Direct Testimony and Schedules Gene H. Wickes
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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
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
i Docket No. E002/GR-13-868
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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.
1 Docket No. E002/GR-13-868
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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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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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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.
5 Docket No. E002/GR-13-868
Wickes Direct1 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
6 Docket No. E002/GR-13-868
Wickes Direct1 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
7 Docket No. E002/GR-13-868
Wickes Direct1 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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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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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
10 Docket No. E002/GR-13-868
Wickes Direct1 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
11 Docket No. E002/GR-13-868
Wickes Direct1 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.
12 Docket No. E002/GR-13-868
Wickes Direct1 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.
13 Docket No. E002/GR-13-868
Wickes Direct1 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
14 Docket No. E002/GR-13-868
Wickes Direct1 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?
15 Docket No. E002/GR-13-868
Wickes Direct1 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?
16 Docket No. E002/GR-13-868
Wickes Direct1 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.
17 Docket No. E002/GR-13-868
Wickes Direct1
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
18 Docket No. E002/GR-13-868
Wickes Direct1 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.
19 Docket No. E002/GR-13-868
Wickes Direct1 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,
20 Docket No. E002/GR-13-868
Wickes Direct1 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?
21 Docket No. E002/GR-13-868
Wickes Direct1 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
Wickes Direct1 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
Wickes Direct1 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
Wickes Direct1 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
Wickes Direct1 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:
26 Docket No. E002/GR-13-868
Wickes Direct1 • 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
Wickes Direct1
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
Wickes Direct1
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
Wickes Direct1 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?
30 Docket No. E002/GR-13-868
Wickes Direct1 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.
31 Docket No. E002/GR-13-868
Wickes Direct1 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.
32 Docket No. E002/GR-13-868
Wickes Direct1 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
Wickes Direct1 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
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