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BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION
OF IDAHO POWER COMPANY FOR
AUTHORITY TO INCREASE ITS RATES
AND CHARGES FOR ELECTRIC SERVICE
TO ELECTRIC CUSTOMERS IN THE STATEOF IDAHO CASE NO. IPC-O3-
IDAHO POWER COMPANY
DIRECT REBUTTAL TESTIMONY
BRADLEY FOWLER
Would you please state your name, business
address, and present occupation?
My name is Bradley Fowler, and my business
address is Milliman USA, Sui te 3800, 1301 5 th Avenue, Seattle
I am a Principal and Consulting ActuaryWashington 98101.
specializing in pensions and employee benefits.
What is your general educational background?
I graduated from the Uni versi ty of Washington
in Seattle in 1969 with honors, receiving a Bachelor of
Science degree in, Mathematics.In 1971, I received a Master
of Arts degree from Cornell University in Mathematics.
1979, I completed The Management Program in the Business
Department of the Uni versi ty of Washington.
What is your professional educational
background?
The highest-level professional designation in
the actuarial profession is Fellowship in the Society of
This is obtained through a series ofActuaries.
examinations covering actuarial mathematics, principles of
insurance and employee benefi ts, investments, economics,
taxation, insurance and benefi t law, accounting and
financial reporting, model building, underwriting, benefit
plan design , and plan funding.During the period when I was
pursuing the examinations, there were nine examinations,
requiring an average of 300 to 400 hours of study for
FOWLER, Di-Reb
Idaho Power Company
successful completion of each exam.I completed my
Fellowship in 1976.Wi th the passage of the Employee
Retirement Income Security Act (ERISA) of 1974, actuaries
practicing in the area of pension plans were required to
become Enrolled Actuaries under ERISA to certify plan
funding to the IRS as required annually.I became an
My enrollment number is 02-3089.Enrolled Actuary in 1980.
In order to maintain my status as an Enrolled Actuary, I am
required to complete a minimum of 30 hours of continuing
education in supervised settings during each three year
I have completed this continuing education throughperiod.
seminar attendance, and presenting seminars to others.
have also made presentations to clients and other
professionals on topics such as pension funding, pension
accounting, and proj ection of pension funding and expense
I am also a member of therequirements into the future.
American Academy of Actuaries since 1978 Thi s is the body
that develops qualification standards for its members to
sign statements of actuarial opinion, such as those
supporting the pension expense and obligation measurements
reported by companies like Idaho Power in their annual
reports to shareholders.
would you outline your business experience?
Milliman USA is an international firm of
Mi 11 imanactuaries and consultants with 1800 employees.
FOWLER, Di-Reb
Idaho Power Company
provides actuarial and administration services to many
pension plan sponsors, including Idaho Power Company.
began working for Milliman USA, then called Milliman and
Robertson, in Seattle as a summer student in 1966, and I
continued working part time until 1972 when I joined
In 1974, I transferred to M&R Services,Milliman full time.
the data processing company of Milliman responsible for
large scale actuarial system development, and for operating
In 1979, I became thethe firm s mainframe computer center.
Chief Operating Officer of M&R Services.In 19 8 4,
returned to Milliman as an actuary and consultant in the
I was elected a Shareholder ofretirement practice.
Milliman in 1985, and a Principal in 1987.I began working
as the senior consultant and actuary for Idaho Power Company
in 1986, and have had responsibility for the actuarial
valuation of the Idaho Power Company Pension Plan since
I am a senior Principal in the Seattle Employee1987.
Benefi ts practice wi th management responsibility for several
maj or practice areas in addition to my consulting role.
primary consulting relationships are with corporate clients
similar to or larger than Idaho Power Company, and with
several large non-profit hospitals.
What services do you provide to Idaho Power
and its pension plan that are related to the Company
current revenue requirement filing?
FOWLER, Di-Reb
Idaho Power Company
In my role as Idaho Power s plan actuary, I
supervise the annual valuation of the pension plan
The valuation process measures the expectedliabilities.
payouts that will be due to participants from the plan,
using census data and assumptions regarding how long
participants are expected to work for Idaho Power, their
rates of salary growth, their expected lifetime following
retirement, and other contingencies affecting the amount of
The valuation results are measured under thebenefits due.
FAS 87 required methods and assumptions for use in financial
reporting in Idaho Power s financial statements, and
separately under the IRS required methods and assumptions
for tax deductibility and minimum contribution purposes.
sign the report that is used by Idaho Power and relied upon
by their auditors supporting pension expense in the
I also sign the annual actuarialfinancial statements.
report and filings made to the IRS under ERISA, certifying
that minimum contribution levels have been met.I consul t
with Idaho Power regarding forecasts of future pension
expense and pension contributions, and recommend changes to
assumptions when appropriate.
What is the purpose of your testimony in this
proceeding?
The purpose of my testimony is to offer
expert opinion on the pension cost items in Idaho Power
FOWLER, Di-Reb
Idaho Power Company
filing and to respond to Staff witness Mr. Donn English'
recommendation that the Commission exclude all pension
expense from Idaho Power s revenue requirement.
Idaho Power used the Service Cost methodology
to compute its pension cost in this case.Wha t is your
opinion regarding the use of Service Cost as the basis for
pension cost recovery?
Service Cost computed on the basis ,of' the
assumptions used for financial reporting represents a fairly
stable measure of the value of benefits being earned each
It is often used to convey the value of the plan toyear.
participants, because it is independent of experience gains
and losses, and is relatively stable as a percentage of
However, for the purpose of utility ratecovered payroll.
making, Service Cost does not include several other
important costs of providing the pension benefits.These
are the financing cost, which is the net effect of interest
cost on liabilities offset by investment income on plan
assets, and the cost of gains or losses due to experience
more or less favorable than assumed.Gains and losses occur
from assets earning more or less than assumed, retirees
living longer than assumed, salaries growing more slowly or
more rapidly than assumed, etc.In my opinion, the
financing cost, and the cost of gain or loss experience are
appropriately shared by the Company and its customers The
FOWLER, Di-Reb
Idaho Power Company
impact of these elements may be either to lower total cost
below the Service Cost, or raise it above Service Cost.
What is the most important characteristic to
consider in selecting a method for recognizing the cost of
pension benefits in utility rate making?
Consistency is the primary characteristic
that should be present in the treatment of pension cost for
By consistency, I mean consistency from onerate making.
This is also a primaryrate filing to the next.
characteristic necessary for measurement of pension costs
for financial reporting purposes, and was one driver behind
the development of FAS 87, the accounting standard required
for financial reporting purposes.
What basis for measuring the cost of pension
benefi ts do you believe is appropriate for utility rate
making purposes?
I support the use of FAS 87 Net periodic
Pension Cost as the best measure of pension costs for rate
making purposes, because it is a publicly disclosed and
audited value, controlled by a well defined and consistent
This view is supported by the directaccounting standard.
FAS 87 was specifically developedtestimony of Mr. English.
to create consistency of measurement from period to period,
and to facilitate comparison of pension costs on a
consistent basis from one company to another.Therefore, I
FOWLER, Di-Reb
Idaho Power Company
support using the net periodic pension cost included in the
Company s rate filing of $7,018,000, the net periodic
pension cost is the value prior to application of the
service cost adjustment proposed by the Company.Removing
the service cost adjustment results in a reduction of
170,160 from the Company s proposed pension expense
To that extent I agree that the adjustment proposedamount.
by Mr. English is appropriate.
Does consistency mean that the Net periodic
Pension Cost is stable from period to ,period?
Changes in prevailing interest rates,No.
rates of inflation, rates of return on plan assets, and
other experience will impact the amount of the Net periodic
Large changes will impact the pension costPension Cost.
The recent downward changes in interestsignificantly.
rates and large losses on pension assets have had a major
upward impact on pension expense for virtually all plans.
But the underlying methodology and discipline for
measurement, for selection of assumptions, and for
recogni tion of gains and losses is consistent.The
consistent use of Net periodic Pension Cost also avoids
significant discretionary adjustments because of the public
and audited nature of the values.
Mr. English proposes to adjust Idaho Power
pension cost by an additional $1,379,148.Wha t is your
FOWLER, Di - Reb
Idaho Power Company
opinion regarding this additional Staff adjustment to
pension cost?
The rationale provided by Staff for this
addi tional adjustment is invalid, and represents a
misunderstanding of the requirements of FAS 87.As reported
by Mr. English, the discount rate for 2003 was reduced from
00% to 6.75% and the future expected return on plan assets
was reduced from 9.00% to 8.50%.These changes resulted in
an increase in pension expense for Idaho Power.However,
these changes in assumptions were fully consistent with the
Milliman tabulated FAS requirements of FAS 87.
assumptions for 2003 for the largest 100 companies in the
The median discount rate used by these companies forus.
2003 was 6.75%, down from a median of 7.25% in 2002.The
median assumed long term rate of return on assets for these
100 companies declined from 9.50% in 2002 to 9.00% in 2003.
Additionally, the 2004 Greenwich Associates report states
that the mean reduction in rate of return on plan assets of
032 corporate pension plans between 2002 and 2003 was .40%
from 8.9% to 8.5%, as seen on Exhibit No. 70.The size of
Idaho Power s Plan is better represented in the Greenwich
Associates data which places Idaho Power at their median.
In general, smaller companies with smaller plans tend to use
slightly lower assumptions than the largest funds (Fortune
100 companies), in part because they incur greater
FOWLER, Di-Reb
Idaho Power Company
investment expenses as a percentage of assets.
Is changing actuarial assumptions common?
Under FAS 87, it is not only common, but
required that the assumptions be re-examined annually.The
discount rate under FAS 87 is defined as the rate of
interest at which the obligations could be settled,
prevailing on or close to the measurement date for financial
This means that in an environment of rapidlystatements.
falling interest rates, such as occurred from 2002 to 2003,
it was required that companies change their discount rate.
98 of the 100 largest companies in our study reduced their
discount rate from 2002 to 2003.The assumed long-term rate
of return on assets assumption is changed less often than
annually by most companies.Due to the fall in interest
rates over several years, and the fall in inflation,
however, it became increasingly hard for companies to
support the long-term rate of return assumptions used in
2001 and 2002 with the asset mix in the plans.This is
because yields on bonds, comprising for most plans 35% to
40% of the portfolio, had dropped into the 4% range.From
2002 to 2003 the great majority of companies reduced their
long-term rate of return assumptions on pension plan assets.
Under the conditions described, would a
change in the investment policy of the pension plan be
needed to justify a reduction in the assumed return?
FOWLER, Di - Reb
Idaho Power Company
No. The basis for the reduction rested on the
fall in interest rates and inflation, not on a change in the
asset mix.
Mr. English asserts that it is unusual or
irregular for the Company to document in a letter to the
Company s actuaries, Milliman USA, their choice of financial
assumptions for FAS 87 reporting purposes.Is he correct?
No. It is in fact appropriate and routine.
FAS 87 requires that the assumptions used for measuring
pension obligations and pension expens,e in 'the financial
statements of the Company represent management's best
estimate, subj ect to the requirements of FAS 87 for
selection of assumptions.This is consistent with the
general requirements of financial reporting, that the annual
statement is the report of management.The role of the
actuary is to advise the Company on their selection of
assumptions by providing advice on what we believe is
appropriate under the requirements of FAS 87 for the current
year, the actions of other similarly situated organizations,
and data on external relevant measures, such as bond yields
Ultimately, it is the Company s decisionand annui ty rates.
The actuary is required in ourwhat assumptions to use.
report to state that we believe the reported results based
on these assumptions meet the requirements of FAS 87.I did
that on behalf of Milliman for Idaho Power Company for 2003.
FOWLER, Di - Reb
Idaho Power Company
The assumptions the Company selected were entirely
consistent with our recommendations, and with our
Further, therecommendations to other clients we serve.
entire annual report was subj ect to review by the Company'
auditors.
Is the responsibility for selection of
assumptions different for reports to the IRS under ERISA?
Yes.Under ERISA, the Enrolled Actuary and
not the Company is responsible for th~ selection of
actuarial assumptions, and must certify that they represent
The definition of thethe actuary s best estimate.
assumptions used under ERISA differs from the requirements
under FAS 87, and the ERISA assumptions are changed less
frequently.
What is your opinion about the Staff'
proposed final reduction of $5,638,851 to pension expense?
I do not support the third adjustment.This
adjustment abandons FAS 87 Net periodic Pension Cost
entirely as the basis for rate making, and substitutes the
The critical need for usingcash contribution methodology.
a consistent methodology from year to year is disregarded
when the pension cost allowed is switched from a FAS
basis in one rate filing to a cash basis in the next.
Why is FAS 87 Net periodic Pension Cost for
the Idaho Power pension plan currently higher than the
FOWLER, Di-Reb
Idaho Power Company
required cash contribution?
There are two primary reasons.
(1) The liabilities under FAS 87 are measured
using a 6.75% discount rate for 2003.For cash
contributions, liabilities are measured using an 8% discount
rate.The FAS 87 basis produces a higher value for the
liabili ties in the current interest rate environment.For
many years after the initial adoption of FAS 87, this
relationship was reversed.The discount rate for FAS 87 was
higher than the rate used for cash contributions.
(2) Idaho Power uses market value of assets
for determining their Net periodic Pension Cost, and a
smoothed value of assets for computing the cash
contribution.At the beginning of 2003, the market value
was $282 million , while the smoothed value was $339 million.
The smoothed value recognizes gains and losses on plan
investments over a period of five years I so much of the very
bad asset performance in 2000-2002 was not yet reflected in
the cash contribution calculation.However, those losses
are still to be phased into that calculation.In tha
sense, the FAS 87 cost is more up to date, because the
effect of the losses is more completely reflected.
Will the FAS 87 Net periodic Pension Cost
always remain higher than the cash contribution amount?
Looking at the period from 1986 when FASNo.
FOWLER, Di-Reb
Idaho Power Company
87 was adopted through 2003, a period of 18 years, Idaho
Power s contribution exceeded the Net periodic Pension Cost
(NPPC) in 12 years, and was less than NPPC in 6 years.The
years where NPPC was higher have been primarily times when
the discount rate was low, and/or asset performance was poor
The times when cash contributionsrelative to assumptions.
have been higher have been times when the discount rate was
high and/or asset returns were well above assumptions.
Is the cash contribution method recommended
by Mr. English less subj ect to discretion than the FAS
Net periodic Pension Cost?
No, there is a greater level of discretion in
The IRS permits several differentthe cash contribution.
For a particular year, different methodsfunding methods.
produce different levels of minimum contributions.The IRS
allows companies to change methods every five years without
approval , and in certain cases more often wi th approval.
The IRS allows companies to use a smoothing method on plan
Companies may change assetassets or to use market value.
methods wi thou t approval every five years.
In many years, the calculation of the minimum
and maximum cash contributions produces a very large range.
The Company has the opportunity to select the amount of
their contribution within this range, and may vary their
contribution considerably from year to year.
FOWLER, Di-Reb
Idaho Power Company
All of these factors make the cash
contribution method recommended by Mr. English less stable
and consistent in methodology from year to year than the FAS
87 Net periodic Pension Cost.
Why not simply allow the lesser of the cash
contribution and the Net periodic Pension Cost?
This is the equivalent of saying to the
Company, heads I win, tails you lose. The size of ,the cash
contribution and the Net Periodic Pension Cost will vary
differently from year to year , but over time, both
calculations reflect the size of the benefits actually paid
Any over or under estimate madeout to plan participants.
along the way becomes an adjustment to amounts needed in
Taking the lower of the two results is afuture periods.
method that will not ultimately pay the cost of the
benefi ts, because the cumulative amounts considered will be
less than the amounts calculated under either a cash method
or a FAS 87 method.
What is prepaid pension expense?
Prepaid pension expense represents the
cumulative amount since the adoption of FAS 87 by which cash
contributions to the Idaho Power Pension plan have exceeded
So it representsthe recorded Net periodic Pension Cost.
the excess of funding over what has been expensed.
Is prepaid pension expense an asset of the
FOWLER, Di-Reb
Idaho Power Company
Company?
Yes, under generally accepted accounting
principles, as defined by FAS 87.Under FAS 87, the amounts
recognized as Net periodic Pension Cost are by definition
the proper allocation of pension cost to current and past
I f the Company has paidperiods for accounting purposes.
more cash into the plan than the amount of NPPC recognized,
they have prepaid pension benefit cost, and there ,is' an
expectation that this will be reversed in some future
period, with expense exceeding the contribution.The asset
is not a claim on investments that are inside the pension
trus t .As described by Mr. English, plan assets may not
easily be removed by the Company due to ERISA law.The use
of plan assets is limited to providing benefits to plan
participants until all the promised benefits have been
The prepaid pension expense asset is a creditdelivered.
for having given up cash in excess of the NPPC.That cash
did not get charged as an expense, so i t represents the
exchange of one asset, cash, for another asset, the prepaid
pension expense.
Why should this asset be included in the rate
base?
It is aThis asset represents a use of cash.
consequence of providing a pension plan for employees,
following the required rules for funding the plan, and
FOWLER, Di-Reb
Idaho Power Company
recording the expense of the plan on the Company s books.
The pension plan is an important benefit for attracting and
retaining the employees needed to provide reliable electric
service to the Company s customers.In addi tion, the
prepaid pension expense was allowed as an asset in the
Company s last rate filing (Case No. IPC-94-5).
Mr. English calculates Idaho Power s 15-year
average annual rate of return in its pension fund at 12.97%
and states that his calculated return , was below the DJIA,
S&P 500 and the NASDAQ wi th returns of 13.89%, 15.02% and
Mr. English opines that the investment21.6%, respectively.
results of Idaho Power s pension fund are no better than the
performance of the general market.Do you agree wi th that
opinion?
I do not agree with that assessment.First
of all, Mr. English compares Idaho Power's pension fund
return against stock market index averages.This is not an
appropriate comparison , as a prudent pension fund normally
holds 35% to 40% in fixed income securities like bonds and
Secondly, as a part of creatingonly 60% to 65% in stocks.
our annual Actuary s Report Milliman USA calculates a rate
of return based on the change in fund assets from period to
Idaho Power s investment performance hasperiod.
consistently been among the best of all of the pension plans
I review.
FOWLER, Di - Reb
Idaho Power Company
Mr. Fowler, can you summarize your rebuttal
testimony?
Staff wi tness Mr. English advocatesYes.
making three downward adjustments to the Company s test year
pension expense and removing the entire prepaid asset from
ra te base.I disagree with the reduction of $1,379,148
based on recalculating the 2003 pension expense at a higher
rate of return on plan assets of 9%, the removal of
$5,638,851 of the remaining FAS 87 Net periodic Pension Cost
to equate FAS 87 pension expense to zero, ahd the removal of
the prepaid pension asset of $17,800,477 from rate base.
do agree with Mr. English's reduction in pension expense in
the amount of $2,170,160 which results from not applying the
Company s 2003 Service Cost adjustment to the 2003 FAS
Net periodic Pension Cost of $7,018,000.
Does this conclude your rebuttal testimony in
this case?
Yes, it does.
FOWLER, Di - Reb 1 7
Idaho Power Company
BEFORE THE
IDAHO PUBLIC UTiliTIES COMMISSION
CASE NO. IPC-03-
IDAHO POWER COMPANY
EXHIBIT NO. 70
B. FOWLER
Actuarial Earnings Rate of Return
On Plan Assets
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