Before the Public Utilities Commission of The State of Minnesota

Transcription

1 Rebuttal Testimony Mr. George C. Sanger Before the Public Utilities Commission of The State of Minnesota In the Matter of the Application of CenterPoint Energy Resources Corp., d/b/a CenterPoint Energy Minnesota Gas For Authority to Increase Rates for Natural Gas Utility Service in Minnesota Docket No. G-008/GR Exhibit (GCS-R) Pension Assumptions December 23, 2013

2 MR. GEORGE C. SANGER Docket No. G-008/GR TABLE OF CONTENTS Page I. Introduction... 1 II. Background... 2 III. Pension Assumption Requirements... 4 IV. Appropriate Assumptions for the Company... 7

3 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR I. INTRODUCTION Q. Please state your name, business address, and current relationship with CenterPoint Energy. A. My name is George C. Sanger. My business address is 9500 Lakeside Boulevard, The Woodlands, Texas I am an Associate Partner in the Retirement Consulting practice with Aon Hewitt, a global leader in human capital consulting and outsourcing solutions. Aon Hewitt provides actuarial services for CenterPoint Energy ( Company ) and the CenterPoint Energy Retirement Plan ( Plan ). I am the lead actuary for the plan Q. Please briefly describe your education and business experience. A. I have been employed continuously by Aon Hewitt since 1997, first by Hewitt Associates from 1997 until a merger with Aon in 20 and thereafter by the merged entity, Aon Hewitt. I have provided actuarial services for that entire period including retirement actuarial valuations and design consulting. I joined the CenterPoint Energy account in 1998 and became the lead actuary for the account in Over my tenure at Aon Hewitt, I have also provided actuarial services for additional utilities in Texas and Oregon. I received a Bachelor s of Science degree in mathematics with an actuarial science concentration from the University of Texas at Austin. I am a Fellow of the Society of Actuaries and an Enrolled Actuary for the Joint Board for the Enrollment of Actuaries Q. Please describe your duties as they relate to the scope of this rebuttal. 1

4 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR A. Among my duties as an actuary is to provide CenterPoint Energy with data and analyses that support the company s selection of actuarial assumptions for employer accounting under Accounting Standards Codification Topic 715 ( ASC 715 ) and funding requirements under the Employee Retirement Income Security 5 Act ( ERISA ), as amended. 1 I also certify the results of those actuarial 6 7 valuations based on those assumptions, current participant data, and current plan provisions as often as is required by ASC 715 and ERISA Q. What is the purpose of your testimony? A. The purpose of my testimony is to describe and support the actuarial assumptions and methods employed by the company in determining pension costs for the Plan during the test period. More specifically, I describe and support the 7.25% Long-Term Rate of Return and the 4.75% Discount Rate used in the determination of ASC 715 pension expense used for the test year pension cost II. Q BACKGROUND Please describe what a Long-Term Rate of Return is and why it is important A. The Expected Long-Term Rate of Return is an assumption as to the rate of return on plan assets reflecting the average rate of earnings expected on the funds invested to provide for the plan s benefits. This assumption is used to 1 Prior to 20, employer accounting for pensions in the United States was primarily governed by Financial Accounting Standards Board Statement number 87 ( FAS 87 ). This statement has since been incorporated into ASC 715 under revised codification that generally became effective in 20. 2

5 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR calculate the expected dollar earnings for the pension assets during the year, which offsets the other components of pension expense under ASC Q. Please describe what a Discount Rate is and why it is important. A. A Discount Rate is an interest rate used to adjust for the time value of money. A benefit payable by the plan in the future may be, in theory, provided by an asset today, which will grow with interest to provide that benefit. The discount rate is that interest rate associated with that asset. The asset needed today is smaller than the ultimate benefit payable because the asset will provide interest to further pay for the benefit in the future. Hence, the benefit is discounted to today for interest. Different types of assets, such as government bonds, corporate bonds, and stock investments will have different interest rate assumptions. ASC 715 and pension funding law dictate what type of assets, and therefore what discount rates, the actuary must assume would be used to provide for the future benefits of the plan. These required discount rates are distinct from the plan s current Expected Long-Term Rate of Return on Assets The discount rate is a key assumption in determining pension expense and minimum funding requirements as both are directly related to the present value of pension benefits using the discount rate Q. If assumptions and methods that differ from those permitted by US GAAP and federal law were used for ratemaking purposes, what would be the effect? 3

6 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR A. Using assumptions and methods that are different from U.S. GAAP, as well as inconsistent with minimum funding requirements under ERISA, will cause an incongruity between ratemaking and GAAP expense. The Company s expense and contribution requirements will not change. However, the rates will no longer cover those expense and contribution requirements. 6 7 III. PENSION ASSUMPTION REQUIREMENTS Q. Please briefly describe what ASC 715 requires as it relates to the Discount Rate assumption. A. ASC 715 requires future pension obligations to be discounted with interest to the current measurement date using rates at which pension benefits could be settled. For this purpose, it is appropriate to look to available information about rates implicit in current prices of annuity contracts that could be used to effect settlement of the obligation, or employers may also look to rates of return on high quality fixed income investments currently available and expected to be available during the period to maturity of the pension benefits. [ASC ] Q. Do employers typically look to rates implied by annuity contracts or to rates of return on high quality fixed income investments? A. Companies use rates of return on high quality fixed income investments because they are generally higher than the rates of return implied by annuity contracts. This results in a lower company expense. Since high quality fixed income rates 4

7 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR have become the de facto basis for ASC 715 discount rate setting, using annuity rates may indeed be considered contrary to financial comparability by company auditors and other financial users Q. Does the Securities and Exchange Commission ( SEC ) provide any guidance on this issue? A. Yes. In 1993, the SEC clarified that high-quality fixed income investments are those classified in one of the two top-most bond ratings by a recognized rating agency, such as S&P or Moody s Q. What discount rate does federal law require for minimum annual cash funding requirements? A. ERISA, as amended by the Pension Protection Act of 2006 ( PPA ), generally requires pension obligations to be discounted using high-quality corporate bond yields Q. Please briefly describe what ASC 715 requires relating to Expected Long-Term Rate of Return assumptions. A. The expected long-term rate of return on plan assets reflects the average rate of earnings expected on the funds invested to provide for the benefits included in the projected benefit obligation. [ASC ] The expected return on assets during the current year based on the current plan asset mix provides a credit to pension expense. 5

8 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR Q. Why do the Discount Rate and Long-Term Rate of Return differ under U.S. GAAP? A. U.S. GAAP, as well as pension funding requirements codified by Congress in 2006 in the Pension Protection Act ( PPA ) no longer recognize long-term asset return assumptions to be appropriate for discounting pension obligations. Instead, these two distinct figures must be determined as I have described above Q. What is the most important actuarial objective when determining the appropriate Discount and Long-Term Rates of Return? A. The most important actuarial objective after the promulgation of ASC 715 and the PPA is the security of pension benefits already earned by plan participants. Pension benefits are at risk if a financial sponsor encounters sudden duress. Pension plans have become significant obligations in relation to other corporate debt items on company balance sheets and more and more companies are voluntarily searching for ways to settle some or all of their pension obligations in order to reduce prospective risk to the company due to the significant interest and asset volatility seen in recent years. Other companies, including CenterPoint Energy, are moving pension asset allocations away from equities such as stocks, to fixed income securities such as bonds so that assets will better match pension obligations, thereby reducing risk to both the company and participants. Longterm asset return assumptions based on the current plan asset mix are no longer considered appropriate for discounting pension benefits by the accounting and 6

9 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR actuarial professions, as well as Congress. Instead, discount rates are required to be closer to settlement rates in order to satisfy this objective. 3 4 IV. APPROPRIATE ASSUMPTIONS FOR THE COMPANY Q. Are the actuarial assumptions used and methods employed by the Company appropriate and reasonable? A. Yes. The assumptions and methods used by the Company are individually reasonable and are compliant with GAAP, ASC 715, and federal law Long-Term Rate of Return Q. What is the process by which the long-term rate of return for the plan is chosen? A. CenterPoint Energy reviews the long-term rate of return assumption at each measurement date, generally at the end of each company fiscal year. The rate is chosen based on objective and expert data developed by Hewitt EnnisKnupp, a global investment consulting firm and subsidiary of Aon. Company auditors review the selected assumption for reasonableness, and will challenge the assumption if it is not reasonable Q. What factors influence the expected long-term rate of return for the plan? A. The long-term rate of return assumption is directly related to the CenterPoint Energy Retirement Plan s target asset allocation, as well as the expected return for each asset class in that allocation, and expected long-term inflation. The expected return for each asset class and expected inflation are based on 7

10 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR forward-looking long-term capital market assumptions developed by Hewitt EnnisKnupp. Hewitt EnnisKnupp uses the latest generally accepted economic principles in developing these expectations. For instance, market expectations of future inflation may be inferred in part, from comparing current market values of long-term Treasury bonds with and without embedded inflation-indexing Since rates of return vary from one asset class to another, the composite expected long-term rate of return assumption for a pension plan is directly impacted by the percentage of assets that will be invested in fixed income securities (e.g. bonds) versus equities (e.g. stocks). Companies sponsoring pension plans with target asset mixes that differ from other companies plans will potentially have different long-term rate of return assumptions. A plan with a higher target allocation in bonds will generally have a lower expected long-term rate of return than a plan with a higher target allocation in equities Q. What were the target asset allocation and long-term rate of return assumption previously used by the Company? A. As of December 31, 2012, and for several years prior, CenterPoint Energy had a target allocation of 60% equities and 40% fixed income, and as such, used an 8.00% long-term rate of return assumption that was supported by Hewitt EnnisKnupp analyses. 8

11 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR Q. What does Aon Hewitt project for the asset allocation mix as of December 31, 2013 and why is 7.25% the appropriate expected long-term rate of return as of that date? A. As of December 31, 2013, Aon Hewitt projects that plan assets will be 50% in equities and 50% in fixed income. Based on Hewitt EnnisKnupp capital market assumptions for the fourth quarter of 2013, the expected long-term rate of return for this portfolio is 7.09% [refer to Exhibit (GCS-R, Schedule 1]. For forecasting 2014 expense, this result was rounded up to 7.25%, which results in a slightly lower expense than the expense that would result from a 7.09% longterm return on asset assumption Q. Can you explain why this changed and what the objective of that change was? A. In 20, CenterPoint Energy adopted a formal investment policy that will shift some of the asset allocation from equities to fixed income assets over time, as the plan s funded ratio increases from 80% to 0%. More specifically, the plan s equity percentage will decline from 60% to 20%, and the plan s fixed income percentage will increase from 40% to 80%. The objective of this policy is to reduce prospective pension expense volatility as fixed income assets will be more in sync with pension obligations since both the assets and pension obligations will react similarly to changes in bond yields and will be less impacted by volatility in the stock markets. This will reduce risk, stabilize year-to-year pension expense for ratemaking, and reduce benefit restriction and other risks of underfunding to participants. 9

12 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR Q. How would the assumption of a higher long-term rate of return, as advocated by Department witness Mr. Johnson, impact Plan obligations and expense? A. All else equal, a higher assumed long-term rate of return would decrease pension expense Q. Is Mr. Johnson s 8.00% figure a reasonable alternative expected long-term rate of return assumption as of either September 30, 2013 or December 31, 2013? A. No. Hewitt EnnisKnupp no longer supports an 8.00% long-term rate of return as of either September 30, 2013 or December 31, The gap between the model result of 7.09% discussed above, and an assumption of 8.00%, is too large to attribute to rounding. The Company s external auditors are not likely to approve a long-term rate of return assumption of 8.00% Q. Would you expect further changes to the expected long-term rate of return after 2014? A. While the expected long-term rate of return is not an assumption that is typically changed every year by pension plan sponsors, we expect subsequent changes to this assumption for the Plan after 2014 as the plan s asset mix is expected to be further moved to a higher percentage of fixed income securities in accordance with the company s formal investment policy for the Plan adopted in 20. We expect the expected long-term rate of return assumption to further decline to approximately 6.00% over the next few years. 23

13 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR Discount Rate Q. What is the process by which the discount rate for the plan is chosen? A. As of each measurement date, which is generally at the end of each company fiscal year, Aon Hewitt provides a single weighted-average discount rate of a hypothetical bond portfolio whose cash flows match the projected benefit payments of the Plan. The yields for the hypothetical portfolio are based on the Aon Hewitt AA Above Median Yield Curve. The yield curve itself is developed based on bond data and pricing information provided by Barclay s Capital, a major global financial services provider and bond expert. A yield curve consists of a data set of yields for bonds of differing maturities as of the measurement date. Generally, the market will provide higher yields for bonds with longer-term maturities, although this may not always be the case at all data points. Therefore, a plan with more benefits payable in the distant future would be expected to have a higher discount rate than a plan with more benefits payable in the near future Q. Is the yield curve approach commonly used? A. This yield curve approach is best practice, widely accepted by the auditing community, and used by the vast majority of large pension plan sponsors for objective compliance with ASC % of Aon Hewitt clients used a yield curve approach as of December 31,

14 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR Q. Why is 4.75% the appropriate discount rate for the plan as of December 31, 2013? A. As of November 30, 2013, the yield curve rate for the CenterPoint Energy Retirement Plan was 4.77%, continuing to support the current estimated rate of 4.75% for year-end 2013 obligations and 2014 expense. Please refer to Exhibit (GCS-R), Schedule 2 and note that the column bars in the exhibit chart are the projected benefit payments associated with accrued plan benefits, and the line graph is the yield curve as of November 30, Q. Is rounding to the nearest five basis points accepted? A. Yes. CenterPoint Energy s historical practice of rounding to the nearest five basis points for convenience of financial users without materially impacting pension obligations and expense is acceptable. However, rounding in excess of the nearest 25 basis points would likely be challenged by company auditors Q. Would you expect changes to the discount rate after 2014? A. The discount rate is based on yields on corporate bonds at each measurement date, generally at the end of each company fiscal year, and as such, may be higher or lower in years after Q. How would use of a higher discount rate, such as those discussed by Department witness Mr. Johnson, impact Plan obligations and expense? 12

15 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR A. All else equal, a higher discount rate will result in lower pension obligations and will decrease pension expense Q. What was the first alternative discount rate discussed by Mr. Johnson in his direct testimony? A. 5.35% Q. Would 5.35% be a reasonable discount rate as of September 30, 2013 or December 31, 2013? A. No. The Aon Hewitt AA Above Median yield curve supports an unrounded discount rate of 4.81% for the Plan as of September 30, Although the December 31, 2013 yield curve is yet to be published, the similar result as of November 30, 2013 is 4.77%. In neither case is 5.35% currently supported. Such a difference is more than can be attributed to rounding Q. Could 5.35% represent a potentially reasonable estimate of future discount rates until the company s next rate case? A. Not on the basis of the objective information we know today. Mr. Mark Johnson in direct testimony indicates: It is important to note that the Commission s ratemaking function of establishing a reasonable level of pension expense in rates differs from the utility s accounting or bookkeeping functions as prescribed under ASC 715. The level of such expense in rates must reflect the likely and reasonable expense going forward until the Company s next rate case. The 13

16 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR CenterPoint Energy Retirement Plan yield curve results have increased approximately 64 basis points from historical lows as of December 31, 2012, but have stayed in the 4.68% to 4.87% range for each month-end between June 30, 2013 and November 30, Mr. Johnson refers to a 5.35% average discount rate over the period 12/31/2008 through 12/31/2012. However, this includes a 12/31/2008 rate of 6.90% which was temporarily inflated by an anomalous shortterm event in the financial markets, namely the financial credit crisis at the end of Excluding this event, using a 5-year period from 12/31/2009 through 12/31/2013, instead, provides an average of 4.92%, assuming the current discount 2013 indicators of 4.75% for 12/31/ Q. What did Mr. Johnson propose as another possible future discount rate? A. 8.00% Q. Could 8.00% represent a potentially reasonable estimate of future discount rates until the company s next rate case? A. Absolutely not. Corporate bond yields have not approached this level with the exception for a brief two-month period in late 2008 due to the temporary impact of the financial credit crisis. An 8.00% discount rate is completely incongruous with corporate bond yields required by U.S. GAAP and ERISA

17 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR Xcel Decision Q. Are you familiar with the Xcel Energy references cited by Mr. Johnson in his testimony? A. Yes. I have reviewed the testimony and reference to Docket No. E002/GR in which the Administrative Law Judge and Commission agreed that the discount rate and long-term growth rates used to determine Xcel Energy s testyear pension cost, for one of its plans, should be equal. The long-term rate of return for this plan was 8.00% Q. Does the Xcel plan referenced in Mr. Johnson s testimony resemble the Company s Plan? A. No it does not Q. How does Xcel s plan differ from the Company s Plan? A. In the Xcel case, the recovery mechanism was established prior to the publication of Financial Accounting Standards Board ( FASB ) 87, which has since been re-codified as ASC Xcel used an actuarial cost method called the Aggregate Cost Method ( ACM ) to assign future costs to current periods. Under this method, the present value of benefits, including past and future benefits is compared to assets, and any resulting shortfall is amortized over the remaining lifetimes of active employees. The ACM does not have a mechanism for targeting the security of the currently accrued benefits, and is 15

18 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR vulnerable to volatility in asset return. Assets could be well below the value of current accrued benefits and well short of the costs of current settlement Q. Is ACM still in common use? A. No. Ultimately, this method was not allowed for expense determination under FASB 87. FASB 87 instead required the use of the Unit Credit Method which is based on the present value of accrued benefits using corporate bond yields for reasons discussed earlier in this testimony Q. Is using the ACM for the Company appropriate? A. No, for the reasons I have previously testified. The Company plan follows the FAS 87 and PPA requirements Q. Is an 8.0% discount rate for the Company appropriate? A. No, for the reasons I have previously testified Q. What would the impact on the Company be if it used the ACM or an 8.0% discount rate? A. Using the ACM and/or an 8.00% discount rate for ratemaking will result in rates that are significantly below forthcoming company expense and funding requirements, and would be inconsistent with the assumptions and methods the company must use for ASC, GAAP, and federal law. 16

19 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR Q. How do you respond to Mr. Johnson s testimony wherein he states that the pension obligation would be overstated unless the expected long-term rate of return is the same as the discount rate? A. If the discount rate is set equal to the expected long-term rate of return, the resulting pension obligation will be well below the pension obligations required for company expense under ASC 715 and minimum funding requirements under federal law Summary on Company Pension Assumptions Q. Are the company s discount rate and expected long-term rate of return assumptions consistent with those used by other companies in ratemaking? A. Yes. Attached as, is the Oregon Public Utility Commission s March 2013 survey, entitled Pension Treatment in Rate Making Survey, responded to by the fifty state public utility commissions, the District of Columbia, and the City of New Orleans. Forty-four (44) respondents indicated recovery of ASC 715 expense as the basis for deciding the level of recovery associated with pension costs. Only 4 respondents indicated applying an adjustment to a company s discount rate used to calculate its ASC 715 accrual based expense, generally to reflect updated market conditions, and not to reflect a long-term assumption that is incongruous with expense and contribution requirements

20 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR Q. Is there anything else you wish to point out relating to the discount rate and longterm rate of return selection? A. It is important to note that under the objective yield curve approach that resulting discount rates will vary from plan to plan depending on the plan s underlying demographics and benefit provisions. A plan with more payments expected further in the future where yield rates are currently higher would have a higher weighted-average discount rate than other plans Similarly, long-term asset return assumptions will depend on each plan s asset mix. Plans with a higher percentage of fixed income security investments will have a lower expected long-term rate of return assumption than plans with a higher percentage of equity investments, all else equal Companies set their assumptions using objective actuarial analyses that are based on their specific plan demographics and provisions, and not by comparison with other companies. Outside users, however, may review a company s assumption support further if a company s assumption is an outlier when compared to their peers As of December 31, 2012, the Edison Electric Institute pension survey of actuarial assumptions and statistics for 46 utilities indicates an average discount rate of 4.08% and an average expected long-term rate of return of 7.43%. CenterPoint Energy is not an outlier. 18

21 Mr. George C. Sanger Pension Assumptions Rebuttal Testimony Docket No. G-008/GR Q. Does this conclude your Rebuttal Testimony? A. Yes. 19

22 Exhibit (GCS-R), Schedule 1 Hewitt EnnisKnupp Expected Rate of Return Tool, Q4 2013, released October Based on expected CenterPoint Energy Retirement Plan asset mix as of December Asset Allocation Expected Nominal Return 1 Expected Risk (Volatility) Allocation # 1 Equity Large Cap U.S. Equity 7.1% 19.5% 20.70% Small Cap U.S. Equity 7.6% 25.5% 4.30% Global Equity (Developed & Emerging) 7.6% 20.5% 0.00% International (Non-U.S.) Equity 7.4% 21.0% 20.30% (Developed) Emerging Markets Equity 9.1% 29.0% 4.70% Fixed Income Cash (Gov't) 3.8% 2.0% 0.00% Cash (LIBOR) 4.1% 2.5% 0.00% TIPS 3.6% 4.5% 0.00% Core U.S. Fixed Income (Market Duration) 4.6% 5.5% 0.00% Long Duration Bonds Gov t / Credit 4.8% 11.5% 0.00% Long Duration Bonds Credit 5.3% 13.0% 50.00% Long Duration Bonds Gov t 4.2% 11.0% 0.00% High Yield Bonds 5.9% 14.5% 0.00% Non-US Developed Bond (0% Hedged) 4.1% 11.0% 0.00% Non-US Developed Bond (50% Hedged) 4.1% 6.5% 0.00% Non-US Developed Bond (0% Hedged) 4.0% 4.5% 0.00% Emerging Market Bonds (Sov. USD) 6.3% 13.0% 0.00% Short Duration Bonds - Gov't 3.9% 2.5% 0.00% Short Duration Bonds - Credit 4.3% 3.0% 0.00% Intermediate Duration Bonds - Gov't 3.9% 4.0% 0.00% Intermediate Duration Bonds - Credit 4.8% 5.0% 0.00% Emerging Market Bonds (Corporate USD) 6.7% 12.5% 0.00% Emerging Market Bonds (Sov. Local) 6.6% 14.5% 0.00% Alternative Investments Hedge Fund-of-Funds Universe (Median 6.1% 8.5% 0.00% Manager) Real Estate (Broad Market) 7.3% 14.5% 0.00% Core Private Real Estate 6.2% 12.5% 0.00% Commodities 6.3% 19.0% 0.00% Private Equity 9.3% 27.0% 0.00% Infrastructure 7.8% 17.0% 0.00% Bank Loans 5.1% 7.5% 0.00% Broad Hedge Funds (Diversified Portfolio 7.8% 8.5% 0.00% of Direct HFs) U.S. REITs 6.6% 20.5% 0.00% Total Portfolio 0.00% U.S. Inflation (CPI) 2.2% Expected Return/Risk Results Allocation # 1 Expected Nominal Return % 1

23 Exhibit (GCS-R), Schedule 2 Aon Hewitt AA Above Median Yield Curve Analysis For the CenterPoint Energy Retirement Plan As of November 30, 2013 Selected Yield Curve and Details AA Above Median (11/30/2013) Date 11/30/2013 Weighted Avg Discount Rate 4.77% Estimated Duration 09.8 Yrs Graphical Results Payment Amount $160,000,000 $140,000,000 $120,000,000 $0,000,000 $80,000,000 $60,000,000 $40,000,000 $20,000,000.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% Corporate Spot Curve $ Payment Maturity (yrs) 0.0% Annual Cash Flows ($) Discount Curve (%) 1

24 Page 1 of 24 Oregon Public Utility Commission Pension Survey Pension Treatment in Rate Making Survey Summary Report Thursday, March 28, 2013 This document is a compilation of the Public Utility Commission of Oregon (OPUC) survey, Pension Treatment in Rate Making. The survey was sent to and responded by the fifty state utility commissions, The District of Columbia, and the City of New Orleans. The OPUC greatly appreciates the time and effort taken by the commission to respond to the survey. The answers provide below will help to inform all of the utility commissions about the types of regulatory recovery utilities in the United States are receiving from their utility regulatory authorities. It also identifies by the commission answers where in the United States that these regulatory methodologies are being applied.

25 Page 2 of 24 Question - 1 Please pick which method, listed below from A through H, that your commission used as its basis for deciding the level of recovery that companies receive in rates for cash contributions and pension expenses related to the funding and operation of... (Response Rate: 0% (N=52) Question Type: Choose many) A. Recovery of "FAS 87/ASC 715 Expense" in rates (Defined as the Net Periodic Pension (Benefit)/Cost) B. Recognition of "Prepaid Pension Asset/Liability" (Delta of defined benefit contribution minus FAS 87/ASC 715 expense; recognized in rates through allowing a return on amount invested in asset) C. Included in "Working Capital" (As an adjustment to the balance of working capital) D. "Cash Pension Contributions" pay-as-you-go (Use of cash contributions instead of the accrual based FAS 87/ASC 715 by including cash contributions during the test-year in the revenue requirement) E. "Cash Pension Contributions" (deferral and amortization of cash contributions through a balancing account) F. "Rate of Return Adjustment" (An adjustment to the allowed rate-of-return) G. "Combination of Methods" of the above 6 H. "Other Method(s)" 3 Total Responses 78 Note: Will not add up to 52 (number of participating commissions) because more than one of the above statements could be chosen as applicable to explain commission orders related to pension expenses.

26 Page 3 of 24 Question 1 (Table) Question - 1 (Text Field - 1) If you selected multiple methods, please provide a brief explanation of how the methods are used Response Rate: 35% (N=18) Question Type: Paragraph South Carolina Public Service Commission - A rider comprised of the difference between the FAS-87 expense in rates and the FAS-87 project subject to true up. Pennsylvania Public Utility Commission One company that I know of uses FAS 87 accrual method (PPL). Generally speaking, for all others, we review the company's actuarial study and verify whether claim falls between ERISA and IRC amounts. Oklahoma Corporation Commission A combination of A and B. Public Service Commission of West Virginia - Virginia Historically the WV PSC has recognized pensions based on the cash contribution method (ERISA) and continues to utilize that method for most private utilities. Recently in Mountaineer Gas (case # E-42T), the Commission recognized pension expense at the level of the FAS 87 accured expense, but only on condition proposed by Mountaineer that they will fund the pension plan annually at the FAS 87 expense level (even if the FAS 87 level exceeds the ERISA cash funding requirement). In addition, the Commission has allowed pension recovery using the FAS 87 accrual level for American Water Works Service Company charges to West Virginia-American because the majority of the 21 states regulating AWW subsidiaries recognize FAS 87 for pension recovery. Kentucky Public Service Commission KYPSC does not require a specific recovery method. While ash "pay-as-you-go" was used historically, in some recent cases have transitioned to FAS 87/ASC 715 expense. New Mexico Public Regulation Commission The NMPRC historically has allowed the FAS 87 Expense to be included as a recoverable operating expense. In Case 07-

27 Page 4 of UT, however, the NMPRC also allowed the applicant utility, Southwestern Public Service Company, to include a prepaid pension asset because the utility demonstrated that the pre-paid pension asset caused a negative pension expense. The fact that the prepayment resulted from a high rate of return on the pension fund, as opposed to the utility having made discretionary excess contributions to the fund, appears to have caused the NMPRC to be more favorably disposed to allow inclusion of the prepaid pension asset in rate base. This is the most recent litigated rate case that addressed this issue. Public Utility Commission of Utah In Utah there is only one investor owned utility. Older employees are grandfathered into a defined benefit plan along with the union employees (FASB 87). Effective June 1, 2007, the Company shifted its benefit determination for the non-union workforce to a cash balance plan/401k approach. For non-union employees, all vested benefits under the current final average pay approach were frozen as of May 31, 2007 and will be provided to employees at the time of retirement. Effective June 1, 2007, the Company established an account for each employee that will grow based on credits of 6.5 percent of annual pay (base plus incentive) plus 4.0 percent of pay in excess of the Social Security taxable wage base ($97,500 in 2007). In addition, on an annual basis each account will receive an interest credit based on the account balance and the annual credit rate. A transition benefit was provided for employees who are age 40 or older on May 31, Employees falling in this category will receive additional pay credits for five years (ending in 2012), structured as follows: Year 1-3 = 4.0 percent Year 4 = 2.5 percent Year 5 = 1.5 percent All new hires eligible to participate in the pension plan after June 30, 2006 will receive a pay credit rate of 5.0 percent The Company no longer offers defined benefit plan to those not grandfathered into old plan. District of Columbia Public Service Commission The Commission allows the electric and natural gas utilities to use the ASC 715 method to account for Pension by reflecting in the utility's operating expense the actuarily determined net periodic Pension cost or benefit. However as described in a later survey response, the Commission has allowed the Electric utility to include in rate base the electric utility's prepaid pension asset balance. Maine Public Utilities Commission In the Stipulation approved in Docket No (paragraph 19), it was agreed that the utility would amortize a regulatory liability representing the actuarial gains not yet recognized in pension expense amounts over 5 years. The liability was required due to the merger of the utility and a new parent. California Public Utilities Commission The answer above is to the best of my knowledge. New York State Public Service Commission NYPSC allows ASC 715 expense with reconciliation so to recover actual expense. Carrying charges accrued to ratepayers on balance of "internal reserve" where pension costs provided in rates (expense plus amounts charged to CWIP) are greater than contributions to fund.

28 Page 5 of 24 Vermont Public Service Department - In Vermont, the expense under FAS 87 is recoverable in rates. Additionally, the net asset or liability balance is included in the rate base. Illinois Commerce Commission - Pension expense is based on FAS 87 Expense. In addition, a return on the Pension Asset recorded on the utilities books has been approved for Commonwealth Edison in rate cases since Docket No Massachusetts Department of Public Utilities - We use both A and D. New Jersey Board of Public Utility - Recovery of FAS 87 expense as well as adding the prepaid pension balance to cash working capital study to get a return on that balance. Minnesota Public Utilities Commission - A. on a case by case basis has allowed recovery as a test year cost either the FAS 87 cost or an average of several years of FAS 87 cost. B.In one instance the Commission has allowed the excess of the company's contributions over the amounts recovered in rate to be included in rate base as part of a settlement. Virginia State Corporation Commission - The expensed amount of the NPBC is included in O&M, the accrued Pension Asset/Liability is usually recognized as a working capital adjustment in a lead/lag study. Public Utility Commission of Texas - Pension expense determined in rate case by FAS 87. Each year thereafter, reserve account is debited or credited for difference between amount included in rates and that year's FAS 87 pension expense amount. Next rate case any deficit or surplus in the reserve account is amortized over a reasonable time with the unamortized balance earning a return. Question - 1 (Text Field - 2) You answered H. "Other Methods, to question 1, please provide a brief explanation of the method used. Response Rate: 6% (N=3) Question Type: Paragraph Tennessee Regulatory Authority - Latest minimum funding level in latest actuarial report allowed as pension expense in rates. Missouri Public Service Commission - Prior rate recognition of FAS 87 pension credits is also amortized to cost of service in current cases. For most Missouri utilities, the amount of the required pension case contributions is set equal to the utilities' FAS 87/ASC 715 annual expenses. Washington Utilities and Transportation Commission - We also use a four-year average of cash contributions to the pension asset. Different utilities may get different treatment.

29 Page 6 of 24 Question - 2 Has your commission allowed the inclusion in a company's "rate base" any portion of a company's pension expenditures that are excess contributions over FAS 87/ASC 715 based expenses or result in "pre-paid pension expense" in a company's "rate base" used for setting rates, or are deferred pension costs allowed a carrying charge? (Response Rate: 0% (N=52) Question Type: Choose one) Yes - 24 Colorado Public Utility Commission Connecticut Department of Public Utility Control District of Columbia Public Service Commission Florida Public Service Commission Hawaii Public Utility Commission Illinois Commerce Commission Louisiana Public Service Commission Michigan Public Service Commission Minnesota Public Utilities Commission Mississippi Public Service Commission Missouri Public Service Commission New Hampshire Public Utilities Commission New Jersey Board of Public Utility New Mexico Public Regulation Commission New Orleans City Council Utilities Regulatory Office New York State Public Service Commission North Carolina Utilities Commission Oklahoma Corporation Commission Public Utilities Commission of Ohio Public Utility Commission of Texas Rhode Island Public Utilities Commission South Carolina Public Service Commission Vermont Public Service Department Virginia State Corporation Commission No 28 Total Responses - 52

30 Page 7 of 24 Table Question 2 30 Has your commission allowed the inclusion in a company's "rate base" any portion of a company's pension expenditures that are excess contributions over FAS 87/ASC 715 based expenses or result in "pre-paid pension expense" in a company's "rate base" used f Yes 28 No Question - 2 (Text Field - 1): Has your commission allowed the inclusion in a company's "rate base" any portion of a company's pension expenditures that are excess contributions over FAS 87/ASC 715 based expenses or result in "pre-paid pension expense" in a company's "rate base" used for setting rates, or are deferred pension costs allowed a carrying charge? South Carolina Public Service Commission The difference between the FAS-87 expense in rates and the projected FAS-87 expense is amortized over 30 years with the unamortized balance in rate base that earns a return at the allowed ROR. Louisiana Public Service Commission - Allowed as a pre-payment as a rate base Oklahoma Corporation Commission Prepaid pension assets are generally included in rate base. However, this is a contentious item amongst the parties to the cause. Also the rate of return/cost of debt allowed is also a contentious item. New Hampshire Public Utilities Commission Prepaid expenses. Missouri Public Service Commission - Any additional pension funding by the utilities above the FAS 87/ASC 715 level associated with minimum ERISA or Pension Protection Act of 2006 requirements is generally allowed to be deferred on the utilities balance sheets, and then placed in rate base in subsequent general rate proceedings. New Mexico Public Regulation Commission - As explained above, the NMPRC has allowed a pre-paid pension asset to be included in rate base, earning the utility's allowed

31 Page 8 of 24 weighted average cost of capital, if the utility demonstrated satisfactorily that the pre-paid pension asset caused a negative pension expense. New Orleans City Council Utilities Regulatory Office While "pre-paid pension expense" has been allowed, the level of contributions is closely monitored to ensure the Company is not over funding pension plans. Connecticut Department of Public Utility Control This is done on a case by case basis depending on the circumstances of each case. District of Columbia Public Service Commission In FC 53 (See DC PSC Order No issued on January 30, 2008). Pepco was allowed to include $23.3 million in its rate base for prepaid asset/opeb liability net of taxes. In that case, the Commission found that inclusion of Prepaid Pension Asset/OPEB Liability in the rate base is consistent with Commission precedent. In an earlier case concerning another utility (BA-DC), the Commission found that BA-DC was required to continue its policy of placing an amount equal to the SFAS accrual into an external funding mechanism to the extent that tax advantaged vehicles exist, with any accruals in excess of that amount applied as a reduction to rate base. In a subsequent case involving PEPCO, the Commission similarly found that "as in the BA-DC case, it is appropriate that PEPCO account for any amounts not externally funded... as a reduction to the rate base." The Commission found that investor-supplied cash contributions have resulted in an asset from which PEPCO's customers receive a tangible benefit in the form of reduced pension expenses. Therefore, investors are entitled to earn a return on the capital they provided. If the Prepaid Pension Asset is included in rate base, the related OPEB Liability should also be included as a reduction. Both the asset and the liabilitv result from the existence of a differential between thecompany's obligation regarding future benefits owed to current employees and the level of those benefits the Company funds currently. Rhode Island Public Utilities Commission The pension contributions in excess of the accrued liability are allowed a return in the pension reconciliation mechanism. North Carolina Utilities Commission Excess contributions, typically, would beincluded in rate base. New York State Public Service Commission With authorization of the NYPSC a NY utility can accrue carrying charges at its allowed rate of return where contributions to date are in excess of pension expense allowed in rates and charged to CWIP. Vermont Public Service Department - Yes, when there is/was an unfunded pension obligation. Illinois Commerce Commission - While the "pre-paid pension expense" has not been allowed for recovery in "rate base", utilities have been allowed to recovery a return on what it has recorded as a "pension asset" at the weighted average cost of capital in its

32 Page 9 of 24 operating statement. Colorado Public Utility Commission - The prepaid pension asset is also included. New Jersey Board of Public Utility - If the utility's pension is prepaid, the 13 month average to the cash working capital requirement rolls into rate base. Minnesota Public Utilities Commission - In one instance as part of a rate case settlement this was allowed. Hawaii Public Utility Commission - We have a pension and OPEB tracking mechanism that is designed to provide for the recovery of pension and OPEB costs over time. By preventing the over or under recovery of costs, by establishing a prepaid pension asset or liability. The pension tracking mechanism ensures that over time the pension costs recovered through rates are based on the actuarially calculated NPPC as reported for financial reporting purposes and ensures that all amounts contributed to the pension trust fund are in amounts at least equal to actual NPPC and recoverable through rates. Thus, the test year NPPC is estimated and incorporated into rates in each rate case. Once new rates are effective and until rates are changed in a subsequent rate case, taht amount of NPPC in rates and the actual NPPC is separately tracked. The difference between the NPPC in rates and athe actuarially calculated NPPC for the year is charged/credited to a regulatory asset/liability. this unamortized regulatory asset/liability is included in rate base. When new raes are established in a rate case, the regulatory asset/liability is amortized over a five year period. The total test year pension costs is the test year NPPC in rtes plus or minus the amortization of the regulatory asset/liability. Also, the pension tracking mechanism allows the utilty to reverse the pension AOCI charge to equity and credate a regulatory asset for financial statement purposes. Virginia State Corporation Commission - The expensed amount of the NPBC is included in O&M. The accrued Pension Asset/Liability is usually recognized as a working capital adjustment in a lead/lag study. Public Utility Commission of Texas - Several years ago AEP companies made excess contributions to pension funds and were allowed to include these amounts in rate base. See PUCT Docket No Michigan Public Service Commission - Our Commission uses the balance sheet method for working capital and all assets and liabilities associated with pension are included in working capital.

33 Page of 24 Question - 3 Has your commission applied an adjustment to a company's discount rate used to calculate its FAS 87/ASC 715 accrual based expenses used in setting rates? Response Rate: 0% (N=52) Question Type: Choose one Yes 4 Idaho Public Utilities Commission Public Service Commission of Wisconsin Connecticut Department of Public Utility Control New Hampshire Public Utilities Commission No 48 Total Responses 52 Table Question Has your commission applied an adjustment to a company's discount rate used to calculate its FAS 87/ASC 715 accrual based expenses used in setting rates? Yes No Question - 3 (Text Field - 1): Has your commission applied an adjustment to a company's discount rate used to calculate its FAS 87/ASC 715 accrual based expenses used in setting rates? Idaho Public Utilities Commission - In 2003, the Utility decreased its discount rate prior to a test year for a general rate case from 8.5% to 8%, although the returns for the previous 15 years averaged 13%. The Commission found that the utility's change in discount rate was unwarranted. However, the issue was mute because the Utility had not been funding contributions for over years, so the Commission didn't allow any recovery in rates

34 Page 11 of 24 Public Service Commission of Wisconsin - No adjustments in recent years other than to include updated information from actuarial studies completed during Commission staff's audit of the forward looking test year. Connecticut Department of Public Utility Control - The PURA adjusts the discount rate based on market conditions projected for the future. New Hampshire Public Utilities Commission - It depends on company's filing and its actuarial study Question - 4 Has the commission applied an adjustment to a Company's "rate-of-return" used to calculate a Company's FAS 87/ASC 715 based pension plan portfolio value used in setting rates? Response Rate: 0% (N=52) Question Type: Choose one Yes 3 Connecticut Department of Public Utility Control New Hampshire Public Utilities Commission Public Service Commission of Wisconsin No 49 Total Responses 52 Table Question Has the commission applied an adjustment to a Company's "rate-of-return" used to calculate a Company's FAS 87/ASC 715 based pension plan portfolio value used in setting rates? Yes 49 No