony? A. Yes. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

14 III. PENSION AND BENEFITS OVERVIEW Q. Please summarize the pension and other benefits that SPS offers to its eligible employees. A. In addition to the cash compensation discussed by Ms. Reed, SPS offers the following non-cash benefits to its employees: 0 0 Pension and other post-employment and retirement benefits, which include: o a defined benefit qualified pension plan that provides eligible employees with a defined benefit amount upon retirement; o a non-qualified pension restoration benefit that allows SPS to attract and retain employees who would otherwise be disadvantaged by the restrictions imposed under the qualified pension plan; o a retiree medical plan available to certain retired employees; and o LTD benefits; Active health and welfare benefits, which include medical, dental, pharmaceutical, vision, life insurance, and other miscellaneous benefits; Workers compensation benefits, including both self-insured and third-party-insured benefits; and Other types of benefits, including a 0(k) defined contribution plan and certain types of deferred compensation. As I mentioned previously, SPS is not requesting recovery of its non-qualified pension expense. Q. What are the requested amounts for each of the elements of non-cash compensation offered by SPS? A. Table RRS-RR- (next page) sets forth the amounts of the pension and benefit costs that SPS seeks to recover in rates. Column B represents the per book amount for each element of expense during the Test Year. Column C shows the incremental changes that result when the estimates for the Update Period are Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

15 substituted for amounts incurred during the last three months of 0. Column D contains the known and measurable adjustments for changes that will occur after the end of the Update Period. Finally, Column E shows the amount for each element of expense that is included in the cost of service in this case. Table RRS-RR- A B C D E Benefit Test Year ( months ended September 0, 0) Incremental Change Due to Update Period Estimates Known and Measurable Adjustment Amount Included in Cost of Service Qualified Pension,,, 0,0, FAS 0 Retiree Medical (,) (,) 0 (0,) FAS Long-Term Disability (Self-Insured),, 0,00 Active Health Care,, (,),,0 Long-Term Disability (Third-Party-Insured),, 0,0 Life Insurance,0, 0,0 Miscellaneous Benefit Programs and Costs 0,0 (,0) 0, 0(k) Match,, 0,,, Miscellaneous Retirement-Related Costs, 0, 0, Workers Compensation (Self-Insured) (0,) 0 0, 0 Workers Compensation (Third-Party-Insured), (,), 0, Total Pension and Benefits Expense $,,0 $(,) $, $,, The per book amount for active health care in the cost of service is $,,. That amount is an estimate, as explained in Section V of this testimony, and it must be adjusted to reflect health care claims that were incurred near the end of the Test Year but not reported until after the Test Year. Adding the Incurred But Not Reported ( IBNR ) amount, which is $(,), to the per book amount creates an actual Test Year amount of $,,. The $(,) adjustment to the per book amount in the cost of service is a combination of the IBNR adjustment and the $(,) incremental change due to Update Period estimates. Schrubbe Direct Revenue Requirement Page RR - Page of 0 00

16 Q. Is SPS seeking to recover any other amounts related to pension and benefits? A. Yes. SPS is requesting recovery of $,, of deferred pension and OPEB benefits, which I discuss later in this testimony. SPS also seeks Commission approval to continue including a prepaid pension asset in rate base, consistent with the Commission s treatment of prepaid pension assets in prior cases, including SPS s most recent base rate case, Docket No.. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

17 IV. RECOVERY OF CURRENT PENSION AND OTHER POST-EMPLOYMENT AND RETIREMENT BENEFITS EXPENSE 0 0 Q. What topic do you discuss in this section of your testimony? A. I discuss the amounts requested for pension and other post-employment and retirement benefits expenses, which include qualified pension expense, FAS 0 retiree medical expense, and FAS LTD benefits. Q. Does any Texas ratemaking standard address the recovery of pension and OPEB expense? A. Yes. PURA.0(a) provides that the Commission shall include in the rates of an electric utility expenses for pension and other post-employment benefits, as determined by actuarial or other similar studies in accordance with generally accepted accounting principles, in an amount the [Commission] finds reasonable. Q. Are the pension and other post-employment and retirement benefit amounts that SPS seeks to include in the cost of service determined by actuarial studies or similar studies prepared in accordance with Generally Accepted Accounting Principles ( GAAP )? A. Yes. SPS s pension and other post-employment and retirement benefit expense amounts are calculated in accordance with actuarial standards, and the results are set forth in actuarial studies that are attached to my testimony as Attachment RRS-RR- and Attachment RRS-RR-. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

18 0 0 A. Qualified Pension Q. How are qualified pension costs determined? A. Pension costs are determined under FAS, Employers Accounting for Pensions. Q. Please describe SPS s qualified pension plan and the nature of the costs of the plan. A. The qualified pension plan is a traditional defined benefit pension plan, which promises bargaining employees monthly pension annuity payments based upon their level of pay and years of service. It promises non-bargaining employees a choice of either a lump sum payout or a monthly pension annuity based upon their level of pay and years of service. Under a defined benefit pension plan, the promised pensions are a commitment by SPS. Q. Do accounting rules and laws determine the cost for SPS s pension plan? A. Yes. As I noted earlier, SPS accounts for the cost of its pension plan under the rules set forth in FAS, which prescribes the rules that companies must follow in determining whether their pension costs comply with GAAP. However, FAS does not dictate how a company must fund the plan. The funding of the plan is determined based upon prudent business practices, with constraints imposed by the requirements of the Pension Protection Act of 00, the Employee Retirement Income Security Act ( ERISA ), and the Internal Revenue Code ( IRC ): In 00, FAS was renamed Accounting Standards Codification -0, but for the sake of convenience I will refer to it in this testimony as FAS. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

19 There are minimum required contributions; There are maximum contributions that can be deducted for tax purposes; and SPS has a fiduciary responsibility to prudently protect the interests of the plan participants and beneficiaries. 0 0 The minimum and maximum funding rules set forth under the Pension Protection Act, ERISA, and the IRC are different from the methodology used under FAS to determine pension cost. Over the long run, the cumulative employer contributions made to a plan should equal the cumulative accounting costs, but in the short and intermediate run there can be significant differences. Q. Please explain how FAS applies to regulated industries. A. Because regulatory accounting must follow specific accounting standards unless superseded by regulatory requirements, FAS is used for regulatory accounting by the vast majority of utility companies. In addition, PURA.0 requires that pension costs be determined by actuarial or other similar studies in accordance with GAAP. Therefore, under PURA.0, pension costs are based on FAS. Q. How is pension cost determined under FAS? A. Under FAS, pension cost is composed of the following:. the value of pension benefits that employees will earn during the current year (service cost);. increases in the present value of the pension benefits that plan participants have earned in previous years (interest cost);. investment earnings on the pension plan assets that are expected to be earned during the year (expected return on assets ( EROA ));. recognition of costs (or income) resulting from experience that differs from the assumptions (amortization of unrecognized gains and losses); and Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

20 0 0. recognition of the cost of benefit changes the plan sponsor provides for service the employees have already performed (amortization of unrecognized prior service cost). Q. Taking each of these five components in order, how is the service cost component calculated? A. The service cost component recognized in a period is the actuarial present value of benefits attributed by the pension benefit formula to current employees service during that period. Actuarial assumptions are used to reflect the time value of money (the discount rate) and the probability of payment (assumptions as to mortality, turnover, early retirement, and so forth). Q. Next, how is the interest cost component calculated? A. The interest cost component recognized in a fiscal year is determined as the increase in the projected benefit obligation ( PBO ) due to the passage of time. Measuring the PBO as a present value requires accrual of an interest cost at a rate equal to the assumed discount rate. Essentially, the interest cost identifies the time value of money by recognizing that anticipated pension benefit payments are one year closer to being paid from the pension plan. Q. How is the third component, EROA, calculated? A. The EROA is determined based on the expected long-term rate of return on plan assets and the market-related value of plan assets. The market-related value of plan assets for SPS is a calculated value that recognizes changes in the fair value in a systematic and rational manner over five years. Schrubbe Direct Revenue Requirement Page 0 RR - Page of 0 0

21 0 0 Q. With regard to the fourth component, what are the unrecognized gains and losses? A. Unrecognized gains and losses are the asset gains and losses or the liability gains and losses from prior periods. In effect, those asset or liability gains and losses arise when the experience in a prior period differed from what was expected. Q. Please explain the distinction between asset gains and losses and liability gains and losses. A. Asset gains and losses arise when the actual returns on the pension trust assets in prior years are greater than or lesser than the EROA. Suppose, for example, that the plan expects a % return on its pension trust assets, which total $ billion. The EROA for that year would be $0 million. If the actual return in that year is %, the asset gain will be $0 million. Of course, the opposite can also occur. If the EROA is % and the actual return on the assets is %, the plan suffers a $0 million asset loss. Liability gains and losses arise when the other components of pension cost differ from expectations. Those components include such things as the discount rate, the expected number of retirements, mortality rates, and wage increases. For example, if SPS assumes a % discount rate at the beginning of the year but the actual discount rate measured at year end for the next year turns out to be %, SPS will have a liability gain because the higher discount rate reduces the amount SPS must set aside to satisfy future pension liabilities. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

22 0 0 Q. Is the distinction between assets gains and losses and liability gains and losses important? A. Yes. The distinction is important because, as I will discuss in more detail below, the asset gains and losses are phased in over time, whereas the liability gains and losses are not. Asset gains and losses are phased into an amortization pool, for lack of a better term, over a five-year period. Liability gains and losses are not phased in, but instead are placed into the amortization pool in a single year. Because gains and losses may reflect refinements in estimates as well as real changes in economic values, and because some gains in one period may be offset by losses in another or vice versa, FAS does not require recognition of gains and losses as a component of net pension cost in the period in which they arise. Q. Please describe what you mean by the term phase in of gains or losses. A. The term phase in is used to describe the process of moving asset gains or losses into an amortization pool. Under FAS, the asset gains or losses are incorporated into the calculation of pension cost over a period of five years. Thus, 0% of a gain or loss is phased into the amortization pool during the first year after the gain or loss occurs, another 0% is phased into the amortization pool during the second year after the gain or loss occurs, and so forth until the fifth year, when the full amount of the gain or loss is phased in. Unlike asset gains or losses, liability gains and losses are not phased in, as I mentioned earlier. The portion of gains and losses that enter the amortization pool are then amortized over a specific period of years if they satisfy the criteria I discuss below. Schrubbe Direct Revenue Requirement Page RR - Page 0 of 0 0

23 0 0 Q. Why does SPS phase-in asset gains and losses and then amortize them over the average years to retirement of active employees? A. When SPS moved to FAS accounting in, it elected to phase-in asset gains and losses and to amortize these gains and losses over a period not to exceed the average remaining service life (average years to retirement) of employees. The purpose of the election was to reduce financial statement volatility in individual accounting periods by ensuring that gains and losses are spread out over time, and that they are not recognized in just the period that they occur. This phase-in and amortization approach reduces volatility in recognized cost by smoothing gains and losses over the longest allowed duration. Q. Why are asset gains and losses phased-in but not liability gains and losses? A. The assumptions used to establish pension liability (e.g., mortality rates, discount rates, etc.) typically do not vary greatly from year to year, and therefore the drafters of FAS did not consider it necessary to require the phase in of liability gains and losses. In contrast, the market returns on pension fund assets can vary greatly from year to year, as evidenced by the dramatic difference between the EROA and the actual returns that SPS experienced on its pension fund assets in 00. Because of the effects that such volatility would have on businesses income statements, the drafters of FAS decided that it was appropriate to phase-in market gains and losses. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

24 0 0 Q. How are unrecognized gains and losses amortized? A. SPS aggregates its current year s gains or losses with the prior years gains or losses to calculate a net unamortized gain or loss. That net unamortized gain or loss is then compared to the present value of the PBO and to the market-related value of the assets in the pension trust. If the net unamortized gain or loss is outside a 0% corridor that is, if it is more than 0% of the greater of the PBO or the market-related value of the trust assets SPS must amortize that net gain or loss. If amortization of the unrecognized gains or losses is required, the amortization amount is equal to the amount of the unrecognized gain or loss in excess of the corridor divided by the average remaining future service of the active participants in the plan. For SPS s bargaining employees this is approximately years, and for SPS s non-bargaining employees it is approximately years. Q. Returning to the five elements of FAS pension cost, what is the fifth element unrecognized prior service cost? A. Unrecognized prior service cost results from pension plan amendments that change benefits based on services rendered in prior periods. FAS does not generally require the cost of providing such retroactive benefits (prior service cost) to be included in net periodic pension cost entirely in the year of the amendment but instead provides for recognition over the future years. Q. How is unrecognized prior service cost amortized? A. Unrecognized prior service cost is amortized in the same manner as unrecognized gains and losses, with the exception of the 0% corridor. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

25 0 0 Q. Please summarize the calculation that is required to be used under FAS to quantify annual pension cost. A. Annual pension cost is quantified using the following calculation: Current service cost + Interest cost - EROA +/- Loss (gain) due to difference between expected and actual experience of plan assets or liabilities from prior periods + Amortization of unfunded prior service cost = Annual pension cost Q. Is the annual pension cost produced by this formula always a positive number? A. No. In some years, the negative amounts in the calculation (i.e., the EROA and the gains resulting from the difference between expected and actual experience from prior periods) can be larger than the positive amounts. When that happens, the annual pension cost is actually negative. And if that occurs in a rate case test year, the annual pension cost included in the cost of service may be a negative number, which reduces the overall cost of service. But even when the annual pension cost is negative, shareholders are still providing the capital to fund the prepaid pension asset. Q. What amount of qualified pension expense did SPS incur during the Test Year? A. The Test Year per book qualified pension expense was $,, (total company) for the twelve months ended September 0, 0. Schrubbe Direct Revenue Requirement Page RR - Page of 0 00

26 0 0 Q. Is SPS proposing to update that amount to reflect the estimated costs from the Update Period? A. Yes. Replacing the qualified pension expense for the last three months of 0 with estimates of qualified pension expense for the last three months of 0 increases the qualified pension expense by $,. SPS will update this estimate with actuals in its -day Update. Q. Why did qualified pension expense increase during the Update Period relative to the corresponding period from 0? A. The qualified pension expense increased during the Update Period relative to the corresponding period from 0 primarily due to an increase related to updating the mortality tables and a decrease in the discount rate. Those increases were offset to some extent by the reduced amortization of historical asset loss amounts, including the 00 market loss. Q. Is SPS proposing to make any known and measurable changes to the qualified pension expense for events occurring after the end of the Update Period? A. No. B. Retiree Medical Q. How are retiree medical costs determined? A. Retiree medical costs are determined under FAS 0, Employers Accounting for Post Retirement Benefits Other Than Pensions. The components and calculation are identical to FAS, with one exception: The pension asset gains and losses are phased into the loss amortization calculation by 0% each year, whereas retiree medical asset gains and losses are not. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

27 0 0 Q. Please describe SPS s retiree medical plan and the plan expenses. A. SPS s plan consists primarily of retiree medical benefits, but it also includes retiree life and dental insurance. SPS eliminated those benefits for all active nonbargaining employees more than ten years ago, and SPS bargaining employees hired on or after January, 0 no longer receive retiree medical benefits. Thus, the current expense for retiree medical benefits is a legacy of the prior programs. Q. What amount of retiree medical expense did SPS incur during the Test Year? A. The Test Year SPS retiree medical expense was $(,) (total company) for the twelve months ending September 0, 0. Q. Is SPS proposing to update that amount to reflect the estimated costs from the Update Period? A. Yes. Replacing the retiree medical expense for the last three months of 0 with estimates of retiree medical expense for the last three months of 0 reduces the retiree medical expense by $,, which makes the amount in the cost of service even more negative. SPS will update this estimate with actuals in its - day Update. Q. Why did retiree medical expense decline during the Update Period relative to the corresponding period from 0? A. The retiree medical expense decreased during the Update Period relative to the corresponding period from 0 primarily due to favorable claims experience. That decrease was offset to some degree by a lower EROA and unfavorable historical asset performance. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

28 0 0 Q. Is SPS proposing to make any known and measurable changes to the retiree medical expense for events occurring after the end of the Update Period? A. No. C. Self-Insured Long-Term Disability Q. Please describe LTD in more detail and explain how it is accounted for. A. The LTD costs are attributable to benefits provided by SPS to former or inactive employees after employment but before retirement. The LTD plan provides employees with income protection by paying a portion of an employee s income while he or she is disabled by a covered physical or mental impairment. SPS has two types of LTD a self-insured benefit and a third-partyinsured benefit. In a third-party-insured plan, which I will discuss in more detail later in this testimony, SPS purchases an insurance plan from an outside insurance provider that assumes the risk. In a self-insured plan, SPS provides the benefits to the covered individuals and therefore effectively acts as the insurer. For the selfinsured piece, SPS is required to accrue for LTD costs under FAS, Employers Accounting for Post-employment Benefits. The FAS accrual represents the expected disability benefit payments for employees that are not expected to return to work. Q. Which groups of employees are covered under the self-insured plan and which groups are covered under the third-party-insured plan? A. Within the LTD benefit, all employees disabled before January, 00 are covered under the self-insured plan, and all employees disabled on and after January, 00 are covered under a third-party-insured plan. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

29 0 0 Q. What amount of expense did SPS incur during the Test Year for self-insured LTD benefits? A. The self-insured LTD benefit costs in the Test Year were $, (total company) for the twelve months ending September 0, 0. Q. Is SPS proposing to update that amount to reflect the estimated costs from the Update Period? A. Yes. Replacing the self-insured LTD expense for the last three months of 0 with estimates of self-insured LTD expense for the last three months of 0 increases the expense by $,. SPS will update this estimate with actuals in its -day Update. Q. Why did self-insured LTD costs increase during the Update Period relative to the corresponding period from 0? A. The self-insured LTD expense increased during the Update Period relative to the corresponding period from 0 due to an updated actuarial calculation provided by Towers Watson in May 0 to reflect the most recent assumptions for 0 costs. Q. Is SPS proposing to make any known and measurable changes to the selfinsured LTD expense for events occurring after the end of the Update Period? A. No. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

30 0 D. Reasonableness of SPS s Pension and Other Post-Employment and Retirement Benefits Expense Q. Are the amounts of SPS s pension and other post-employment and retirement benefits expense reasonable? A. Yes. SPS follows a well-established, objective, and verifiable process to determine the assumptions used within the actuarial calculations that yield the pension and other post-employment and retirement benefits expense amounts for the Test Year. The assumptions and the actuarially calculated total cost amounts are reflected in my Attachment RRS-RR-, which is the actuarial study for 0. In addition, the reasonableness of Xcel Energy s Total Rewards Program design, which includes pension and other post-employment and retirement benefits, is discussed in the direct testimony of Ms. Reed. Schrubbe Direct Revenue Requirement Page 0 RR - Page of 0 0

31 0 0 V. HEALTH AND WELFARE COSTS Q. What topics do you discuss in this section of your testimony? A. I discuss four types of active health and welfare costs, which are: () active health care costs; () fully-insured LTD costs; () life insurance costs; and () miscellaneous benefit costs. A. Active Health Care Q. What types of costs are included in active health care? A. Active health care costs are all costs associated with providing health care coverage to employees. Those costs include medical, pharmacy, dental and vision claims, administrative fees, employee withholdings, pharmacy rebates, Health Savings Account ( HSA ) contributions, transitional reinsurance fees, trustee fees, and interest income. Q. What was the Test Year amount of active health care expense? A. The Test Year amount of active health care expense was $,, on a total company basis for the twelve months ending September 0, 0. This amount is also shown in Table RRS-RR-. Q. Does the Test Year amount match the per book amount of active health care costs? A. No. The per book numbers for active health care amounts include estimates because there is generally an average lag of approximately 0 days between when health care is provided and when SPS receives a bill for that care. Therefore, the actual amount of active health care expense was not available at the time SPS The difference between the estimated amount and the actual amount is generally not material enough to restate SPS s GAAP books when the actual amount becomes known. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

32 0 0 recorded its per book amount at year-end 0. Because SPS needs to close its books before it receives all of those health care claims, it takes the actual amounts recorded through a certain point in the year and estimates the additional amount that will be incurred but not reported by the end of the year, which is the IBNR reserve. During the following year, SPS receives the actual amounts attributable to care provided in the last part of the prior year, and at that time it trues up the IBNR estimate to the actual incurred expense. The Test Year amount includes the actual amount incurred for the last three months of 0, including an IBNR adjustment for claims incurred in 0 but not recorded until 0, and the actual amount incurred for the first nine months of 0, which also includes an IBNR adjustment for amounts incurred but not recorded by September 0, 0. Q. Is SPS proposing to update the Active Health Care amount from the Test Year to reflect the estimated costs from the Update Period? A. Yes. Replacing the Active Health Care expense for the last three months of 0 with estimates of Active Health Care LTD expense for the last three months of 0 reduces the expense by $,. SPS will update this estimate with actuals in its -day Update. Q. Why did Active Health Care expense decrease during the Update Period relative to the corresponding period from 0? A. The active health care expense decreased during the Update Period relative to the corresponding period from 0 primarily due to favorable claims experience. Q. Is SPS proposing to make any known and measurable changes to the Active Health Care expense for events occurring after the end of the Update Period? A. No. Schrubbe Direct Revenue Requirement Page RR - Page 0 of 0 0

33 0 0 B. Third-Party-Insured Long-Term Disability Q. Please describe the third-party-insured LTD costs that SPS incurs. A. As explained earlier, SPS offers long-term disability coverage that provides benefits to former or inactive employees after employment but before retirement. The LTD plan provides employees with income protection by paying a portion of an employee s income while he or she is disabled by a covered physical or mental impairment. In a third-party-insured plan, SPS purchases an insurance plan from an outside insurance provider that assumes the risk, and the cost of the thirdparty-insured piece is simply the cost of the insurance premium incurred each year along with any other miscellaneous costs. Q. What groups of employees are covered under the third-party-insured benefit? A. As noted earlier, all employees disabled on and after January, 00 are covered under the third-party-insured plan. Q. What amount of expense did SPS incur during the Test Year for third-partyinsured LTD benefits? A. SPS incurred $, on a total company basis for third-party-insured LTD benefits. Q. Is SPS proposing to update that amount to reflect the estimated costs from the Update Period? A. Yes. Replacing the third-party-insured LTD expense for the last three months of 0 with estimates of third-party-insured LTD expense for the last three months of 0 increases the expense by $,. SPS will update this estimate with actuals in its -day Update. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

34 0 0 Q. Why did third-party-insured LTD increase during the Update Period relative to the corresponding period from 0? A. The third-party-insured LTD increased during the Update Period relative to the corresponding period from 0 due to small changes in participant counts, insurance rates, and participant salary levels. Q. Is SPS proposing to make any known and measurable changes to the thirdparty-insured LTD expense for events occurring after the end of the Update Period? A. No. C. Life Insurance Q. Please describe the life insurance cost that SPS incurs. A. The life insurance category consists of life insurance premiums and offsetting employee life insurance withholdings. Life insurance is provided to non-bargaining employees at 00% of base pay and to SPS bargaining employees at 0% of base pay. Employees also have the option to purchase additional life insurance. Q. What amount of expense did SPS incur during the Test Year for life insurance benefits? A. SPS incurred $,0 in costs on a total company basis for life insurance benefits. Q. Is SPS proposing to update that amount to reflect the estimated costs from the Update Period? A. Yes. Replacing the life insurance expense for the last three months of 0 with estimates of life insurance expense for the last three months of 0 increases the Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

35 0 expense by $,. SPS will update this estimate with actuals in its -day Update. Q. Why did life insurance increase during the Update Period relative to the corresponding period from 0? A. The life insurance expense increased during the Update Period relative to the corresponding period from 0 primarily due to small changes in participant counts, participant salary levels, and insurance rates. Q. Is SPS proposing to make any known and measurable changes to the life insurance expense for events occurring after the end of the Update Period? A. No. D. Miscellaneous Benefits Q. What types of miscellaneous benefit programs does SPS offer to its employees? A. The types of costs included in the miscellaneous benefit programs and costs category are: 0 Tuition reimbursement, Employee Assistance Program costs, Wellness program costs, Costs incurred by the HR Service Center to answer employee retirement or benefit questions, Health and welfare plan actuarial and audit fees, Administrative fees for short-term and long-term disability plans, and Administrative fees for employee flexible spending and HSA s. Schrubbe Direct Revenue Requirement Page RR - Page of 0 00

36 0 0 Q. What amount of expense did SPS incur during the Test Year for miscellaneous benefits? A. SPS incurred $0,0 on a total company basis for miscellaneous benefits. Q. Is SPS proposing to update that amount to reflect the estimated costs from the Update Period? A. Yes. Replacing the miscellaneous benefit expense for the last three months of 0 with estimates of miscellaneous benefit expense for the last three months of 0 reduces the expense by $,0. SPS will update this estimate with actuals in its -day Update. Q. Why did miscellaneous benefit expense decrease during the Update Period relative to the corresponding period from 0? A. The miscellaneous benefit expense decreased during the Update Period relative to the corresponding period from 0 primarily due to a reduction in utilization of SPS s various employee benefit programs. Q. Is SPS proposing to make any known and measurable changes to the miscellaneous benefit expense for events occurring after the end of the Update Period? A. No. E. Reasonableness of Health and Welfare Costs Q. Are the amounts of SPS s health and welfare expense reasonable? A. Yes. It is appropriate for the Test Year cost of service to include these benefits because they reflect a reasonable and necessary level of expense. As Ms. Reed explains in more detail, Xcel Energy s compensation plans and benefits are required for Xcel Energy and its subsidiaries to attract, retain, and motivate Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

37 employees needed to perform the work necessary to provide quality services for SPS customers. Without these benefits, SPS and XES would have to pay significantly higher current compensation to attract employees. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

38 VI. WORKERS COMPENSATION COSTS 0 0 Q. Is SPS seeking recovery of the costs associated with workers compensation benefits? A. Yes. SPS is seeking recovery of both self-insured workers compensation benefits and third-party-insured workers compensation benefits. A. Self-Insured Workers Compensation Q. Please briefly describe SPS s self-insured workers compensation program. A. Xcel Energy provides workers compensation benefits under the FAS accounting standard to employees who are former or inactive employees after employment, but before retirement. Post-employment benefits are all types of benefits provided to former or inactive employees, beneficiaries, and covered dependents. Those benefits include, but are not limited to, salary continuation, supplemental unemployment benefits, severance benefits, and disability-related benefits (including workers compensation). Q. How are self-insured workers compensation amounts determined? A. SPS s workers compensation costs are calculated using actuarial assumptions such as mortality tables and discount rates. A copy of the 0 actuarial report from which SPS s self-insured workers compensation expense is derived is attached to my testimony as Attachment RRS-RR-. Q. What amount of expense did SPS incur during the Test Year for self-insured workers compensation benefits? A. SPS incurred $(0,) on a total company basis for self-insured workers compensation benefits for the twelve months ending September 0, 0. This amount is also shown in Table RRS-RR-. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

39 0 0 Q. Why is the self-insured workers compensation amount negative for the Test Year? A. The negative expense is due to no future claims being expected under the self-insured workers compensation plan. As a result, the liability was reduced to zero, and expense was decreased. Q. Is SPS proposing to update that amount to reflect the estimated costs from the Update Period? A. No. Q. Is SPS proposing a known and measurable adjustment to the Test Year level of expense for self-insured workers compensation benefits? A. Yes. As mentioned above, SPS is not expecting any additional claims at this point, and therefore the expense should be zero. The known and measurable adjustment is an increase of $0, on a total company basis to bring the Test Year amount from $(0,) to zero. B. Third-Party-Insured Workers Compensation Q. Please briefly describe SPS s third-party-insured workers compensation program. A. For employees who are injured on or after August, 00, all workers compensation benefits are covered under an insured program. The only cost to Xcel Energy for this benefit cost is the insurance premium. In a third-partyinsured plan, SPS purchases an insurance plan from an outside insurance provider that assumes the risk, and the cost of the third-party-insured piece is simply the cost of the insurance premium incurred each year along with any other miscellaneous costs. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

40 0 0 Q. How are third-party-insured workers compensation amounts determined? A. The costs are calculated by actuaries of the vendor from whom SPS purchases the insurance. The actuaries presumably base the costs on company-specific historical loss data and payroll to determine exposure related to the policy period. Q. What amount of expense did SPS incur during the Test Year for third-partyinsured workers compensation benefits? A. SPS incurred $, on a total company basis for third-party-insured workers compensation benefits. Q. Is SPS proposing to update that amount to reflect the estimated costs from the Update Period? A. Yes. Replacing the third-party-insured workers compensation expense for the last three months of 0 with estimates of third-party-insured workers compensation expense for the last three months of 0 reduces the expense by $,. SPS will update this estimate with actuals in its -day Update. Q. Why did third-party-insured workers compensation expense decrease during the Update Period relative to the corresponding period from 0? A. The third-party-insured workers compensation expense decreased during the Update Period relative to the corresponding period from 0 because of forecasts of lower premiums in December 0. Q. Is SPS proposing to make any known and measurable changes to the thirdparty-insured workers compensation expense for events occurring after the end of the Update Period? A. Yes. SPS is proposing to increase the third-party-insured workers compensation expense by $, to account for increases in SPS s workers compensation insurance premiums. Schrubbe Direct Revenue Requirement Page 0 RR - Page of 0 0

41 0 C. Reasonableness of Workers Compensation Benefit Costs Q. Is it reasonable for the Test Year cost of service to include the self-insured and third-party-insured workers compensation costs incurred by SPS? A. Yes. It is appropriate for the Test Year cost of service to include these benefits because they reflect a reasonable and necessary level of expense. Xcel Energy s workers compensation plans and benefits are required for Xcel Energy and its subsidiaries to attract, retain, and motivate employees needed to perform the work necessary to provide quality services for SPS customers. Without these benefits, SPS and XES would have to pay significantly higher current compensation to attract employees. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

42 VII. OTHER BENEFIT COSTS 0 0 Q. Is SPS seeking recovery of any retirement benefits in addition to the ones discussed earlier? A. Yes. SPS is seeking recovery of 0(k) match costs and miscellaneous retirement-related costs. A. 0(k) Match Q. Please briefly describe SPS s 0(k) match plan. A. SPS s retirement income plan is based on a combination of a defined benefit pension plan and a 0(k) plan, which is a defined contribution plan. Unlike some defined benefit pension plans, SPS s defined benefit pension plan is not intended to provide an employee s total retirement income. Rather, the defined benefit pension plan and 0(k) plan are designed so that the two plans in combination provide retirement income to SPS and XES employees. Q. How are the 0(k) match costs determined? A. The 0(k) plan is a defined contribution plan to which employees must contribute in order to obtain employer matching. It is based on the amount that employees contribute as a percentage of their salary with a maximum match of %. For the majority of SPS s workforce, the employee must contribute % of eligible income for SPS to contribute the maximum company match of % of eligible income. The remaining employees, who are in the Traditional Plan, receive a maximum match of $,00. Q. What amount of expense did SPS incur during the Test Year for 0(k) match benefits? A. SPS incurred $,, on a total company basis for 0(k) benefits. Schrubbe Direct Revenue Requirement Page RR - Page 0 of 0 0

43 0 0 Q. Is SPS proposing to update that amount to reflect the estimated costs from the Update Period? A. No. Q. Is SPS proposing to make any known and measurable changes to the 0(k) expense for events occurring after the end of the Update Period? A. Yes. SPS is requesting a known and measurable adjustment of $, for 0(k) benefit expense. Because the 0(k) match is based on the amount that employees contribute as a percentage of their salary, escalation factors of % and % have been applied to non-bargaining and bargaining employees, respectively. For justification of the merit increase, please refer to Ms. Reed s direct testimony. B. Miscellaneous Retirement-Related Costs Q. What costs are included in miscellaneous retirement-related costs? A. This category includes costs such as 0(k) plan administration fees, compensation consulting and survey costs, retirement plan actuarial and audit fees, and a small amount for the deferred compensation plan. Q. What amount of expense did SPS incur during the Test Year for miscellaneous retirement-related costs? A. SPS incurred $, on a total company basis for miscellaneous retirementrelated costs. Q. Is SPS proposing to update that amount to reflect the estimated costs from the Update Period? A. Yes. Replacing the miscellaneous retirement-related costs for the last three months of 0 with estimates of miscellaneous retirement-related costs for the Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

44 0 0 last three months of 0 increases the expense by $0,. SPS will update this estimate with actuals in its -day Update. Q. Why did miscellaneous retirement-related costs increase during the Update Period relative to the corresponding period from 0? A. The miscellaneous retirement-related expense increased during the Update Period relative to the corresponding period from 0 primarily due to various changes in SPS s professional consulting fee costs. Q. Is SPS proposing to make any known and measurable changes to the miscellaneous retirement-related costs for events occurring after the end of the Update Period? A. No. C. Reasonableness of Other Benefit Costs Q. Is it reasonable for the Test Year cost of service to include the 0(k) match and miscellaneous retirement-related costs incurred by SPS? A. Yes. It is appropriate for the Test Year cost of service to include these benefits because they reflect a reasonable and necessary level of expense. Xcel Energy s compensation plans and benefits are required for Xcel Energy and its subsidiaries to attract, retain, and motivate employees needed to perform the work necessary to provide quality services for SPS customers. Without these benefits, SPS and XES would have to pay significantly higher current compensation to attract employees. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

45 VIII. PENSION AND OPEB RESERVE ACCOUNT 0 Q. Does SPS defer pension and OPEB expense amounts that are greater than or less than the levels of pension and OPEB amounts included in base rates? A. Yes. PURA.0(b) allows a utility to establish a reserve account to record the difference between the annual amount of pension and OPEB expense approved in the utility s last general rate case and the annual amount of pension and OPEB expense that the utility actually incurs. If the amount of pension and OPEB expense in the utility s approved rates is greater than the actual expense, the utility will have a surplus in its reserve account. If the amount of pension and OPEB expense in the utility s approved rates is less than the actual expense, the utility will have a shortage in its reserve account. Q How is the reserve account treated for ratemaking purposes? 0 A. PURA.0 states that if a reserve account for pension and OPEB expense is established, the Commission: at a subsequent general rate proceeding shall: () review the amounts recorded to the reserve account to determine whether the amounts are reasonable expenses; () determine whether the reserve account has a surplus or shortage under Subsection (c); and () subtract any surplus from or add any shortage to the electric utility s rate base with the surplus or shortage amortized over a reasonable time. Schrubbe Direct Revenue Requirement Page RR - Page of 0 00

46 Q. Did the Commission establish baselines for the pension and OPEB tracker in SPS s last rate case? A. Yes. In Docket No., the Commission set a baseline amount of $,0, for qualified pension expense and of $, for OPEB expense. Q. What is the total amount of pension and OPEB costs related to the tracker that SPS is requesting to recover in this case? A. As noted earlier in my testimony, SPS is requesting recovery of $,, of deferred pension and OPEB benefits for the Texas retail jurisdiction. That amount is the net of two balances: 0 The first amount represents the unamortized balance of the pension and OPEB amounts deferred through August, 0, which is $,,00. That amount reflects accruals in excess of the agreed upon baselines set in Docket Nos., 0 and 00. The second amount represents the total deferrals for January through December of 0, which total $(,0). 0 Mr. Freitas has reflected the $,, of net deferred pension and OPEB expense in the cost of service study he presents. The deferred amounts appear under FERC Account 0. Q. How did SPS calculate the unamortized balance of the pension and OPEB amounts deferred from prior cases? A. SPS calculated the unamortized balance of pension and OPEB amounts deferred from prior cases by the following steps: In the Docket No. Order, the Commission concluded that SPS s request to recover $,,0 of deferred pension and OPEB balances was reasonable, and the Commission authorized SPS to recover that amount Docket No., Application of Southwestern Public Service Company for Authority to Change Rates, Order at, Finding of Fact Nos. and. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

47 over months, 0 which yields a monthly amount of $, (($,,0 / = $,). Under PURA., the rates set in this docket are to become effective days after filing, which will be on or about July 0, 0. As a result, approximately ten months worth of amortized costs will remain unrecovered when the rates set in this case become effective. Multiplying 0. months by $, per month equals an unamortized balance of $,,00. The calculation appears on my Attachment RRS-RR-. 0 Q. How did SPS calculate the unamortized balance of the pension and OPEB amounts deferred from prior cases? A. In Docket No., SPS calculated the difference between the pension and OPEB baselines and the actuarially determined pension and OPEB costs through the end of calendar year 0. Therefore, the comparison in this case of the baseline amounts to the actuarially determined amounts is limited to calendar year 0. SPS calculated that 0 amount by the following steps: 0 0 As noted earlier, the rates established in Docket No. became effective on June, 0. Thus, after that date, the baselines established in Docket No. were compared to the actuarially determined pension expense. From January, 0 through June 0, 0, the baselines established in SPS s prior rate case, Docket No. 00, were in effect. Because of the two different baselines, it was necessary to calculate the differences between the baselines and the actuarially determined expense on a monthly basis. During the period from June, 0 to December, 0, the actuarially determined pension expense was $, per month higher than the baseline established in Docket No.. During the period from January, 0 to June 0, 0, the actuarially determined expense was $, per month lower than the Docket No. 00 baseline. The combination of those amounts leads to an overall balance of $(,0) for 0. 0 Docket No., Order at, Finding of Fact Nos Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

48 Q. What is the total of the deferral amounts that SPS is asking to recover? A. The table below shows the unamortized amounts for prior periods and the amount for 0: Table RRS-RR- Pension and OPEB Deferrals Pension and OPEB expense deferred from prior cases $,,00 Pension and OPEB expense deferred in 0 $(,0) Total Net Pension and OPEB Deferrals $,, 0 Q. How does SPS propose to treat the amount in the reserve account? A. SPS proposes to amortize the accrued amount over a two-year period and to recover the full amount. I have supplied the accrued balance shortage amount to Mr. Freitas, and he has reflected it in the cost of service calculation. Q. Are the amounts of pension and OPEB expense recorded in the reserve account reasonable? A. Yes. The pension and OPEB expense amounts are reasonable for the reasons discussed earlier in connection with the forward-looking pension and OPEB expense. SPS s pension plans are administered prudently and in accordance with GAAP, and the amounts contributed are consistent with the actuarial projections that are based on third-party projections and assumptions. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

49 IX. SPS S PREPAID PENSION ASSET Q. What topic do you discuss in this section of your testimony? A. I describe SPS s prepaid pension asset and explain that it should be included in rate base. Q. Did the Commission address this issue in Docket No.? A. Yes, this was a contested issue in Docket No.. In the Docket No. order, the Commission allowed SPS to include its prepaid pension asset in rate base. Thus, I am recommending the same ratemaking treatment in this case that 0 the Commission approved in Docket No.. The Commission accurately noted in that case that [i]nvestment income on the prepaid pension asset reduces qualified pension costs calculated under FAS, which benefits customers by reducing the amount of pension costs included in base rates. The Commission also allowed the utilities to include their prepaid pension assets in rate base in Docket Nos. 0,, and 0, among other cases. Q. What is a prepaid pension asset? A. A prepaid pension asset represents the difference between: () the cumulative actuarially determined net periodic pension cost calculated in accordance with Docket No., Order at, Finding of Fact No. ( The prepaid pension asset is appropriately included in rate base because it represents a prepayment by SPS. ). Docket No., Order at, Finding of Fact No.. Application of Southwestern Electric Power Company for Authority to Change Rates and Reconcile Fuel Costs, Docket No. 0, Order on Rehearing at, Finding of Fact Nos. - (Mar., 0). Application of Entergy Texas, Inc. for Authority to Change Rates, Reconcile Fuel Costs, and Obtain Deferred Accounting Treatment, Docket No., Order on Rehearing at, Finding of Fact Nos. -A (Nov., 0). Application of AEP Texas Central Company for Authority to Change Rates, Docket No. 0, Order on Rehearing at (Mar., 00). Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

50 FAS ; and () the cumulative cash amounts contributed to the pension trust fund. Q. Please provide an example of how the difference arises. A. Suppose that the pension plan has been in existence for five years, and that the cash contribution to the pension trust for each of five years has been $00 million, whereas the pension cost calculated in accordance with FAS has been $0 million in each of those five years. Table RRS-RR- shows how the excess of cash contributions each year creates a cumulative prepaid pension asset: Table RRS-RR- (amounts in millions) Year Pension Contribution Pension Cost Cumulative Prepaid Pension Asset $00 $0 $0 $00 $0 $0 $00 $0 $0 $00 $0 $0 $00 $0 $0 Total $00 $0 $0 0 At the end of the five year period, the utility has cumulative cash contributions of $00 million and cumulative pension cost of $0 million, which produces a prepaid pension asset of $0 million, as shown in Figure RRS-RR- (on the next page): Schrubbe Direct Revenue Requirement Page 0 RR - Page of 0 0

51 Figure RRS-RR- Q. Why are the contributions and cost different in any given year? A. As I explained earlier in my discussion of qualified pension expense, the cost calculation is governed FAS, but the contributions are driven by federal law requirements under ERISA, the IRC, and the Pension Protection Act. Although the cost and contribution calculations both use accrual methodologies, the assumptions, attribution methods, and periods of time over which the costs are required to be recognized are different and thus can often result in different annual amounts. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

52 0 0 Q. Can the utility withdraw the prepaid pension asset and use it to fund capital requirements or to pay for O&M expense? A. No. Federal law prohibits the withdrawal of any amounts from the pension trust fund except for the payment of benefits and plan expenses. After the contributions are made, they are essentially locked away. Q. Does SPS currently have a prepaid pension asset? A. Yes. The thirteen-month average of the prepaid pension asset balance as of December, 0 is $,, on a total company basis. Q. Is SPS seeking to include that prepaid pension asset in rate base? A. Yes. SPS is requesting Commission approval to include the Texas retail jurisdictional share of the prepaid pension asset in rate base and to earn a return on that portion of the rate base at the weighted average cost of capital ( WACC ) that SPS has proposed in this case, which is.%. Q. Do you recommend that the Commission include the prepaid pension asset in rate base? A. Yes. The standard ratemaking practice is for prepayments to earn a return at the utility s WACC. For example, Texas retail customers effectively earn a return on the Accumulated Deferred Income Tax ( ADIT ) balance included in the cost of service at SPS s WACC because that ADIT balance is removed from rate base, meaning customers are not paying a return on the portion of rate base equal to the ADIT balance. Moreover, it is reasonable and equitable to include the prepaid pension asset in rate base and for SPS to earn a return on it because customers are also earning a return on the prepaid pension asset. Schrubbe Direct Revenue Requirement Page RR - Page 0 of 0 0

53 0 Q. Please explain what you mean when you state that customers are also earning a return on the prepaid pension asset. A. As I explained in a prior section of my testimony, one of the components of the annual pension cost calculation is the return that the pension trusts are expected to earn on the assets in the trust. Suppose, for example, that a pension trust has assets of $00 million and is expected to earn a return of % in the current year. Under those assumptions, $ million would be included in the annual pension cost calculation as the EROA. As I explained in a prior section, the EROA is subtracted from the service cost and other elements of the annual pension cost. Therefore, in this example, the return on the pension trusts would reduce annual pension cost by $ million. Q. Does the pension trust fund balance that is multiplied by the EROA include the prepaid pension asset? A. Yes. As shown in Figure RRS-RR- (on the next page), customers receive the benefit of the earnings on the entire amount of assets in the pension trust, not just the amount that has been recognized in annual pension cost. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

54 Figure RRS-RR- 0 That means all of the assets in the pension trust, including the assets that comprise the prepaid pension asset, are used and useful to SPS s Texas retail customers. Q. Does the fact that customers are receiving a return on the prepaid pension asset portion of the trust funds justify including the prepaid pension asset in rate base and allowing SPS to earn a return on it? A. Yes. As demonstrated in Figure RRS-RR- (on the next page), including the prepaid pension asset in rate base provides a return to the utility, and that return offsets the reduction in the revenue requirement that results from the earnings on the prepaid pension asset included in the annual pension cost. With an exception I will discuss below, the return on the prepaid pension asset portion of rate base is The amounts in this figure are just examples to show that customers earn a return on the entire amount in the pension trust fund, including the prepaid pension asset. The actual prepaid pension asset on which SPS s customers earn a return is larger than $0 million. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

55 simply the mirror image of the return that customers receive as a result of earnings on the prepaid pension asset. Figure RRS-RR- Thus, if customers receive the benefit of the earnings on the prepaid pension asset, it is appropriate for SPS to receive a return on the prepaid pension asset portion of rate base. Conversely, if SPS does not receive a return on the prepaid pension asset portion of rate base, customers should not receive the benefit of the earnings on the prepaid pension asset. Schrubbe Direct Revenue Requirement Page RR - Page of 0 00

56 Q. How much are SPS s customers saving in annual pension cost as a result of the prepaid pension asset? A. As Table RRS-RR- shows, SPS s customers are saving $,, million per year in annual pension cost as a result of the prepaid pension asset. Table RRS-RR- Pension Plan NCE Non- Bargaining SPS Bargaining Date Prepaid Pension Asset -Month Average EROA Cost Reduction from Prepaid Pension Asset //0 to //0 $0,0,.0% $,, //0 to //0 $,0,.% $,0, Total $,, $,, 0 Q. Please explain SPS s request regarding its prepaid pension asset. A. SPS is requesting that the Test Year qualified prepaid pension asset of $,, (total company) be included in rate base to provide a corresponding return to shareholders. Otherwise, the qualified prepaid pension asset is solely generating a return for customers through lower pension expense. The prepaid pension asset represents assets that are delivering a direct benefit to customers because the investment income on those assets lowers the pension expense under FAS. It is therefore appropriate to include the prepaid pension asset in rate base. The calculation to support the prepaid pension asset thirteen-month average can be found in my Attachment RRS-RR-, and the cumulative qualified prepaid pension asset balance since the adoption of FAS can be found in my Attachment RRS-RR-. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

57 0 0 Q. If SPS had an unfunded accrued pension cost instead of a prepaid pension asset, would you be recommending that amount be subtracted from rate base? A. Yes. In fact, that is the situation with SPS s FAS 0 and FAS balances, which are underfunded. SPS has reduced its rate base to reflect the unfunded liabilities. Q. Is SPS s requested WACC on the prepaid pension asset in this case higher than the EROA on the prepaid pension asset? A. Yes. In this case, SPS s requested WACC is.%, and the weighted average of the EROA for the SPS Bargaining Plan and the New Century Energies ( NCE ) Non-Bargaining Plan forecasted for 0 is.%. Q. Why should SPS be allowed a return on the prepaid pension asset based on the WACC if the ratepayers are only receiving a reduction in cost based on the lower EROA on the prepaid pension asset? A. There are two reasons. First, although the simplified example in Figure RRS-RR- shows an equivalent prepaid pension asset balance on which customers and the utility are earning a return, the amounts are not equal insofar as SPS is concerned. SPS s annual pension cost includes costs for three different pension plans the SPS Bargaining Plan, the New Century Energies ( NCE ) Non-Bargaining Plan, and the XES Plan. All three of those plans have prepaid pension assets, and NCE refers to New Century Energies, Inc., which merged with Northern States Power Company in 000 to create Xcel Energy. The EROA for the SPS Bargaining Plan is.%, and the EROA for the NCE Non-Bargaining Plan is.%. The weighted average of those amounts is.%. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

58 customers earn a return on all three plans. However, SPS does not include the XES Plan portion of the prepaid pension asset in rate base. Therefore, SPS s customers are receiving a return on the XES Plan portion of the prepaid pension asset, but they do not pay a return on that asset. To reflect SPS s actual circumstances, it is necessary to modify the figure as reflected in Figure RRS-RR- to show the actual amount on which SPS earns a return as part of rate base: Figure RRS-RR- 0 As this figure shows, customers earn a return on a larger prepaid pension asset balance than SPS does. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

59 0 0 Q. What was SPS s portion of the XES Plan prepaid pension asset as of December, 0? A. SPS s portion of the XES Plan prepaid pension asset was approximately $. million as of the end of 0. With an EROA of.0% for the XES Plan, SPS ratepayers received $0. million (total company) of return on an asset on which they pay no return ($. million x.0 = $0. million). Q. Please describe the other reason that the prepaid pension asset results in a net benefit to customers. A. As previously described, contributions in excess of the annual pension costs result in a prepaid pension asset. These additional contributions allow SPS to avoid incurring additional Pension Benefit Guaranty Corporation ( PBGC ) premiums that would otherwise be included within the annual pension cost charged to customers. Q. Please explain what the PBGC is. A. The PBGC is a federal agency established by Congress as part of ERISA to insure pension benefits under private sector defined benefit pension plans. If a pension plan is terminated without sufficient money to pay all benefits, PBGC s insurance program will pay employees the benefits promised under the pension plan, up to the limits set by law. The funding for the PBGC comes partly from premiums charged to pension sponsors and partly from returns on assets held by the PBGC. Q. What types of premiums does the PBGC charge? A. The PBGC charges two types of premiums: () a per capita premium that is charged to all single-employer defined benefit plans; and () a variable-rate Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

60 0 premium charged to underfunded plans. The amounts of the premiums are set by Congress and must be paid by sponsors of defined benefit plans, such as SPS. Q. Are the variable-rate premiums applicable to underfunded plans increasing? A. Yes. For 0, the variable-rate premium for a single employer plan such as that of SPS was $ per $,000 of unfunded vested benefit. For 0 Congress has set the variable-rate premium at $ per $,000 of unfunded vested benefits. Q. Are SPS s pension plans currently underfunded? A. Yes. And absent the prepaid pension asset, the plan would be further underfunded. Q. How much would the pension plans be underfunded in the absence of the prepaid pension asset? A. In the absence of the prepaid pension asset, the three pension plans would have been further underfunded by approximately $0. million as of the end of 0. 0 Q. By how much would the PBGC premiums increase in the absence of the prepaid pension asset? A. The PBGC premiums would be $. million higher in 0 on a total company basis without the prepaid pension asset, as shown in Table RRS-RR-. A plan can be underfunded at the same time it has a prepaid pension asset, because they measure different things. As I testified earlier, the prepaid pension asset is the amount by which cumulative cash contributions exceed cumulative recognized pension expense. A pension plan is underfunded when its pension benefit obligations exceed the value of its assets. 0 The $0. million is the prepaid pension asset balance as of December, 0. The $. million prepaid pension asset that SPS is seeking to include in rate base is a -month average and does not include the XES prepaid pension asset. Schrubbe Direct Revenue Requirement Page 0 RR - Page of 0 0

61 Table RRS-RR- Increase in 0 PBGC Premiums without Prepaid Pension Asset (total company) Benefit Plan SPS Bargaining Plan NCE Non- Bargaining Plan Xcel Energy Services Pension Plan Prepaid Pension Asset as of //0 (millions) Variable Rate per $,000 of Unfunded Vested Benefit PBGC Premiums Due (millions) $0,, $ $,, $,,00 $ $,0 $,, $ $,0 Total $0,0, $ $,,0 0 Q. Are PBGC premiums included in the annual pension cost? A. Yes. PBGC premiums are included in the annual pension cost calculation. Therefore, SPS s customers saved approximately $. million (total company) in 0 as a result of the prepaid pension asset, and they will save even more during the time the rates set in this case are in effect because the PBGC premiums will be $ per $,000 of unfunded vested benefit in 0, instead of $ per $,000 of unfunded vested benefit. Q. In light of the asymmetrical return on the XES Plan prepaid pension asset and the avoidance of PBGC premiums, what conclusion do you draw about the prepaid pension asset? A. I conclude that the prepaid pension asset confers a net benefit to SPS s Texas retail customers, even when SPS is allowed to earn a return on the prepaid pension asset at its WACC. Customers receive the benefit of approximately $ million (total company) of return on the XES Plan asset, even though they pay no Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

62 0 0 return on that asset. Moreover, customers receive an effective rate reduction of $. million (total company) through the avoidance of incremental PBGC premiums. Thus, customers are better off as a result of the prepaid pension asset. Q. Does SPS s prepaid pension asset include any pension cost capitalized to Construction Work in Progress ( CWIP )? A. No. By definition, the prepaid pension asset consists of amounts that are in excess of the actuarially determined pension cost for a given year. Suppose, for example, that the pension trust fund asset value increases by $ million in a given year, but the actuarially determined pension cost for that year is only $ million. Some part of the $ million will be capitalized and assigned to CWIP, but none of the $ million will be included in the prepaid pension asset. Only the $0 million in excess of the $ million will be included in the prepaid pension asset, and none of that $0 million is capitalized and assigned to CWIP. Therefore, none of SPS s prepaid pension asset reflects costs that have been capitalized and assigned to CWIP. Q. Thus far you have been discussing the justification of including the prepaid pension asset in rate base. Is including the prepaid pension asset in rate base the only way of dealing with the prepaid pension asset issue? A. No. Another solution would be to exclude the earnings on the assets represented by the prepaid pension asset from the calculation of annual pension cost for regulatory purposes. The basic point is that customers should not be earning a That is true even after the gross-up for taxes. Schrubbe Direct Revenue Requirement Page RR - Page 0 of 0 0

63 return on the prepaid pension asset without providing a corresponding return. It would be inequitable to deny SPS a return on the prepaid pension asset while providing to customers all the benefits arising from the existence of this asset. The entire prepaid pension asset produces investment income to offset pension expenses, regardless of when the amounts were contributed or realized. Thus, if the prepaid pension asset is excluded from rate base, the earnings on the prepaid pension asset should be excluded from the calculation of annual pension cost, as depicted on Figure RRS-RR-: Figure RRS-RR- The ADIT, FAS 0, and FAS balances would have to be adjusted as well. Again, these numbers are merely illustrative, but they demonstrate that customers are worse off if the prepaid pension asset is excluded from the calculation of annual pension cost. In the example in Figure RRS-RR-, customers get credit for $ million in earnings, whereas without the $0 million prepaid pension asset, they get credit for only $. million in earnings. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

64 0 Q. Do you recommend that the Commission exclude the return on the prepaid pension asset from rate base and from the calculation of annual pension cost? A. No. As I explained earlier, SPS s customers are actually better off as a result of the prepaid pension asset because they receive a return on the XES prepaid pension asset but do not pay a return on it. In addition, the customers receive a benefit from the avoidance of incremental PBGC premiums as a result of the prepaid pension asset. When all of those factors are considered, SPS s customers are better off if the prepaid pension asset is included in both rate base and the calculation of annual pension cost, even after the return on the prepaid pension asset is grossed up for taxes. Q. How would it affect SPS s annual pension cost if the earnings on the pension trust assets were excluded from the cost of service? A. SPS s annual pension cost would increase by $. million (total company) if the earnings on the pension trust assets were excluded from the cost of service. Because pension costs are passed through to customers on a dollar-for-dollar basis, SPS s revenue requirement would increase by the same amount. Schrubbe Direct Revenue Requirement Page RR - Page of 0 0

65 0 X. PENSION AND BENEFIT COST TRENDS Q. What topic do you discuss in this section of your testimony? A. In this section of my testimony, I discuss the trend of pension and benefit costs over the five-year period from 00 through 0. Q. How does your testimony on pension and benefit cost trends relate to other SPS testimony? A. My testimony on trends for pension and benefit-related costs relates to the testimony of Richard Starkweather, who discusses the compound annual growth rate ( CAGR ) of SPS s O&M expense in recent years. I explain that, although it initially appears that SPS s pension and benefit-related O&M costs may have grown at a faster rate than similar costs of other utilities, the raw numbers are potentially misleading because they do not necessarily account for factors such as: the effect that the statutory deferred pension and OPEB tracker has on the pension and benefit expense reported by SPS under GAAP; the differences in the gain and loss amortization methods used by utilities in the study; the baseline from which growth is measured; the differences in the amounts of pension contributions made each year by the utilities in the study; 0 changes in headcounts over the five-year period from 00 to 0; and inclusion in FERC Account of costs that SPS does not request in its cost of service. Schrubbe Direct Revenue Requirement Page RR - Page of 0 000

66 0 0 Q. What were the pension and benefit-related cost amounts over the period from 00 to 0? A. My Attachment RRS-RR- presents the total company pension and benefit amounts for FERC Account over the five-year period from 00-0 based on SPS s accounting records. Q. According to Attachment RRS-RR-, SPS s overall FERC Account balance steadily increased during that five-year period. Does that show that SPS s costs are increasing year-over-year? A. No. Although the overall amount appears to be increasing year-over-year, that is only because of the effect of the pension and OPEB deferral balances, which made the overall total appear smaller than it actually was during the period from 0-0 and larger than it actually was in 0. A more accurate picture of the cost trends appears when one looks at the individual components of cost, such as the qualified pension cost. Attachment RRS-RR- shows that qualified pension cost declined by more than $ million from 0 to 0. Q. Attachment RRS-R-, however, also shows steady increases in qualified pension expense from 00 to 0. Does that indicate SPS was failing to control pension costs during that time? A. No. The increases from 00 to 0 occurred because SPS was phasing in the market losses from 00. Like nearly all utilities with defined benefit qualified pension plans, SPS experienced significant asset losses when the equities markets fell precipitously during the 00 market crisis. SPS phased in those market losses over the five-year period from 00-0 in accordance with FAS. Schrubbe Direct Revenue Requirement Page RR - Page of 0 00

67 In addition, the Federal Reserve undertook a sustained effort to bolster the United States economy in the wake of the 00 market crisis by reducing interest rates. That in turn lowered the discount rate used to measure the present value of benefit obligations, which caused SPS and other utilities to suffer significant liability losses during the period from reflected in pension costs as well. Those losses had to be 0 0 Q. Weren t other companies with defined benefit pension plans also phasing in the 00 market losses during that time? A. That is not necessarily correct. Companies can elect to phase in and amortize losses over different time periods. At the time SPS elected to be governed by FAS, it chose the longest available phase-in period, which is five years. Other companies, however, may have chosen shorter periods. In fact, some companies may have elected to recognize all of their losses at once, and any company that made such a choice would have recognized its entire 00 market loss in 00, which was before the time period included in Mr. Starkweather s study. In that instance, the company s losses would not show up at all in the CAGR analysis Mr. Starkweather performed, whereas SPS s pension expense increased steadily over the period from 00 to 0 because of the phase-in of the 00 market losses. That lack of uniformity in loss recognition periods makes it difficult to perform an apples-to-apples comparison of qualified pension expense among utilities. As I explained earlier, the higher the discount rate, the lower the present value of future benefits. Conversely, the lower the discount rate, the higher the present value of future benefits. Thus, reducing the discount rate had the effect of making the present value of SPS s future benefit obligations larger. Schrubbe Direct Revenue Requirement Page RR - Page of 0 00

68 0 0 Q. Are there any other potential differences among utilities that can make simple comparisons of year-over-year pension cost increases misleading? A. Yes. There are several additional factors that make comparisons difficult, such as the baseline from which the comparison began, the company s contribution strategy, and changes in headcounts. Q. Please explain what you mean when you refer to the baseline from which the comparison began. A. For many years leading up to 00, SPS had negative qualified pension expense. The pension expense became positive only when SPS began phasing in the 00 asset losses and recovering the liability losses during the period from Q. Why does it matter whether SPS began the measurement period from a very low starting point? A. It is axiomatic that an amount appears larger from a percentage perspective when the baseline from which it is measured is a smaller number. For example, a $ million qualified pension expense increase, which is approximately what SPS had from 00 to 0, is a far greater percentage increase when the starting point is $ million than it would be if the starting point were, say, $ million. I have not analyzed the starting points for the qualified pension expense amounts for the other utilities in Mr. Starkweather s study, but is unlikely that all of them started the measurement period with baselines as low as SPS s baseline was. As I explained earlier, negative pension expense occurs when the EROA and prior-period gain components are larger than the combination of the service cost, interest cost, and prior unrecognized service cost. Schrubbe Direct Revenue Requirement Page RR - Page of 0 00

69 0 Q. You also indicated that a company s contribution strategy can influence the growth trends. Please explain what you mean by that. A. Pension contributions decrease pension expense by increasing the asset base that is multiplied by the EROA. For example, suppose a company made a $00 million pension contribution in 00 and it had an EROA of %. That would cause its 0 pension expense to decrease by $ million ($00 x %). I have not evaluated the contribution strategies of the utilities in Mr. Starkweather s study, but some of them may have made large contributions to their pension trust funds in the wake of the 00 market losses. Q. Did SPS make large contributions to its pension plan during the period from 00 to 0? A. No. SPS chose not to make significant pension contributions during that time, in part because that would have increased the prepaid pension asset. SPS instead decided to focus on sustaining the plan s funded status through a balanced approach to diversification within the investment portfolio. SPS sought to 0 achieve dual objectives of growth and protection from sustained low interest rates, and a long-term, stabilized contribution forecast. The combination of portfolio allocation and moderate contributions was considered the best overall approach to restoring the funded status of the plan through a period of continued expected volatility in financial markets. Funded status compares a pension fund s asset balance to its liability. If a plan s asset balance is larger than the liability, a plan is considered overfunded. A pension plan is considered underfunded when its liability exceeds the value of its assets. Schrubbe Direct Revenue Requirement Page RR - Page of 0 00

70 Q. What were SPS s pension contributions from 00 to 0? A. Table RRS-RR- shows the SPS pension contributions from 00 to 0. Table RRS-RR- SPS Pension Contributions ($ in Thousands) $0 $, $0 $, $,00 $,0 $, 0 0 It is unclear whether the other utilities had a contribution strategy similar to that of SPS and whether these potentially differing contribution strategies affected the FERC Account costs within Mr. Starkweather s CAGR comparison. Q. You testified earlier that changes in headcount may also make it difficult to compare pension costs. Did SPS headcount increase from 00 to 0? A. Yes. The headcount increased by over 00 employees from 00 to 0. That increase affects a number of the FERC Account balances, such as the 0(k) match, active health care, and qualified pension expense. It is unclear whether the other utilities in Mr. Starkweather s analysis experienced the same type of increase. Q. Are there any other factors that make it difficult to conduct a comparison of FERC Account balances among utilities? A. Yes. There are numerous other factors that would have to be taken into account to develop a meaningful comparison among utilities. For example, the average age of the utility s employees has a bearing on the FERC Account expense. Moreover, just because an expense is recorded in FERC Account does not mean that customers will pay that expense. SPS, for example, is not asking for Schrubbe Direct Revenue Requirement Page 0 RR - Page of 0 00

71 0 recovery of FAS expense or non-qualified pension expense in this case. Those two items alone totaled nearly $ million in 0, but they have no bearing on the FERC Account costs charged to customers. Thus, from a customer s perspective, it is irrelevant whether those costs are increasing or decreasing. A simple comparison of FERC Account costs does not recognize the distinction between costs that are included in the cost of service and those that are not. Q. Do you have an overall opinion regarding the reasonableness of SPS s yearover-year growth trends for FERC Account expense? A. Yes. I conclude that, when all of the relevant factors are considered, SPS s growth trends for FERC Account expense are reasonable and likely commensurate with those of other utilities. Moreover, my Attachment RRS-RR- show that SPS s overall costs are declining after the effect of the pension and OPEB deferral is removed. SPS s customers benefit from those declining costs. Q. Does this conclude your pre-filed direct testimony? A. Yes. FAS requires the sponsor of a defined benefit plan to recognize amounts resulting from an irrevocable action that relieves the employer or the plan of primary responsibility for an obligation and eliminates significant risk related to the obligation and the assets used to effect a settlement. Schrubbe Direct Revenue Requirement Page RR - Page of 0 00

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73 Attachment RRS-RR- Page of Docket No. Southwestern Public Service Company Calculation of Pension, OPEB, Non-Qualified Pension, FAS Long-Term Disability and Workers Compensation Costs Months Ended December, 0 Total Cost Amounts from Actuarial Reports SPS-NCE SPS-Barg $ FAS LONG-TERM QUALIFIED PENSION OPEB RETIREE MEDICAL DISABILITY FAS WORK COMP ,0,000 SPS Total $ (,000) $,000 $ - $,0,000,0,000 Xcel Service $,,000 $,,000 $,000 $ - () () () () Calculation of Total Cost Amounts to Cost of Service Amounts SPS QUALIFIED PENSION SPS-NCE Total Cost $,0,000 SPS-Barg Total Cost,0,000 OPEB RETIREE MEDICAL TOTAL PENSION & OPEB RETIREE MEDICAL FAS LONG- TERM DISABILITY FAS WORK COMP TOTAL FAS LTD & FAS WORK COMP Total SPS $,0,000 $ (,000) $,,000 $,000 $ - $,000 Percent to SPS O&M FERC.0%.0%.0%.% Amount to SPS O&M FERC $,, $ (0,) $,, $, $ - $, Xcel Service Xcel Service Total Cost $,,000 $,,000 $ 0,,000 $,000 $ - $,000 Percent to SPS O&M FERC.0%.%.0%.%.% Amount to SPS O&M FERC $,, $, $,,0 $, $ - $, Affiliate Charges/misc $, $ (,) $,0 $ $ - $ Total Amount to SPS O&M FERC $,0, $ (0,) $,,0 $,00 $ - $,00 ) Attachment RRS-RR-, Exhibit I Page of ) Attachment RRS-RR-, Exhibit III Page of ) Attachment RRS-RR-, Exhibit VI RR - Page 0 of 0 00

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