Direct Testimony and Schedules Gene H. Wickes

 
Direct Testimony and Schedules Gene H. Wickes
Direct Testimony and Schedules
                                                          Gene H. Wickes

         Before the Minnesota Public Utilities Commission
                       State of Minnesota

In the Matter of the Application of Northern States Power Company
  for Authority to Increase Rates for Electric Service in Minnesota

                  Docket No. E002/GR-13-868
                     Exhibit___(GHW-1)

                Pension Design and Accounting

                        November 4, 2013
Direct Testimony and Schedules Gene H. Wickes
Table of Contents

I.     Introduction                                                           1
II.    Introduction to Defined Benefit Plans                                  4
III.   Defined Benefit Plan Design Changes                                   10
IV.    Pension Design Compliance Item                                        18
V.     Accounting Methods and Assumptions                                    23
       A.        Actuarial Assumptions                                       24
       B.        SFAS 87 and Aggregate Cost Method                           28
       C.        Discount Rate and EROA                                      32
       D.        2008 Market Loss                                            33
VI.    Conclusion                                                            36

                                     Schedules

Qualifications                                                      Schedule 1

Summary Comparison of ACM and SFAS 87 Methods                       Schedule 2

2011 Towers Watson Retirement Attitudes Survey                      Schedule 3

Pensions in Transition: Retirement Plan Changes and
                                                                    Schedule 4
Employer Motivations, 2012 Towers Watson Report

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Direct Testimony and Schedules Gene H. Wickes
1                                  I. INTRODUCTION
2
3    Q. PLEASE STATE YOUR NAME AND OCCUPATION.
4    A.   My name is Gene H. Wickes. I am employed by Towers Watson & Co.
5         (Towers Watson) as a Senior Consultant and Actuary. I also serve as the
6         Managing Director for Towers Watson’s Benefit Segment.
7
8    Q. PLEASE SUMMARIZE YOUR QUALIFICATIONS AND EXPERIENCE.
9    A.   I attended Brigham Young University, where I received a Bachelor of Science
10        degree in Mathematics, a Master of Science degree in Mathematics, and a
11        Master of Science degree in Economics. I have over 35 years of experience
12        consulting with organizations on the design and financial considerations of
13        their pension programs. I am a Fellow of the Society of Actuaries, a Fellow of
14        the Conference of Consulting Actuaries, and an Enrolled Actuary under the
15        Employee Retirement Income Security Act of 1974 (ERISA). My resume is
16        included as Exhibit___(GHW-1), Schedule 1.
17
18   Q. WHAT IS THE PURPOSE OF YOUR TESTIMONY?
19   A.   My testimony supports the request of Northern States Power Company, doing
20        business as Xcel Energy (NSPM or the Company), to recover in electric rates
21        the costs associated with its pension plans. I do this by:
22           • Demonstrating that defined benefit plans are prevalent among utilities;
23              and
24           • Explaining that without a market-competitive, effectively designed
25              retirement program, including the use of a defined benefit plan, the
26              Company would be disadvantaged in retaining and recruiting the highly
27              skilled workforce it needs to provide safe, reliable electric service.

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Direct Testimony and Schedules Gene H. Wickes
1
2         In addition, I will demonstrate that the accounting methods and assumptions
3         used by the Company to calculate its pension cost, including the treatment of
4         the 2008 market loss, are consistent with the Company’s historical practice
5         and appropriate under the various guidelines established by the applicable
6         regulatory entities.
7
8    Q. ARE YOU PROVIDING ANY INFORMATION RESPONSIVE TO THE COMMISSION’S
9         ORDER IN THE COMPANY’S LAST ELECTRIC RATE CASE?

10   A.   Yes. In Sections II through IV of my testimony, I will address Order Point 45
11        from the September 3, 2013 Order in Docket No. E002/GR-12-961, which
12        provides as follows:
13             In the initial filing of its next rate case, Xcel shall discuss the
14             extent of any and all of its exploration and evaluation of freezing,
15             or otherwise amending, prior pension benefits and expanding the
16             application of the five percent Cash Balance pension fund
17             formulary to its veteran active employees hired prior to
18             introduction of this formulary benefit (for both the non-
19             bargaining and bargaining unit employees).
20
21        In Section V of my testimony, I will discuss the methods and assumptions
22        used in developing Xcel Energy’s pension cost. This will supplement the
23        Company’s response to Order Point number 35, which provides as follows:
24             The Company’s 2008 market loss shall be included in the qualified
25             pension cost for ratemaking purposes; that determination is
26             limited to this proceeding. Further evaluation of and evidence of
27             the Company’s policy and practice pertaining to past and future
28             pension policies, including surplus, shall be provided in the initial
29             filing of its next rate case.
30

31   Q. PLEASE SUMMARIZE YOUR TESTIMONY.

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Direct Testimony and Schedules Gene H. Wickes
1    A.   The utility industry relies on a highly-trained, technical, bargaining and non-
2         bargaining workforce to provide service to its customers. Additionally, the
3         utility workforce is generally older, which brings with it the need to effectively
4         manage work force transition.       These are unique attributes of the utility
5         industry.
6
7         Due to the industry’s need for an educated and skilled workforce that is on
8         average older than workforces in other industries, the utility industry is also
9         presented with significant recruiting, training, development, and retention
10        challenges. Offering a defined benefit plan as part of a market-competitive
11        retirement program is commonplace among utilities because it helps with
12        retention, recruiting, workforce planning, and allowing for more orderly
13        retirement patterns.
14
15        The Company’s defined benefit plans are consistent with those offered by
16        others in the utility industry. It is my expert opinion that the Company needs
17        to continue providing this form of a retirement opportunity in order to avoid
18        losing its highly-skilled employees to other employers, to be able to attract
19        talented individuals to work for the Company, and to provide a mechanism
20        for a seamless transition of the workforce by providing incentives for the
21        highly experienced employees to share their knowledge with younger
22        generations in advance of retirement.
23
24        Like other utilities, the Company has implemented design changes to its
25        defined benefit plans to control costs. The Company’s transition strategy to a
26        five percent cash balance plan, which is applicable to only new hires after a
27        certain date, is consistent with the industry practice of making pension plan

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Direct Testimony and Schedules Gene H. Wickes
1         changes applicable to new hires in order to promote stability in the workforce
2         and to provide an orderly transition to the next generation of employees.
3
4         Finally, the accounting methods and assumptions used by Xcel Energy for
5         their pension plans are consistent with the Company’s historical practice, and
6         appropriate under the various guidelines established by the applicable
7         regulatory entities.   If the Commission were to require the Company to
8         introduce non-standard changes into these methods and assumptions, or if the
9         Commission were to exclude the recognition of the 2008 market loss, it would
10        disrupt the appropriate cost recognition process, creating uncertainty and risk
11        for all stakeholders, including the Company’s customers.
12
13               II. INTRODUCTION TO DEFINED BENEFIT PLANS
14
15   Q. WHY DO COMPANIES OFFER RETIREMENT BENEFITS?
16   A.   Employers offer retirement programs to facilitate the overall management of a
17        workforce, including attracting, retaining and most importantly, retiring its
18        employees.
19
20   Q. WHAT      ARE THE GENERAL CONSIDERATIONS THAT GO INTO DESIGNING

21        RETIREMENT BENEFITS?

22   A.   The specific designs of retirement benefits are driven by the overall workforce
23        strategy of the company. Employers will determine the appropriate level of
24        the benefits and then design plans they think best fit the preferences of the
25        workers they are trying to attract and retain. For instance, some workers will
26        seek out firms that provide strong retirement benefits while other workers
27        have a stronger preference for current income.       Likewise, employers will

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1             consider the retirement needs of the employees they need to retain in
2             designing retirement benefits.
3
4    Q. HOW DO RETIREMENT BENEFITS HELP ADDRESS RETENTION ISSUES?
5    A.       Retaining employees is critical in industries that invest significant resources
6             training and developing specialized workforces, like utilities.                Long-term
7             employee retention allows for a more stable workforce and increases the
8             likelihood that the Company will get a return on its investment in the
9             employees. Depending on the design of the plan, retirement benefits can
10            significantly increase in value in the latter part of an employee’s career,
11            particularly benefits tied to final average pay and service, which provides
12            incentives for employees to stay.             The research supports that retirement
13            benefits have a significant impact on employee retention. In the Towers
14            Watson Retirement Attitudes Survey, published in 2012, more than three-
15            quarters of new hires at companies sponsoring defined benefit plans said that
16            the retirement program gives them a compelling reason to stay on the job, and
17            85 percent hoped to work with their employer until they retire1.
18
19   Q. WHAT ARE THE             TYPICAL COMPONENTS OF A RETIREMENT PROGRAM?

20   A.       There are varying components to a retirement program and the mix of the
21            components will largely depend on a company’s workforce strategy,
22            philosophy, and needs. The most typical components are a defined benefit
23            plan, a defined contribution plan, a retiree medical program and a retiree life
24            insurance offering.
25
26   Q. WHAT IS A DEFINED BENEFIT PLAN?

     1 2011   Towers Watson Retirement Attitudes Survey, see Exhbit___(GHW-1), Schedule 3.

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1    A.   A defined benefit plan provides a benefit that is defined by a fixed formula
2         and is typically based on pay and years of service. Historically, these benefits
3         have been defined as annuities payable at age 65. More recently, companies
4         have been adopting a new type of defined benefit plan, called a “hybrid” plan.
5         Like the traditional defined benefit plan, the benefit accrues based on a
6         defined fixed formula, but the benefit is defined as a lump sum account
7         balance, rather than a monthly annuity benefit at age 65. The most common
8         type of hybrid plan is a cash balance plan. In a cash balance plan, a percentage
9         of pay (i.e., a pay credit) is periodically allocated to the employee’s account,
10        along with a periodic interest credit. The interest credit is selected by the
11        employer and is typically tied to a benchmarking interest rate, such as the 30-
12        year Treasury rate. While the account looks and feels similar to a defined
13        contribution plan, this design is still considered a defined benefit plan, because
14        the employer bears the risk of the assets and investments.
15
16   Q. HOW     DO DEFINED BENEFIT PLANS COMPARE TO A DEFINED CONTRIBUTION

17        PLANS?

18   A.   Similar to a “hybrid” defined benefit plan, a defined contribution plan defines
19        the annual contribution that is made to an account today. The key difference
20        is that the participant generally directs the investments and always bears the
21        risk of the actual investment earnings on the individual account assets. As a
22        result, the participant’s account balance is unpredictable and can vary
23        significantly depending on market returns.
24
25   Q. AREN’T MANY COMPANIES ELIMINATING DEFINED BENEFIT PLANS?
26   A.   Many companies have eliminated their defined benefit plan (primarily for new
27        hires), but the continued use of defined benefit plans is very common in

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1         several industries (utilities being one) and largely depends on the overall
2         workforce objectives of a company.
3
4    Q. CAN YOU EXPAND ON YOUR COMMENT THAT THE USE OF A DEFINED BENEFIT
5         PLAN CAN VARY BY INDUSTRY?

6    A.   The retirement programs that a company offers largely depend on the
7         workforce and workforce strategy. Industries that can tolerate, or even desire,
8         high turnover may be more likely to offer defined contribution plans.
9         Additionally, industries that have experienced rapid change with significant
10        financial and competitive pressures have moved away from defined benefit
11        plans. The largest shifts from defined benefit to defined contribution plans
12        have been in the auto and transportation equipment, communications and
13        high-tech sectors. On the other hand, industries that have highly specialized
14        skills, longer training cycles, significant unionized populations, limited labor
15        pools, and physically demanding jobs may be more likely to offer a defined
16        benefit plan. Industries that continue to offer defined benefit plans include
17        energy/natural resources, insurance, and utilities.
18
19   Q. CAN YOU EXPAND ON YOUR COMMENT THAT THE USE OF A DEFINED BENEFIT
20        PLAN CAN VARY DEPENDING ON WORKFORCE OBJECTIVES?

21   A.   These programs can aid in the overall management of the workforce,
22        including attracting, retaining, and very importantly, retiring older workers.
23        Employers need to consider the types of employees they are trying to attract,
24        the length of time they would like their employees to stay with the company,
25        and the transitions that are required at the end of an employee’s tenure with
26        the company. Employers determine the desired level of benefits and they
27        then design plans that they think best fit the preferences of the workers they

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1            are trying to attract.     In my opinion, the most important reason why
2            employers sponsor any type of retirement plan is to enable employees to retire
3            when it is time for them to retire – that is, when it is in the best interest of the
4            employer and the employee. A company can design a plan targeting a specific
5            income replacement after a specified tenure or specified retirement age,
6            thereby increasing the potential that employees will be able to retire in a
7            predictable, orderly manner.
8
9    Q. ARE DEFINED BENEFIT PLANS STILL COMMON IN THE UTILITY INDUSTRY?
10   A.      Yes, defined benefit plans are still common in the utility industry due to the
11           unique characteristics of the industry. The BENVAL® study referenced in
12           Company witness Ms. Darla Figoli’s testimony provides that 60 percent of
13           utility employers offer a defined benefit plan to their salaried new hires and 64
14           percent offer a defined benefit plan to their bargaining new hires. Prevalence
15           is even higher for larger utilities (revenue in excess of $5 billion), with 79
16           percent offering a defined benefit plan to their new hires (both salaried and
17           bargaining2). That study is an exhibit to Ms. Figoli’s testimony.
18
19   Q. WHY        DO YOU BELIEVE DEFINED BENEFIT PLANS CONTINUE TO BE WIDELY

20           USED AMONG UTILITIES?

21   A.      As noted earlier, defined benefit plans result in more stable and orderly
22           retirements, which are important in an industry that has longer training cycles
23           and knowledge transfers, and where effective succession planning is critical to
24           the stability of the business. In addition, defined benefit plans are also favored
25           by unionized populations, which can limit a company’s ability to significantly
26           or rapidly change the mix of programs.

     2   Towers Watson BENVAL® study, October 2013.

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1
2    Q. DO YOU BELIEVE THAT DEFINED BENEFIT PLANS WILL CONTINUE TO BE USED
3         BY UTILITIES IN THE FUTURE?

4    A.   Yes. I believe that a defined benefit plan as a component of a competitive
5         retirement program continues to make sense for this industry, particularly
6         given the workforce management advantages previously cited.              Properly
7         designed, they will ensure that the utility will get a return on its investment in
8         the employees’ training and development. A defined benefit plan allows a
9         utility to provide a competitive total rewards package to ensure it attracts
10        critical skill employees. In addition, defined benefit plans are economically
11        efficient in that they better allocate the benefits to long-service employees.
12
13   Q. DOES THE COMPANY HAVE A DEFINED BENEFIT PLAN?
14   A.   Yes. As Ms. Figoli states in her testimony, the Company offers newly hired
15        employees a five percent cash balance plan that provides for an annual five
16        percent company contribution of the employee’s annual salary into an
17        account. This account has interest credited to it annually based on the 30-year
18        Treasury rates. Non-bargaining employees hired prior to January 1, 2012 and
19        bargaining employees hired prior to January 1, 2011 are eligible for the 10
20        percent Pension Equity Plan (the PEP), which results in employees receiving
21        10 percent of their highest 48 months of consecutive earnings.              Other
22        formulas exist for small groups of employees as a result of plan changes that
23        have been made in the past, including the Traditional formula which was not
24        available to non-bargaining employees hired after December 31, 1998 and not
25        available to bargaining employees hired after December 31, 2010; bargaining
26        employees hired between January 1, 2000 and December 31, 2010 were
27        provided a choice between the Traditional and the PEP.

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1
2    Q. WHAT       WOULD BE THE CONSEQUENCES IF THE              COMPANY     NO LONGER

3         OFFERED A DEFINED BENEFIT PLAN?

4    A.   In my opinion, eliminating the benefit would not be in the best interest of the
5         Company or customers because it would result in a benefits package that is
6         below market and it would put the Company at a competitive disadvantage
7         with respect to recruiting and retaining its talent. Absent a defined benefit
8         plan, the Company would need to increase its rewards in other areas such as
9         compensation or an additional defined contribution retirement benefit, in
10        order to provide a competitive total rewards package.          Increasing other
11        rewards would not provide the same workforce management advantages and
12        economic efficiencies offered by a defined benefit plan and could result in
13        unintended consequences such as delayed retirements, increased active
14        medical costs, and productivity losses.
15
16                 III. DEFINED BENEFIT PLAN DESIGN CHANGES
17
18   Q. DO       COMPANIES PERIODICALLY CHANGE THE DESIGN OF THEIR RESPECTIVE

19        DEFINED BENEFIT PLANS?

20   A.   Yes.     Similar to Xcel Energy, many companies periodically review their
21        program design to ensure it is meeting their objectives and workforce needs.
22        But, while we have seen changes in the design of the defined benefit plans
23        offered, the existence of the defined benefit plan is still common in the utility
24        industry. It is also important to note that while a company can change the
25        benefits that are earned in the future, the benefits that the employee has
26        earned to the point of the change may not be eliminated or changed.
27

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1   Q. WHY DOES A COMPANY CHANGE THE DESIGN OF ITS DEFINED BENEFIT PLANS?
 2   A.   Changes in the competitive market as well as industry trends generally drive
 3        the plan changes made by employers. Similarly, changes in a company’s
 4        overall business strategy that impacts its long-term workforce strategy will also
 5        result in changes to a defined benefit program. Finally, legislative and IRS
 6        driven changes in the rules governing pension plans have provided a major
 7        impetus in companies changing their plan designs.
 8
 9   Q. HAS    THE   COMPANY    MADE ANY DESIGN CHANGES TO ITS DEFINED BENEFIT

10        PLAN?

11   A.   Yes, the Company has made several changes throughout the years.               As
12        referenced in Table 12 of Ms. Figoli’s Direct Testimony, the Company has
13        transitioned over time from a traditional final average pay annuity formula to a
14        10 percent Pension Equity formula and then to the current five percent cash
15        balance formula.
16
17   Q. DO YOU KNOW WHY THE COMPANY CHANGED THE DESIGN OF ITS DEFINED
18        BENEFIT PLAN?

19   A.   As discussed by Ms. Figoli in her Direct Testimony, the Company periodically
20        reviews the retirement program and makes changes to align with market
21        changes and the Company’s workforce strategy.
22
23   Q. HAVE OTHER COMPANIES MADE DESIGN CHANGES FOR SIMILAR REASONS?
24   A.   Yes. The market continues to evolve and companies review their programs
25        periodically. Over time, we have seen a movement toward cash balance plans,
26        which are more understandable and valued by employees. At the same time,
27        we have seen a reduction in the commitment to retirement programs overall in

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1         terms of the level of benefits provided (both defined contribution and defined
2         benefit). The recent design changes by the Company are consistent with both
3         of these trends.
4
5    Q. IS XCEL ENERGY’S             DESIGN     STRATEGY      CONSISTENT      WITH    INDUSTRY

6         PRACTICES?

7    A.   Yes. Towers Watson performed a study in 2011 and 2012 to examine changes
8         in pension benefit programs over the past decade3. The study provides insight
9         into how companies approach retirement program design strategy in general
10        and defined benefit plan transitions, in particular.          The types of defined
11        benefit strategies studied fell into three broad categories:
12            1) Closed the plan: Under this approach, the defined benefit plan is not
13               available to new hires after a certain date. New hires after a certain date
14               were provided a defined contribution plan.
15            2) Froze the plan: Under this approach, the defined benefit plan benefit is
16               “frozen” for all employees for service after a certain date. Therefore,
17               current employees stop accruing additional benefits and the defined
18               benefit plan is not available to new hires after that date.
19            3) Changed to a new design: These companies changed from a traditional
20               annuity based formula based on an employee’s final average pay and
21               service to an account-based or “hybrid” formula, similar to what the
22               Company has put in place for their new hires.
23
24        The study showed three things: 1) utilities were less likely to make any changes
25        than general industry over this period; 2) approximately 60 percent of utilities

     3Pensions in Transition: Retirement Plan Changes and Employer Motivations, 2012 Towers Watson
     Report, see Exhibit___(GHW-1), Schedule 4.

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1            continue to provide a defined benefit plan; and 3) when utilities made a
2            change, the most common approach was to change the program for new hires
3            after a certain date. Table 1 below summarizes some of the findings.
4                                                         Table 1
                                                                Broad Industry             Utilities
            Pension Changes4
                                                                (391 employers)        (37 employers)
            No change in the last decade                              28%                   42%
            Changed to new defined benefit design                    12%                     18%
            Froze the plan for all employees                         40%                     16%
            Closed the plan to new hires                             20%                     24%
5
6    Q. WHY          ARE UTILITIES LESS LIKELY TO CHANGE THEIR PENSION PLANS THAN

7            COMPANIES IN GENERAL INDUSTRY?
8    A.      The utility industry has several unique workforce characteristics and challenges
9            that present more risk when changes are made than in other industries.
10           Specifically, stability of the workforce and orderly transitions are critical to
11           providing safe, reliable service. Dramatic retirement program changes in the
12           latter part of an employee’s career can result in unanticipated or accelerated
13           retirements and significant employee engagement challenges. In addition, the
14           high concentration of unionized employees affects the industry’s ability to
15           make significant, rapid changes to the pension benefits because such changes
16           generally require the union’s agreement. If the union is unwilling to accept
17           such changes, changing only the non-union design can potentially increase
18           unionization efforts and company costs, and it can limit the company’s ability
19           to transition employees from union jobs to non-union supervisory positions.
20

     4   Summary excludes employers that changed to a defined contribution plan prior to the last decade.

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1    Q. WHY       ARE ACCELERATED RETIREMENTS POTENTIALLY DISRUPTIVE TO THE

2         BUSINESS?

3    A.   In highly specialized industries, if there is not sufficient time and planning to
4         ensure appropriate knowledge transfer, accelerated and unpredictable
5         retirements can result in instability in the delivery of services. In contrast,
6         other industries with less technical or specialized skills may have different
7         workforce needs. For example, many employers in the manufacturing sector
8         have different workforce requirements and very different external business
9         pressures. In this past recession, many of these employers were faced with the
10        need for significant reductions in their domestic workforce. Therefore, making
11        more dramatic plan changes that could ultimately result in accelerated
12        retirements actually supported what they were trying to accomplish as a
13        business. The utility industry is different. It is not prudent to introduce this
14        type of workforce risk into a utility business model where customers expect
15        and require consistent, reliable service.
16
17   Q. IN THE TABLE ABOVE IT APPEARS THAT 16 PERCENT OF UTILITIES FROZE THEIR
18        PLAN.   WHY DO YOU THINK THAT IS?
19   A.   Pension freezes in the utility industry happen generally with smaller utilities.
20        In this study, half of the utilities that froze their plans had fewer than 5,000
21        participants in the plans. None of the utilities with over 20,000 participants,
22        like the Company, froze their plan.         There are several reasons for this,
23        including workforce attributes and business strategy. For example, smaller
24        utilities are typically those in more rural communities where the utility may be
25        one of the larger employers in the area thereby leading to less competition for
26        those critical skill employees.
27

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1    Q. IN   THE TABLE ABOVE IT ALSO APPEARS THAT             24   PERCENT OF UTILITIES

2         CLOSED THE PLAN. WHY DO YOU THINK THAT IS?

3    A.   Again, we see most of this activity in the smaller utilities for the same reasons
4         cited above. In fact, there were no utilities with more than 20,000 participants
5         that closed their plan. Most of the plan closures were done by utilities with
6         less than 5,000 participants.
7
8    Q. WHEN      A COMPANY CHANGES ITS PLAN DESIGN, AS             18   PERCENT OF THE

9         UTILITIES IN THE SURVEY DID, HOW DOES IT TRANSITION EMPLOYEES TO THE

10        NEW DESIGN?

11   A.   There are multiple transition strategies that companies use. The transition
12        strategy chosen by a company depends on the circumstances driving the
13        changes, the organization’s relationship with its employees, the workforce
14        make-up, the significance of the changes, the overall business conditions, and
15        the competitive environment. The least disruptive method is to only change
16        the benefits for new hires after a certain date. Other approaches include: (1)
17        providing employees a choice between the old program and the new program;
18        (2) “grandfathering,” which means segmenting the population and providing
19        the new benefits to one segment of the population and maintaining the
20        current benefits for a different segment of the population; and (3)
21        transitioning all employees to the new benefit formula. A company that
22        selects the third option will often provide additional benefits, which are
23        referred to as “transition benefits,” to segments of its workforce or to the
24        entire workforce to lessen the impact of the benefit changes for the
25        employees.
26
27   Q. WHAT MIGHT INFLUENCE A COMPANY’S DECISION ON HOW TO TRANSITION?

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1    A.   As stated above, the transition strategy chosen by the company depends on a
2         number of factors, including the circumstances driving the benefit changes,
3         the organization’s relationship with their employees, the workforce make-up,
4         the significance of the changes, the overall business conditions, cost
5         considerations, and the competitive environment. Companies in industries
6         experiencing rapid change with significant financial and competitive pressures
7         often take a more aggressive transition approach. For example, a company in
8         the automotive industry needing to rapidly reduce costs and employee
9         headcount may need to take an abrupt approach toward transition and simply
10        freeze all benefits, knowing that the subsequent exit of large groups of
11        employees would be aligned with the business strategy.
12
13   Q. WHY WOULD A COMPANY CHOOSE TO DRAW OUT THE TRANSITION PROCESS?
14   A.   Employers with many long-service employees often take a less aggressive
15        approach, perhaps grandfathering employees who are closer to retirement or
16        providing a choice of benefit programs.        In addition, employers with
17        workforces that are heavily unionized or in industries where it is critical to
18        have workforce stability through the change process will generally use a more
19        gradual approach, such as changing benefits for new hires only or providing
20        significant transition benefits. A more gradual approach reduces the risk of
21        unplanned retirements, workforce relations and engagement issues, or adverse
22        union relations that can disrupt the company’s operations.          A gradual
23        approach also increases the likelihood of union acceptance of the new benefit
24        program.
25
26   Q. ARE    THERE ANY OTHER REASONS A COMPANY WOULD NOT WANT TO MAKE

27        THE TRANSITION MORE QUICKLY?

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1    A.   Yes. There are significant legal requirements for qualified plans that choose to
2         transition current employees to a new formula and those legal requirements
3         can complicate the administration, compliance, and communication of the
4         benefit programs.      Employers must also consider the resources and
5         infrastructure required to administer, communicate and ensure compliance of
6         the programs as transition strategies are evaluated. In fact, with the passage of
7         the Pension Protection Act in 2006 (PPA), transition requirements for hybrid
8         plans, in particular, changed dramatically, significantly impacting how
9         employers transition to these types of plans.
10
11   Q. WHAT IS THE MOST COMMON APPROACH TO TRANSITIONING EMPLOYEES TO A
12        NEW PENSION DESIGN?

13   A.   As previously noted, the requirements under the PPA created some very
14        complex rules for transitioning current employees to a hybrid pension plan,
15        such as the one used by the Company for its new hires. As a result of these
16        changes in the rules, companies are less likely to transition current employees
17        than they were prior to the implementation of PPA.
18
19   Q. IS THE COMPANY’S TRANSITION STRATEGY APPROPRIATE FOR ITS BUSINESS?
20   A.   Yes. I believe the approach taken by the Company is appropriate for its
21        business and is consistent within the industry. In particular, the make-up of
22        the workforce, including long-service employees and a heavily unionized
23        workforce, and the need for effective succession planning and knowledge
24        transfer make the approach they have taken reasonable and reflective of sound
25        business judgment.

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1
2                      IV. PENSION DESIGN COMPLIANCE ITEM
3
4    Q. DID THE COMMISSION REQUIRE THE COMPANY TO ADDRESS CERTAIN DESIGN
5         CHANGES FOR ITS DEFINED BENEFIT PLAN?

6    A.   Yes. In Order Point 45 from Docket No. E002/GR-12-961, the Commission
7         directed the Company to provide the following information:
 8               In the initial filing of its next rate case, Xcel shall discuss the
 9               extent of any and all of its exploration and evaluation of
10               freezing, or otherwise amending, prior pension benefits and
11               extending the application of the five percent Cash Balance
12               pension fund formulary to its veteran active employees hired
13               prior to introduction of this formulary benefit (for both the
14               non-bargaining and bargaining unit employees).
15
16   Q. THE COMMISSION’S         ORDERING POINT MENTIONS           “FREEZING.”      PLEASE
17        DEFINE “FREEZING” AS IT PERTAINS TO DEFINED BENEFIT PLANS.

18   A.   When a company freezes a plan it means that the employees participating in
19        the plan no longer accrue any benefits – that is, their benefits cease to grow
20        with continued service and compensation increases. The employee continues
21        to be eligible for the benefit that he has earned at the point the plan is frozen,
22        but the benefit will not increase.
23
24   Q. IN   YOUR EXPERIENCE WHEN DOES A COMPANY ELECT TO                    “FREEZE”   ITS

25        DEFINED BENEFIT PLAN?

26   A.   As discussed earlier, companies in industries experiencing rapid change with
27        significant financial and competitive pressures may look to freeze their
28        pension benefits. For example, a company in the automotive industry needing
29        to rapidly reduce costs and employee headcount may need to take an abrupt
30        approach toward transition and simply freeze benefits, knowing that the
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1         subsequent exit of large groups of employees would be aligned with the
2         business strategy.
3
4    Q. WHAT     CONSEQUENCES HAVE YOU SEEN A COMPANY EXPERIENCE WHEN IT

5         “FREEZES” ITS DEFINED BENEFIT PLAN?
6    A.   That depends on the context of the change and the relationship the company
7         has with employees. For example, if a plan is frozen in response to significant
8         financial distress, such as a looming bankruptcy or potential headcount
9         reductions, the employees’ reactions can be fairly muted as employees
10        understand the ramifications of not taking the dramatic action. In situations
11        where there are not such dire external forces, freezing a pension plan can
12        result in significant workforce disruption, employee relations and engagement
13        challenges, and lost productivity. In several situations, employees have taken
14        the company to court over pension changes.
15
16   Q. CAN    YOU PROVIDE A SPECIFIC EXAMPLE WHERE FREEZING A PENSION PLAN

17        WAS ACCEPTED BY THE WORKFORCE?

18   A.   Chrysler recently announced they were freezing their pension plan and it
19        appears to have been somewhat of a non-event, at least based on outward
20        appearances and media coverage.      Given the recent changes and turmoil
21        within the industry and the closing of the Chrysler pension plan to new
22        employees ten years earlier, the announcement was likely not a surprise to the
23        workforce.
24
25   Q. PLEASE PROVIDE A SPECIFIC EXAMPLE WHERE FREEZING A PENSION PLAN WAS
26        NOT WELL ACCEPTED BY THE WORKFORCE.

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1    A.   In 2011, 45,000 Verizon workers walked off the job for a two-week long strike
2         to protest a pension freeze that was proposed as part of their union
3         negotiations. In the final deal, the parties agreed to change benefits for future
4         hires (the approach taken by the Company).
5
6    Q. THE COMMISSION’S        ORDER ALSO MENTIONS AMENDING THE              COMPANY’S
7         DEFINED BENEFIT PLANS.       WHAT    DOES   “AMENDING”     A DEFINED BENEFIT

8         PLAN MEAN TO YOU?

9    A.   When a company amends a defined benefit plan, it means that it is modifying
10        the benefit. Similar to a pension freeze, the employee continues to be eligible
11        for the benefit that he has earned at the point the plan is amended, but the
12        benefit for future service may be different from what was provided under the
13        old plan formula.
14
15   Q. IN   YOUR EXPERIENCE WHEN DOES A COMPANY ELECT TO                   “AMEND”    ITS

16        DEFINED BENEFIT PLAN?

17   A.   As companies monitor the changes in the markets, they will often amend the
18        plan in response to industry trends and changes in the retirement program
19        offerings of peer companies. These amendments can be minor changes to the
20        benefit levels or more dramatic design changes that reflect evolving workforce
21        strategy or business conditions.
22
23   Q. WHAT     CONSEQUENCES HAVE YOU SEEN A COMPANY EXPERIENCE WHEN IT

24        “AMENDS” ITS DEFINED BENEFIT PLAN?
25   A.   It again depends on the circumstances and the magnitude of the change. A
26        more dramatic change can have a similar impact to a pension plan freeze,

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1         including workforce disruption, employee relations issues and lost or reduced
2         productivity.
3
4    Q. CAN YOU PROVIDE A SPECIFIC EXAMPLE WHERE AMENDING A PENSION PLAN
5         WAS ACCEPTED BY THE WORKFORCE?

6    A.   When the Company introduced the Pension Equity Plan (PEP) formula in
7         1999, the company offered its employees a choice between the PEP and the
8         traditional annuity program offered at the time. The change to the new
9         program was carefully designed to address the needs of the employees and the
10        business. The employees were offered communication and educational tools
11        to assist with the decision and the transition was well received by employees
12        and recognized in the national media.
13
14   Q. PLEASE    PROVIDE A SPECIFIC EXAMPLE WHERE AMENDING A PENSION PLAN

15        WAS NOT WELL ACCEPTED BY THE WORKFORCE.

16   A.   In 2012, Consolidated Edison workers were locked out of their jobs for
17        almost four weeks as the union demanded that the company maintain their
18        existing health and benefits structure, while the company proposed moving
19        employees hired after July 1, 2001 into the cash balance plan. In the end,
20        management agreed to maintain the benefit through at least July 1, 2037. In
21        another highly visible case, IBM employees sued the company when they
22        attempted to move employees from a traditional defined benefit plan to a cash
23        balance plan. The case went all the way to the U.S. Supreme Court after a
24        four year battle through the courts.
25
26   Q. DO YOU THINK IT WOULD BE A GOOD IDEA FOR THE COMPANY TO AMEND OR
27        FREEZE THE TRADITIONAL AND PEP DEFINED BENEFIT PLANS?

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1    A.   No. Changing the pension would create several risks for the Company. A
2         pension change, particularly for the large number of employees close to
3         retirement, would run the risk of dis-engaging the employees. Many of those
4         employees might choose to leave or retire, creating succession planning and
5         knowledge transfer issues, potentially resulting in service disruptions and
6         safety issues. Those that choose to stay would likely do so at lower levels of
7         productivity, depending on their levels of engagement. In addition, unless the
8         Company was able to negotiate the change with the union, the change could
9         lead to further unionization efforts, which could result in higher costs. To
10        mitigate these risks, the Company would need to offer significant transition
11        benefits or other forms of compensation to those close to retirement, which
12        would, in turn, increase the costs.
13
14   Q. WHAT WOULD BE IN THE IMPACT TO XCEL’S LONGER-SERVICED EMPLOYEES IF
15        THEY WERE CHANGED TO THE FIVE PERCENT CASH BALANCE FORMULA?

16   A.   Many of them would suffer at least a 50 percent decrease in their future
17        pension accruals and possibly more depending on their age, service with the
18        Company, and pension formula. Such a change would be devastating to their
19        pension benefits.
20
21   Q.   DO YOU THINK IT WOULD BE A GOOD IDEA FOR THE COMPANY TO AMEND OR
22        FREEZE ITS FIVE PERCENT CASH BALANCE PLAN?

23   A.   No. As stated in Ms. Figoli’s testimony, the Company reviewed the industry
24        trends when evaluating the recent defined benefit plan changes, which showed
25        that the Company’s retirement program, including the five percent cash
26        balance plan is well within market, if not slightly below the median, for the

                                                22            Docket No. E002/GR-13-868
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1         industry. Amending or freezing the five percent cash balance plan would put
2         the Company at a competitive disadvantage in attracting qualified candidates.
3
4    Q. DURING     PRIOR ELECTRIC RATE CASES, THERE HAS BEEN SOME DISCUSSION

5         ABOUT    RETROACTIVELY       CONVERTING       THE    COMPANY’S     PEP     AND

6         TRADITIONAL DEFINED BENEFIT PLAN TO THE FIVE PERCENT CASH BENEFIT
7         PLAN. DO YOU THINK THIS WOULD BE A GOOD IDEA?
8    A.   No. In fact, benefits cannot be changed retroactively under the Internal
9         Revenue Code (IRC) and ERISA, the rules governing qualified pension plans.
10        The benefits can be changed for service going forward, but the benefit that
11        the employee has earned to the date of the change may not be taken away.
12
13   Q. WHAT DO YOU MEAN THAT THE BENEFIT “MAY NOT BE TAKEN AWAY”?
14   A.   At retirement, the employee must still receive, at a minimum, the benefit that
15        the employee was entitled to receive at the date of the change.
16
17              V. ACCOUNTING METHODS AND ASSUMPTIONS
18
19   Q. WHAT SPECIFIC TOPICS DO YOU COVER IN THIS SECTION OF YOUR TESTIMONY?
20   A.   I address four topics. First, I provide a background on the professional
21        standards and processes for selecting actuarial assumptions and explain that
22        the Company’s approach is consistent with these requirements. Second, I
23        describe the accounting methodologies used by the Company for calculating
24        pension cost and the reason they are appropriate from a ratemaking
25        perspective.   Third, I address the apparent and unintended consequences
26        created for the Company in calculating its pension costs when the Minnesota
27        Public Utilities Commission ordered changes to the Company’s actuarial

                                               23              Docket No. E002/GR-13-868
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1         assumptions in the 2012 electric rate case.          Lastly, I explain that the
2         Company’s accounting of gains and losses, including the 2008 market loss, are
3         consistent with industry best practices.
4
5         A.     Actuarial Assumptions
6    Q. ARE THERE UNIQUE CONSIDERATIONS FOR ESTABLISHING ANNUAL COSTS FOR
7         PENSION PLANS?

8    A.   Yes. While pension plans pay benefits to retired participants who are in
9         payment status today, there are also active employees who are earning benefits
10        that will be paid in the future and former employees with vested benefits that
11        will also be paid in the future. Determining the plan sponsor’s liability for
12        these obligations and assigning a cost to the current year requires the
13        projection of future benefit payments and the discounting of those future
14        benefit payments back to the current date.
15
16   Q. IS THIS DIFFICULT TO DO?
17   A.   Yes. It is difficult to predict how long people are going to work, their future
18        pay, the trajectory of their respective careers, and how long they will live.
19
20   Q. WHAT     ASSUMPTIONS MUST BE MADE IN CALCULATING AN ANNUAL PENSION

21        COST/LIABILITY?

22   A. Companies must select actuarial assumptions for the occurrence of future
23        events that will affect the determination of the amount of plan benefits for the
24        participants, when they will be paid in the future, and the length of time they
25        will be paid. Future events include demographic changes such as mortality,
26        disability, employment termination, and anticipated retirement dates. Future
27        events also include economic forecasts for a variety of factors such as

                                                24               Docket No. E002/GR-13-868
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1         inflation, salary increases, and expected future returns on bonds and plan
2         investments. These assumptions are set by the plan sponsor in consultation
3         with their actuaries and other advisors.
4
5    Q. CAN A PLAN SPONSOR PICK ANY ACTUARIAL ASSUMPTION IT WANTS?
6    A.   No, for several reasons. First, plan sponsors are not motivated to arbitrarily
7         pick actuarial assumptions because their costs will not be reflected accurately.
8         Second, the accounting standards board, the actuarial standards board, and
9         federal agencies have detailed guidelines on the selection of actuarial
10        assumptions. For purposes of determining the liabilities, funded status, and
11        annual costs for pension plans, the two primary areas of focus for these
12        governing bodies are cash funding requirements and company accounting.
13        For cash funding, IRS rules require specific methods and assumptions be used
14        to determine liabilities and annual funding requirements for pension plans as
15        well as annual reporting to various government agencies.         For company
16        accounting, U.S. Generally Accepted Accounting Principles (U.S. GAAP)
17        requires specific methods and assumptions that must be followed for
18        company financial reporting of liabilities for the balance sheet and annual cost
19        for the income statement under the standard for pension accounting for
20        financial reporting purposes, ASC 715 (also known as SFAS 87).
21
22   Q. WHAT     IS THE TYPICAL PROCESS USED BY A PLAN SPONSOR FOR SELECTING

23        ACTUARIAL ASSUMPTIONS?

24   A.   For company accounting, the Financial Accounting Standards Board (FASB)
25        has issued extensive guidance on assumption selection for purposes of
26        company financial statements. Based on guidance from the FASB, the plan
27        sponsor is responsible for the selection of actuarial assumptions.         It is

                                               25              Docket No. E002/GR-13-868
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1         common for the plan’s actuary to assist in the assumption selection process,
2         particularly in providing documentation that supports the selection.       In
3         addition, the company auditors also need to approve the actuarial
4         assumptions, so there needs to be sufficient evidence supporting that the
5         selected assumptions are reasonable.      Actuaries are bound by Actuarial
6         Standards of Practice, including those that pertain to measuring pension
7         obligations and the assumption selection process. When evaluating a
8         prescribed assumption or method selected by the plan sponsor, actuaries must
9         consider whether the assumption or method significantly conflicts with what,
10        in their professional judgment, would be reasonable for the purpose of the
11        measurement. If there is a significant conflict, actuaries must disclose the
12        conflict in appropriate communications.
13
14   Q. HOW DOES THE COMPANY SELECT ITS ACTUARIAL ASSUMPTIONS?
15   A.   Based on my review of Company witness Mr. Mark P. Moeller’s testimony,
16        the Company follows the process described above.
17
18   Q. DO YOU BELIEVE THE COMPANY’S APPROACH IS CONSISTENT WITH INDUSTRY
19        PRACTICES?

20   A.   Yes.
21
22   Q. DO       YOU BELIEVE THIS ASSUMPTION SETTING PROCESS IS ALSO APPROPRIATE

23        FOR DETERMINING PENSION COSTS IN RATE CASES?

24   A.   Yes. Given the complexity of the actuarial calculations and the importance of
25        the assumptions to the cost determination, the process has the following
26        benefits:

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1            • It is driven by external guidelines and standards of practice that ensure
2               reasonable assumptions are chosen.
3            • It produces assumptions consistent with the economic environment
4               from year to year.
5            • It produces assumptions in line with other organizations thereby
6               producing pension and benefit plan related financial results across
7               industries and companies that are more comparable such that real
8               economic differences in the health and funding of plans is more readily
9               apparent.
10
11   Q. DO    YOU THINK IT IS A GOOD IDEA FOR STATE REGULATORY COMMISSIONS,

12        SUCH AS THE   MINNESOTA PUBLIC UTILITIES COMMISSION,        TO REQUIRE THE

13        USE OF DIFFERENT ACTUARIAL ASSUMPTIONS (NOT U.S. GAAP)?

14   A.   No. When a commission requires the use of different, or non-standard,
15        assumptions, the Company is required to actuarially determine its pension cost
16        under three methods, U.S. GAAP under FAS 87, funding requirements as
17        determined under the IRC, and a new method as required under the order.
18        This is because non-standard assumptions are contrary to the FASB’s design
19        for SFAS87 and the IRS’ design for funding. This new method will result in
20        annual differences between the cost basis used for company financial
21        reporting, funding and ratemaking. The annual differences between these
22        methods can grow over time and become quite significant relative to the
23        company financials, creating doubts with the Company auditors that it will be
24        recovered and raising the concern for impairment.

                                              27              Docket No. E002/GR-13-868
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1
2         B.     SFAS 87 and Aggregate Cost Method
3    Q. WHAT       ACCOUNTING METHODS DOES THE           COMPANY     USE FOR ITS PENSION

4         PLANS?

5    A.   The Company has two pension plans for which it seeks to recover the costs
6         through base electric rates: (1) NSPM Plan and (2) XES Plan. The Company
7         uses the Aggregate Cost Method (ACM) to account for the NSPM Plan costs,
8         and SFAS 87 for the XES Plan costs. Both the ACM and SFAS87 are
9         established methods that have been used for pension cost measurements for
10        decades with well-documented guidance on their application including the
11        setting of assumptions in IRS regulations, FASB guidance, and requirements
12        published by professional actuarial organizations.
13
14   Q. COULD YOU BRIEFLY DESCRIBE THE ACM?
15   A.   Under the ACM, annual pension cost is calculated as a level percent of
16        covered payroll for participants for all future years. The actuary first calculates
17        the plan liabilities based on specific actuarial assumptions such as the discount
18        rate, projected salary levels, and mortality.     Then, the plan liabilities are
19        compared to the plan assets. If the liabilities exceed the assets, the unfunded
20        amount is expensed over the future working lives of current employees as a
21        level percentage of pay. If the assets exceed the liabilities, then the annual
22        pension cost is zero.
23
24        Each year, the actuary updates the liabilities and assets to the current year, and
25        re-calculates the updated annual pension cost. The difference between actual
26        liabilities and assets and expected liabilities and assets since the prior year is
27        brought into the annual pension cost through this annual update.

                                                28               Docket No. E002/GR-13-868
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1
2         The original economic intent behind this method was to take a long-term
3         benefit commitment that could have short term volatility and spread the cost
4         evenly over employee’s careers. It also allowed for “phasing in” asset gains
5         and losses over a period of time (typically five years) further reducing the
6         volatility from investment performance. I will discuss the phasing in further
7         below.
8
9    Q. WHY DOES THE NSPM PLAN USE THE ACM?
10   A.   As Mr. Moeller explains in his Direct Testimony, SFAS 87 became the new
11        standard for pension accounting for financial reporting purposes in 1987,
12        subject to the effects of rate regulation as provided for by SFAS 71. SFAS 71
13        allowed regulated entities, such as NSPM, to reflect the “rate actions of a
14        regulator” and the “effects of the rate-setting process” by regulatory agencies,
15        such as the Commission. The authority provided by SFAS 71 allowed NSPM
16        to continue using the ACM for ratemaking purposes, as it had been before
17        1987. NSPM is a rate-regulated public utility that has used the ACM since
18        1975, and is allowed to report its pension expenses under a different method if
19        that method is used for regulatory purposes (under SFAS 87 and SFAS 71).
20
21   Q. COULD YOU BRIEFLY DESCRIBE THE SFAS 87 METHOD?
22   A.   SFAS 87 is an accounting standard adopted by the Financial Accounting
23        Standards Board in 1987 to govern employers’ accounting for pensions.
24        Among the many objectives behind SFAS 87 were: a) the intention to require
25        all companies to use a consistent method; b) improve the financial disclosures
26        in the company financial statements for pensions; and c) provide a market-
27        based value for assets and liabilities in the disclosures specifically including the

                                                29                Docket No. E002/GR-13-868
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1      requirement that the discount rate for plan liabilities be based on current
2      prices for settling the plan liabilities. This last item is very important as the
3      FASB did not want plan liabilities using a discount rate that included an
4      expected return for equity risk. This is also consistent with changes required
5      by Federal agencies in measuring plan liabilities. Lastly, SFAS 87 preserved
6      many techniques for sponsors to minimize cost volatility from year-to-year
7      including amortizing gains/losses and phasing-in asset gains/losses.
8      Under SFAS 87, pension cost is made up of five components:
9         1) the present value of pension benefits that employees will earn during
10            the current year (service cost);
11        2) the increase in the present value of the pension benefit obligation
12            (PBO) that plan participants have earned in previous years (interest
13            cost);
14        3) the investment earnings that are expected to be earned during the year
15            on the pension plan assets (expected return on assets – EROA);
16        4) recognition of costs (or income) from experience that differs from the
17            assumptions, (e.g., investment earnings different than assumed or
18            amortization of unrecognized gains and losses); and
19        5) recognition of the cost of benefit changes the plan sponsor provides for
20            service the employees have already performed (amortization of
21            unrecognized prior service cost).
22
23     One other important attribute of SFAS 87 is that plan sponsors in surplus
24     were required to recognize pension income.
25
26   Q. WHY   DOES THE   XES PLAN      USE   SFAS 87   FOR DETERMINING ITS PENSION

27     COSTS?

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                                                                           Wickes Direct
1    A.   As Mr. Moeller testified, the XES Plan was not formed until the Xcel Energy
2         merger in 2000 (long after SFAS 87 was adopted), and XES is not a rate-
3         regulated enterprise; thus, it cannot apply SFAS 71 principles, and instead
4         must use SFAS 87 to determine its pension cost.
5
6    Q. DO    THE   ACM   METHOD AND      SFAS 87   METHOD USE THE SAME ACTUARIAL

7         ASSUMPTIONS?

8    A.   Generally, but there is one key difference in the assumptions used under each
9         method.    The key difference is the discount rate used to calculate plan
10        liabilities. Under the ACM as used by the Company, the discount rate is a
11        longer-term rate and is set to equal the expected rate of return on plan assets.
12        SFAS 87 uses a discount rate based on a bond-matching approach, which is
13        recalculated on an annual basis to most accurately value the liability at a point
14        in time using current period information. As a result, SFAS 87 discount rates
15        create more volatility in the value of the pension liability, and as a further
16        result, more gains and losses resulting from those valuation changes.
17
18        I have included a summary and comparison of these methods in
19        Exhibit___(GHW-1), Schedule 2).
20
21   Q.   DO THESE DIFFERENCES CAUSE YOU ANY CONCERNS THAT THE                COMPANY’S
22        PENSION COSTS ARE NOT ACCURATELY DETERMINED?

23   A.   No. The ACM in conjunction with the authority provided by SFAS 71 and
24        SFAS 87 are both are well-established methods that with an economic basis
25        for calculating an annual pension cost over the life of a pension plan.

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1         C.      Discount Rate and EROA
2    Q. DID    YOU REVIEW THE     COMMISSION’S     ORDER REGARDING DISCOUNT RATES

3         AND EROA FROM THE COMPANY’S PRIOR ELECTRIC RATE CASE?

4    A.   Yes. The Order provided that the discount rate used to determine XES Plan
5         test-year qualified pension cost for ratemaking should be based upon the
6         expected return on plan assets (EROA).
7
8    Q. DO YOU HAVE ANY CONCERNS ABOUT THE COMMISSION ORDER TO SET THE
9         DISCOUNT RATE FOR THE     XES PLAN EQUAL TO THE ASSUMED ASSET RETURN
10        RATE?

11   A.   Yes. If carried forward in this case, the new non-standard method will result
12        in annual differences between the cost basis used for company financial
13        reporting and ratemaking with a bias toward understating liabilities and true
14        economic costs in the ratemaking process. The annual difference that Mr.
15        Moeller references will persist and accumulate to a significant accumulated
16        difference over time, again creating doubts with the Company’s auditors that
17        the difference will be recovered and raising the concern for impairment.
18
19   Q. DO      YOU   PREDICT    FURTHER     ACCOUNTING      COMPLICATIONS      IF   THE

20        COMMISSION    CONTINUES TO MAKE ONE-OFF ACTUARIAL ADJUSTMENTS IN

21        THIS OR FUTURE RATE CASES?

22   A.   Yes. Any one-off adjustments in actuarial assumptions that create differences
23        between the Company’s U.S GAAP accounting and costs for ratemaking
24        creates doubts with the Company’s auditors that the difference will be
25        recovered and raise concern for impairment.

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1         D.       2008 Market Loss
2    Q. ARE       YOU AWARE OF THE SIGNIFICANT LOSSES IN VALUE SUFFERED BY THE

3         NSPM PLAN AND XES PLAN DUE TO THE 2008 FINANCIAL MARKET CRASH?
4    A.   Yes.
5
6    Q. HOW       DO THE ACCOUNTING METHODS USED BY THE            COMPANY     TREAT ASSET

7         GAINS OR LOSSES SUCH AS THE 2008 MARKET LOSS?

8    A.   Both the ACM and SFAS 87 allow for spreading the cost of asset gains and
9         losses over future years. This is an intentional rationale underlying these
10        methods because pensions are considered a long-term ongoing commitment.
11        Each year, it is expected that there will be gains and losses. It is important to
12        note three critical factors regarding the recognition of asset gains and losses: 1)
13        asset gains or losses are “phased-in” over a period (not to exceed five years);
14        2) once they are phased-in, the gain or loss is amortized in the annual pension
15        cost over the future working life of the active participants for SFAS 87 and
16        using the 20-year amortization basis for the ACM; and 3) to determine the
17        amount to be amortized, all gains and losses are accumulated together. The
18        impact of this process is to allow for gains and losses to offset each other over
19        time, to minimize economic volatility in annual pension cost, and to the extent
20        that gains or losses persist, to recognize them over time in the annual pension
21        cost.
22
23   Q. WHAT IS MEANT BY “PHASING-IN” OF ASSET GAINS AND LOSSES?
24   A.   Phasing in of asset gains and losses means that only a portion of a particular
25        gain or loss is reflected in the plan assets for purposes of determining annual
26        cost. For example, the 2008 market loss is recognized in plan assets for
27        determining annual costs as follows: 20 percent in 2009; 40 percent in 2010;

                                                33               Docket No. E002/GR-13-868
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1         60 percent in 2011; 80 percent in 2012; and finally in 2013 and beyond the full
2         2008 market loss is recognized in plan assets for determining annual costs. In
3         this example, a significant loss will lead to a pattern in annual pension cost that
4         increases over the five years, and then gradually declines over subsequent
5         years, assuming no further gains or losses have occurred.
6
7    Q. IS “PHASING-IN” OF ASSET GAINS AND LOSSES A COMMON PRACTICE?
8    A. Yes. In Towers Watson’s 2012 year-end survey of 154 large pension plan
9         sponsors, half of the sponsors used a phasing-in approach for asset gains and
10        losses. In the same survey, 71 percent of the 17 utilities used the phasing-in
11        approach.
12
13   Q. WHAT IS MEANT BY “THE GAIN OR LOSS IS AMORTIZED INTO ANNUAL PENSION
14        COST?”

15   A.   Once an asset gain or loss is “phased-in” to the asset value, a portion of the
16        gain or loss is recognized in the annual cost as defined under the method.
17        This approach gradually recognizes the gain or loss in the income statement.
18
19   Q. YOU MENTION A THIRD CRITICAL FACTOR, THAT WHEN YOU DETERMINE THE
20        AMOUNT TO BE AMORTIZED, ALL GAINS AND LOSSES ARE ACCUMULATED

21        TOGETHER.    WHY IS THAT IMPORTANT?
22   A.   The amount of gain or loss that is subject to amortization each year is the
23        accumulated amount for all events that have not been previously recognized in
24        the cost. This means that subsequent gains and losses can have the effect of
25        offsetting each other, thereby reducing volatility attributable to any single
26        event. For example, the 2008 market losses experienced by all plan sponsors
27        may have already been reduced by subsequent asset gains.

                                                34               Docket No. E002/GR-13-868
                                                                               Wickes Direct
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