OCA-T-3
Docket No. RZOOO-1
DIRECT TESTIMONY
OF
EDWIN A. ROSENBERG
ON BEHALF OF
THE OFFICE OF THE CONSUMER
MAY 22,200O
ADVOCATE
Page
TABLE OF CONTENTS
I.
STATEMENT
II.
PURPOSE
III.
RECOMMENDATION
IV.
FACTORS
. . . .. . . .. . .. . . .._....................................,..........
AND SCOPE OF TESTIMONY
__.____.__,.,..,..,..,................................. 2
.,.,.,.._,,...._....................,..,..,.,.....,.....................................
CONSIDERED
Conditions
1
IN RECOMMENDATION
3
. . .. . .. . .. . .. .. . .. .. . .. . .. . .. . . .. . . .. . .. . 7
A.
Economic
B.
The Recent Financial Success of the Postal Service
.. .. .. . . . .. . . . .. . . . 11
C.
The Postal Service’s Ability to Forecast is Improving
12
D.
The Existence
15
E.
The Requested
Increase in the Contingency
Provision Is a
Major Component in the Revenue Deficiency and Should Be
Justified .. . .. . . . .. .._.._.._..............................................................................
F.
V.
OF QUALIFICATIONS
Are Relatively Stable __..........................................
of Other Safety Net Provisions ___...................................
B.
17
Other Analytical
20
Methods are Available
PROVISIONS
,.,.......,......_..............................
LARGER CONTINGENCY
VII.
OTHER REASONS
NOT TO INCREASE
THE CONTINGENCY
PROVISION .. . . .. . ..__.__.......................................................................................
B.
17
The Requested 2.5 Percent Lies Outside the Range of the
Variance Results ..,,..,......,...,......,....,......,.,..,.,..,.,..................................
VI.
A.
15
Many Potential Sources of Expense and Revenue Variation are
Accounted for in the Estimated Revenues and Expenses . . . . . . .. . . .. . . . 16
THE REQUEST
FOR A CONTINGENCY
PROVISION
OF 2.5
PERCENT
IS NOT SUPPORTED
BY THE POSTAL SERVICE’S
VARIANCE ANALYSIS _......,,,.....,...,.,.,..,.,...........,....,....,..,..............................
A.
7
ARE NOT PREFERABLE
The Extra $1 Billion Needed to Increase the Contingency
Provision Is Not Costless .. .. . .. . . .. . ..._..._..................................................
22
23
23
Shortening the Rate Cycle Can Allow for a Smaller Contingency
Provision . . .. . . .. . .. . .. . .. . .. .. . .. .. . .. . .. . .. . .. . . .. . . .. . . .. . .. . .. . .. . .. . .. . .. . .. .. .. . .. . .. . .. . . .. . . .. . . 24
Docket No. R2000-1
VIII.
OCA-T-3
C.
The Contingency Provision Should Not Be Used to Restore The
Equity Account . .. . .. . . .. . .. . .. . .. . .. . .. . .. . .. .. .. . .. . .. .. . . .. . .. . . .. . .. . .. . . .. . .. . .. . .. . .. . . .. .. .. . 26
D.
Increasing the Contingency
CONCLUSION
Provision May Be Counterproductive..........
28
. .. . . .. . . . . . . . .. . .. .. . .. .. . . . . .. .. . .. .. .. . . .. . . . .. .. . . . . .. . . . . .. .. . 29
UNITED STATES OF AMERICA
Before The
POSTAL RATE COMMISSION
WASHINGTON, D.C. 20268-0001
Postal Rate and Fee Changes,
2000
Docket No. R2000-1
1
DIRECT TESTIMONY
OF
EDWIN A. ROSENBERG
1
I.
STATEMENT
OF QUALIFICATIONS
My name is Edwin A. Rosenberg.
2
3
Regulatory
4
the National Association
5
located at The Ohio State University in Columbus,
6
provide
7
Commission.
research
Institute (henceforth,
of Regulatory
and advice
authored
Utility Commissioners
1994, I offered testimony
11
487-TP-ALT.
12
Ohio
to members
of NARUC,
13
regulation,
14
Staff of the Commission
(NARUC).
to an alternative
to shift to from
form of regulation
sponsored
The NRRI is
such as the
regulatory
before the Public Utilities Commission
Company
in 1976 by
Postal
During that time I have authored
In that case, I, along with NRRI colleagues,
Bell Telephone
by The National
Ohio, and its primary mission
a number of reports and papers concerning
10
employed
NRRI), which was established
I have been at The NRRI since 1991.
8
9
Research
I am an economist
issues.
evaluated
cost-of-service,
in that case
Rate
or co-
In addition,
in
of Ohio in Case No. 93-
- in this case,.price-cap
my testimony
is to
a request
by the
or rate-of-return
regulation.
The
Docket No. R2000-1
1
OCA-T-3
Prior to joining The NRRI, I taught economics
2
North Carolina at Asheville
3
an economist
4
Staff of that Commission.
5
on a variety of issues concerning
6
utilities in North Carolina.
7
Carolina
9
Philosophy
10
on the Staff of the North Carolina
II.
11
at Asheville
In that capacity I performed
(1971)
the regulation
analyses
and the Public
and offered testimony
of electric, natural gas, and telephone
of Arts degree in Economics
a Master of Economics
degree in economics
from the University of North
degree
(1973) and a Doctor of
(1985) from North Carolina State University
PURPOSE AND SCOPE OF TESTIMONY
12
the reasonableness
13
provision
14
authority
15
that:
of the United States Postal Service’s
in the amount
of 2.5 percent
for such a contingency
provision
of test-year
Advocate to consider
request
revenues
for a contingency
in this Docket.
The
is found in 39 U.S.C. §3621, which states
Postal rates and fees shall provide sufficient revenues so that the total
estimated income and appropriations to the Postal Service will equal as
nearly as practicable total estimated costs of the Postal Service.
For
purposes of this section, “total estimated costs” shall include (without
limitation) operating
expenses,
depreciation
on capital facilities and
equipment, debt service (including interest, amortization of debt discount
and expense, and provision for sinking funds or other retirements of
obligations
to the extent that such provision
exceeds
applicable
depreciation charges), and a reasonable provision for contingencies.’
1
of
Prior to that, I was
Utilities Commission
Robert Burns and I were asked by the Office of Consumer
16
17
18
19
20
21
22
23
24
at the University
and at North Carolina State University.
I received a Bachelor
8
and statistics
Emphasis added
-2-
OCA-T-3
Docket No. R2000-1
1
Thus, the question
2
rather, whether the amount requested
3
Ill.
4
there should be a provision for contingencies
but,
is reasonable.
RECOMMENDATION
I believe that an increase in the contingency
5
one percent
8
necessary
7
interest.
8
reasonable
9
existing
10
is not whether
of total estimated
for the continued
provision from the existing level of
costs to 2.5 percent of total estimated
successful
operation
costs is neither
of the Postal Service nor in the public
Such an increase would tend to raise rates charged for postal services above
levels given the costs incurred
contingency
provision
At this time, the
by the Postal Service.
of one percent
of total estimated
expenses
should be
continued.
11
I have formed my opinion as a result of the application
12
public
policy and regulatory
13
testimony
principles
and evaluation
of a combination
of USPS Witness
15
regulation.
16
that
Tayman’s
and exhibits.2
The rates of the Postal Service are set using basic principles
14
of sound
of cost-of-service
This principle is found in 39 U.S.C. 53621, which, as noted earlier, states
Postal rates and fees shall provide sufficient revenues so that the total
estimated income and appropriations
to the Postal Service will equal as
nearly as practicable total estimated costs
. and a reasonable provision
for contingencies.
17
18
19
20
2
USPS-T-9.
-3-
Docket No. R2000-1
OCA-T-3
1
Thus, rates should be just sufficient to cover estimated
2
unforeseen
or uncontrollable
3
reasonably
sufficient to do so.
4
circumstances,
The form of rate regulation
expenses
but they should
and allow for some
not be more than
is
applied to the Postal Service is a variant of a form of
5
regulation that has been applied in various public utility sectors in the United States for
6
many years.
7
criticisms.
8
regulated firms to minimize costs, the interaction
9
lag (causing rates to tend to lag costs during periods of rising costs), and prohibitions
Though
These
10
against
retroactive
11
losses
incurred
12
shortcomings
13
the Postal Service.
14
widely applied, cost-of-service
included
its “cost plus” nature
ratemaking
when
(barring
revenues
in cost-of-service
First, in determining
was subject to many
and lack of strong incentives
firms
cover
total
from
recovering
economic
Several
costs).
of these
regulation are avoided in the specific application
the level of test-year
15
revenue deficiency,
16
Indeed. in estimating
17
begin with an historical
18
adjustments
19
historical
20
especially
on an “after
21
projections
of Postal Service management.
for
of historical test years and regulatory
regulated
did not
regulation
estimated
expenses,
form to
revenues,
and
the Postal Service is not required to use a strict historical test year.
test-year
to account
base year.
22
Second,
23
revenue and expense
revenues and expenses,
base
period
and make
for factors that are known
Thus, the estimated
in addition
rates”
basis,
revenues
represent
the Postal Service is allowed to
many pro forma or “roll-forward”
or expected
and expenses
the
best
a reasonable
-4-
provision
the
for the test year,
available
to allowing for pro forma adjustments
accounts,
to occur outside
estimates
or
to arrive at test-year
for contingencies
is added to
Docket No. R2000-1
1
the forecast
2
the estimated
3
and uncontrollable
4
OCA-T-3
revenue requirement.
revenues and expenses
Third,
factors that adversely
if the estimated
5
contingency
6
deficit can be recovered
7
recovery
8
losses should be minimized,
9
that future customers
revenues
provision should, therefore,
miss the mark due to unforeseen,
and expenses
are way off target,
11
for the Postal Service.
turn out to be too small, the resulting operating
basis through
transfer to the extent
the existence
of this provision
opportunity
provides an additional
has three different
level of protection
levels of protection
13
with a reasonable
14
providing
good
15
testimony
and exhibits
16
incomes, or is projected to do so, in each year from 1995 through 2000.’
service
regulatory
19
process
20
projection
21
and their implementation.
to meet its goals of breaking
to consumers
point this out.
regulatory
18
3
the use of the
Of course, reliance on recovery of prior years’
since this creates an inter-temporal
Thus, the Postal Service
Although
and the
are asked to pay costs that rightly belong to today’s customers.
Nevertheless,
17
unexpected,
affect revenues and/or expenses,
in the future on an amortized
of prior years’ loss provision.
10
12
This provision provides some safety margin should
incentives
even financially
Indeed,
for managers
USPS-T-g, p. 3-4.
-5-
positive
the existence
to minimize
costs.
and there is a lag between
of the need for an increase in the general
During this period, managers
while
Mr. Tayman’s
has posted
to be a deficiency,
postal rates is time consuming,
or realization
rates.
The Postal Service
lag is often considered
lag can act to provide
of resetting
at reasonable
that provide it
net
of
The
the
level of postal rates
are likely to find themselves
in
Docket No. RZOOO-1
OCA-T-3
1
the position of having to make decisions to hold down costs so that the Postal Service
2
is able to come as close as possible to its break even target.
3
to be a good thing, since managers
4
controlling
5
efficient, and economical
6
costs.
7
opinion,
8
adverse fluctuations
9
adjust historical
a form
for a contingency
of insurance
provision
against
in revenues
11
So the contingency
12
reasonably
13
serves,
14
contingency
15
provides less of a cushion,
16
contingency?
in the revenue requirement
unforeseen,
unexpected,
and/or expenses.
data to reflect known or projected
nevertheless,
provision
be forecasted
implicitly,
changes
or foreseen.
analysis
consider the following factors:
19
1)
contingency
21
economy.
between
postal
more of a cushion;
of the optimum
Of particular
39 U.S.C. 5 3621.
-6.
is, in my
uncontrollable
is allowed
that are not accounted
to
rate increases.
a smaller
for.
that could not
of its cushioning
contingency
effect, it
A larger
provision
is: What is the optimum size of the
size of a contingency
and types of uncertainties
provision.
because
The essential question
18
20
In addition,
the time
provides
The magnitude
“honest,
in revenues and expenses;
serves as a cushion against occurrences
to lengthen
provision
and
The Postal Service
there will almost certainly be some fluctuations
A disciplined
4
that the Postal Service will exercise
management.“4
10
17
should be in a position of having to seek ways of
Indeed, It is presumed
The allowance
This may be considered
that necessitate
concern
provision
the existence
would
of a
in this regard is the state of the
Docket No. R2000-1
1
2)
The historical experience
2
provision.
3
provisions?
4
3)
OCA-T-3
How
of the Postal Service with respect to its contingency
has the
Postal
Service
under
The short-run and long-run effects of the contingency
5
either too large or too small.
6
a) On the Postal Service and its managers
7
b) On the customers
8
After considering
9
considers
the contingency
existing circumstances-and
increase
percent
12
contingency
13
have come to this opinion based on consideration
14
IV.
of total
provision
expenses
FACTORS CONSIDERED
16
One major purpose
Economic Conditions
errors and unforeseen
18
revenues
and/or expenses.
19
economic
conditions
20
future
21
revenues
22
would
at this time,
and a
should be allowed.
I
of a number of factors.
provision
is to ensure
against forecast
events that have adverse consequences
Other things being equal, relatively favorable
at present and forecasts of reasonable
and expenses
from one
Are Relativelv Stable
and uncontrollable
can be expected
be expected
expenses
provision
IN RECOMMENDATION
of the contingency
17
may be set at a level that
is not necessary
provision of one percent of total estimated
A.
provision turning out to be
in the contingency
11
15
contingency
balances the various interests involved.
the requested
to 2.5 percent
various
of the Postal Service
these factors,
In my opinion,
10
fared
to strengthen
to be more reliable
to forecast
basis, so the Postal Service’s estimates
now than in more uncertain
-7-
and stable
stability over the near-term
the ability of the Postal Service
on a going forward
on
times.
More
OCA-T-3
Docket No. R2000-1
1
accurate
2
contingencies.
3
forecasts
or estimates would tend to allow for a relatively smaller provision for
At the present time, the United States is operating
4
inflation,
5
committed
6
federal
funds
7
Tables
1, 2, and 3 present
8
Congressional
9
DRI for 2000 and 2001.
and
the
Federal
Reserve
Board,
to hold inflation at moderate
rate are pre-emptive
Budget
levels.
strikes
excerpts
Office, Deutsche
The historical
10
Figure
11
moderate
12
for 2000 and 2001 taken from Table 3.
1 and there is reasonable
through 2001.
Chairman
Alan
against
nascent
inflationary
macroeconomic
price inflation
is
in the target
pressures.
forecasts
Bane Alex. Brown, and Standard
path of consumer
low
Greenspan,
Indeed, recent increases
from recent
consensus
I have included
under
in a climate of relatively
by the
and Poor’s
is shown
that inflation is likely to continue
in
to be
DRl’s April 2000 forecast of CPI inflation rates
Figure 1
CPI Inflation 1970 - 2001
Historical Data from Table 4
Estimates for 2000 and 2001 from Table 3
-8-
Docket No. R2000-1
OCA-T-3
Table 1
Congressional Budget Office
Forecast for 2000 and 2001
Estimated
1
Forecasted
Variable
1 2001
1999
2000
Fourth Quarter to Fourth Quarter (Percentage change)
Source: Congressional Budget Office, The Budget and Economic
Outlook: Fiscal Years 2007-2070, released electronically on January
26, 2000.5
5
Accessed at http://www.cbo.gov/showdoc.cfm?index=l8248sequence=O&from=7,
-9-
May 11,ZOOO.
Docket No. R2000-1
OCA-T-3
Table 2
Deutsche Bane Alex. Brown
Economic Forecast
Variable
1 2000 1 2001
Annual Percent Change
CPI
Implicit Price Index
Real GDP
Unit Labor Costs (nonfarm)
Hourly Comp. (nonfarm)
Productivity (nonfarm)
2.7
1.8
3.8
0.8
4.4
2.0
1.6
4.0
1.8
4.7
3.5
2.8
Annual Average
~
Source: Deutsche
1 Varishln
.
.
.
..“_.”
Bane Alex. Brown’
Table 3
DRl’s Forecast for the U.S. Economy
I, 4aa0
9,
.““” ,I -000
1 2001
Annual Percent Rate of Change
1 Al
Real GDP
Source: Standard & Poor’s DRI, CONTROL0400
6
Dated May 5, 2000, http://www.yardeni.com, May I 1, 2000
-lO-
Forecast, April 2000
OCA-T-3
Docket No. R2000-1
1
The United States is currently enjoying the longest economic expansion
2
half a century.
We continue
3
relatively stable inflation.
4
responsibilities
to have robust economic
These conditions
growth combined
with low and
should allow the Postal Service to meet its
with a minimum provision for contingencies.
5
B.
6
The recent experience
The Recent Financial Success of the Postal Service
of the Postal Service is that it has been able to achieve a
7
positive net income over the two most recent rate cycles with a contingency
8
less than the 2.5 percent
9
Postal Service suggests that the 2.5 percent request is necessary.
requested.
Nothing
in the recent operating
Unlike some situations that the Postal Service has experienced
10
in over
provision
history of the
historically,
there
11
is no chronic or growing deficit resulting from an over forecast of revenues and/or under
12
forecast of expenses.
13
achieved
14
during FY 2000.
a positive
As shown in Mr. Tayman’s
net income in every year since 1995 and is projected
In fact, during the 1995 through
15
The contingency
cumulative
17
percent in Docket No. R94-1 and at one percent
18
since implementation
19
quite successfully
20
requested
8
net income
of $5.58 billion.’
of the rates approved
with
a contingency
to do so
2000 period, the Postal Service generated
16
7
Exhibit 9L,’ the Postal Service has
USPS Exhibit 9L.
Calculated from USPS Exhibit 9L.
-II-
in Docket No. R97-1.
was set at two
In each year
in R94-1, the Postal Service has operated
provision
in this Docket.
provision
a
less than the 2.5 percent
it has
Docket No. RZOOO-1
OCA-T-3
1
C.
2
During the period immediately
The Postal Service’s Abilitv to Forecast is Improving
subsequent
to the Postal Reorganization
3
1970, the Postal Service entered a new environment.
4
of experience
5
exercising
6
contingency
7
waters after its reorganization.
8
operating
in a more business-like
honest, efficient,
and economical
provision than was necessary
In addition, economic
conditions
Act of
It has now had nearly thirty years
manner,
Thirty years of experience
management,
in
by itself, justify a smaller
as the Postal Service sailed into uncharted
- especially
inflation rates - were much more
9
volatile and uncertain
in the 1970s and 1980s than they are today.
10
average, considerably
higher then than it has been recently or than it is expected to be
11
over the near-term future.
12
changes
Historical
inflation figures based on December-to-December
in the CPI for all urban consumers
are shown in Table 4.
The rate of inflation is a major area of uncertainty
13
14
contingency
provision.
15
relatively larger contingency
provisions.
17
1999 the Postal Service
18
Finance
19
forecasts.’
20
allow for a smaller contingency
9
function.
that leads to the necessity of a
Other things being equal, higher rates of inflation may justify
In addition to operating
16
Inflation was, on
in a relatively stable economic
created
a sixteen-person
forecasting
The goal of that group is to create
More accurate
climate,
in Fiscal Year
organization
more accurate
within its
and reliable
and reliable forecasts would tend to reduce uncertainty
provision.
Tr. 2/146
-12-
and
Docket No. RZOOO-1
OCA-T-3
Table 4
Consumer Price Index for All Urban Consumers:
1
Using the data shown in Table 4, I have calculated
2
annual
rates of change
3
averages
in the CPI for various
periods.
the simple averages
These simple or arithmetic
are shown in Table 5.
Accessed at http://www.stls.frb.org/fredldata/cpi/cpiaucns
-13-
of the
May 16. 2000,
OCA-T-3
Docket No. R2000-1
Table 5
Arithmetic Averages of Annual CPI
inflation Rates and Contingency Provision
Recommended
1, March 1981 to October
1990
3.5%
1991 1995
3.5%
2.79%
2%
1996 1999
2%
2.33%
1%
1
1988
R84-1, April 1988 to February
1991
R90-1, February 1991 to
December 1994
R94-1, January 1995 to January
1999
R94-1, January 1995 to January
1999
R97-1, January 1999 to present
Table 5 shows that the average rate of CPI inflation has generally been declining
2
since 1980.
3
provision
Table 5 also includes
recommended
information
by the Postal
on the time path of the contingency
Rate Commission
during
the various
time
The PRC recommended 2.5%, but the recommendation was appealed, and the effective
contingency provision was 3%.
11
-14-
OCA-T-3
Docket No. R2000-1
periods.
As can readily be seen here and in Figure 1, above, the time path of inflation
has both trended
lower and become
less erratic in recent years.
Both lower inflation
and less erratic inflation are factors that support a smaller contingency
is confirmed
in the downward
the contingency
trend of the contingency
7
D.
8
Remember
ensure
in Table 5.
that the contingency
the viability
estimates
11
management’s
12
Finally,
13
experiences
of the Postal
of revenues
and expenses,
note that the
the others
Postal
and the Postal Service’s
Service
revenue shortfalls and/or expense
Although
the recovery
being the use of pro forma
the provision for recovery of prior years’ losses,
ability to control expenses,
I would
is able to request
16
these additional
17
as to the appropriate
18
years’
19
provision would be larger.
ability to borrow.
new
rates
if it
increases that put it in jeopardy.
of prior years’ losses provision
should not be relied upon as substitutes
losses
provision is one of several built-in safety nets to
Service,
15
for the contingency
and borrowing
authority
provision, the existence of
safety nets may be taken into account when making a recommendation
size of the contingency
provision
20
21
E.
22
The increase
23
provision over time. To increase
The Existence of Other Safetv Net Provisions
10
14
This
provision from the current one percent to 2.5 percent would certainly
deviate from the past trend illustrated
9
provision.
nor borrowing
were
provision.
available,
If neither the recovery of prior
the appropriate
contingency
The Requested
Increase in the Contingency
Provision Is a Major
Component in the Revenue Deficiencv and Should Be Justified
in revenues
one percent to a contingency
necessary
provision
to move from a contingency
provision
of
of 2.5 percent is more than 27 percent of the
-15-
OCA-T-3
Docket No. R2000-1
1
revenue requirement
deficiency.
2
will be approximately
$3.7 billion
3
contingency
4
on an “after rates” basis, with an adjustment
5
percent of the total revenue
6
Docket should, I believe, require well reasoned justification;
7
necessarily
8
9
F.
Mr. Tayman states that “[t]he Test Year deficiency
.“”
On an “after rates” basis, the increase
reserve is, by itself, approximately
increase.14
$1 ,007,859,510.‘3
In fact, if calculated
for cost savings, the increase
An increase
of the magnitude
is over 36
sought
make it so.
Many Potential
Sources of Expense
Accounted for in the Estimated Revenues
of the provision for contingencies,
and Revenue
and Exoenses
Variation
In his discussion
11
12
13
Volume growth is below historical norms and projections of Fiscal Year
2000 require workyears be held at the Fiscal Year 1999 level while mail
volume and the delivery network continue to grow.‘$
15
16
17
in this
saying it is needed doesn’t
10
14
in the
Mr. Tayman notes that
Mr. Tayman also states that
Health benefit cost increases have now returned to near double digit
rates. Also, the labor contracts which have become effective since the
last rate tiling are significantly more costly than previous contracts.”
USPS-T-S, p. IO.
USPS-T-Q, p. 22, Table 15.
USPS-T-Q, p. 52, Table 58.
USPS-T-Q,pp. 43-44.
USPS-T-Q,p. 44.
-16-
are
OCA-T-3
Docket No. R2000-1
1
However,
he admitted that
2
3
4
estimated volume and delivery network changes and changes in the level
of costs in employee benefits have been accounted for in the estimation
of test year revenues and expenses.17
5
Therefore,
these factors cannot be adduced to justify the contingency
cannot
be used to justify increasing the contingency
6
and they certainly
7
more than $1 billion. Moreover,
provision,
provision
by
Mr. Tayman stated that
The Postal Service’s financial performance
is under much greater
pressure and is subject to substantially greater risks than it was at the
time of the last two omnibus rate cases.”
8
9
10
11
However,
12
he had performed
13
greater detail the reasons for which Mr. Tayman’s testimony
14
increase in the contingency
15
v.
16
he has also admitted that this statement
no studies in this area.‘9
is “subjective
My colleague,
and intuitive” and that
Robert Burns, discusses
is inadequate
to support an
provision.
THE REQUEST FOR A CONTINGENCY
PROVISION OF 2.5 PERCENT
NOT SUPPORTED BY THE POSTAL SERVICE’S VARIANCE ANALYSIS
The Requested
Results
17
18
A.
19
The variance analysis presented
20
the necessity
21
provision
2.5 Percent
of a 2.5 percent
Tr. 21280.
18
USPS-T-Q, p. 45.
19
Tr. 21304.
20
USPS Exhibit QJ, pp. 5-8,
Lies Outside
in Mr. Tayman’s
contingency
of 2.5 percent of total estimated
17
in
provision.
the Range
Exhibit?
IS
of the Variance
also fails to support
The requested
contingency
costs lies outside the range of the results of
-l7-
OCA-T-3
Docket No. R2000-1
1
the variance
2
of the range of the four results is nearly zero (negative 0.05%).
3
as shown
in Table 6, three of the scenarios
4
revenues,
the total of the four scenarios
5
estimated
test year costs.
6
negative,
7
8
analysis, which is from a positive 2.2% to a negative 2.3%.
Mr. Tayman
the contingency
is negative,
Furthermore,
but it is less than one-quarter
presented
Moreover, even though,
assume
lower than expected
but it is less than one percent
of
the average across the four scenarios
is
of one percent of estimated test year costs.
does not favor using the variance
provision.
The mid-point
analysis to determine
the size of
He states
9
10
11
No matter what results an historical variance analysis produces, it is not
appropriate to use historical data to determine the size of the contingency
in lieu of management’s judgment about the future.”
12
The
Postal
13
subjective
14
appears
15
recognizing
16
the necessity
17
accurately
21
Service
guesstimates
prefers,
in determining
to be an attempt
to rely upon
the requested
for the Postal Service
that their ex ante forecasts
for the
instead,
provision
largely
contingency
judgmental
and
provision.
This
to have their cake and eat it too:
may turn out to be wrong ex post - leading to
for contingencies
gauge the amount by which their forecasts
USPS-T-Q, p. 45
-18-
-
but asserting
their
are likely to be wrong.
ability
to
,
OCA-T-3
Docket No. R2000-1
Table 6
Results of Variance Analysis
Scenario
Revenues
Expenses
Revenues
Expenses
Revenues
Expenses
Revenues
Expenses
Total
.962% higher than expected;
1.177% lower than expected
.9165% lower than expected;
1 .I 19% lower than expected
.1367% lower than expected;
.9429% higher than expected
1.23% lower than expected;
.9878% higher than expected
Net Effect
$000's
$I,455557
2.2%
$118,279
0.2%
- $728,039
- 1.1%
- $1,513,889
- 2.3%
%
- $668,092
- 0.994%
Total as a % of Test Year Estimated Cost
Average
- $167,023
Average as a % of Test Year Estimated
- 0.2486%
cost
Source: USPS Exhibit 9J, pp. 5-8
1
If we consider
the Postal Service’s ability to forecast revenues and expenses
2
an “after-rates”
basis, using the figures contained
3
find that the total estimated
4
rate cases (Docket
5
and actual after-rates
6
Postal Service’s
7
0.14 percent,
8
side, total expenses
“after-rates”
in USPS Exhibit 9J, page 3 of 8, we
revenues for the test years in the four previous
Nos. R87-1, R90-1, R94-1, and R97-1) were $200,925.4
revenues
revenue
for the four years were $200,650.8
forecast
billion.
billion,**
Thus, the
for the four years was a total of $274.6 million, or
high with two overestimates
were estimated
on
and two underestimates.
to be $195954.1
On the expense
billion and actual total expenses
Using the “before-rates” estimated revenue for the test year in Docket No. R97-1, because the
Docket No. R97-1 rates were not, in fact, implemented during the test year.
22
-lQ-
OCA-T-3
Docket No. R2000-1
1
were $198,805.7
billion. Thus, the Postal Service’s expense forecast for the four years
was a total of $2.8156
billion, or 1.46 percent,
low, with one overestimate
underestimates.
Over the four years, this amounts to an underestimate
totaling
billion, or 1.57 percent,
$3.1262
estimated
costs).
However,
does not support
increasing
B.
was there an actual
the contingency
provision from one percent
of estimated
total costs.
Other Analvtical Methods are Available
The Commission
10
of total
of the Postal Service after the last four rate cases
total costs to 2.5 percent of estimated
9
of net income
of total actual costs (or 1.6 percent
in only one of those years (FY1992)
net loss. Thus the actual experience
and three
finds variance
analysis
the reasonableness
to be‘a
11
means to evaluate
12
analytical
methods are available that might be useful.
13
industry,
a similar
14
generating
15
allow for unexpected
weather-induced
16
outages of generation
plants.
17
Electric
capacity
situation
often
of a requested
(a reserve margin),
utilities
attempt
available
so that consumers
19
extreme
weather
- and consumers
20
Greater
reserve
capacity
21
unplanned
utilities
periods
of high demand
a reasonable
amount
pay for the maintenance
the
probability
that
Other
in the electric utility
require
are not faced with power brownouts
decreases
provision.
over and above their projected
to keep
18
contingency
For example,
Electric
arises.
useful tool, but not the only
some
excess
peak load, to
and/or for unplanned
of reserve
or blackouts
capacity
during
of this reserve capacity.
extreme
weather
or an
plant outage will result in the utility’s inability to meet the demand placed on
-2o-
OCA-T-3
Docket No. R2000-1
1
its system (loss of load), but greater reserve capacity is costly, so the costs and benefits
2
of a greater or lesser amount of reserve capacity must be considered.
3
One commonly
used way of determining
4
excessive,
5
probabilistic
6
outages.
7
demand and plant availability
8
configurations.
9
predetermined
reserve capacity
analyses
Based
whether
a utility has sufficient,
is to use loss of load probability
analyses
but not
(LOLP).
These
simulate weather variation and allow for random unplanned
on hundreds
or thousands
conditions,
of Monte Carlo simulations
of various
the LOLP can be calculated for different
If the LOLP for a given
value in terms of percent
mix of plants
is at or just below
or days per year, the reserve
Another
criterion
plant
plant
some
capacity
sometimes
is
used is that
10
considered
11
there should be sufficient reserve capacity to meet projected peak loads when one, two,
12
or even three of the largest plants are forced out of service unexpectedly.
13
adequate,
In addition,
but not excessive.
LOLP analyses are also considered
in light of the possibility
14
utility facing internal supply constraints
15
other power generators
16
be able to control portions of its load by curtailing service to customers
17
under
18
practices.
19
needs, given the vagaries
20
the relative costs and benefits of more versus fewer reserves.
21
interruptible
Again, although
Telephone
may be able to purchase power from utilities or
that have excess capacity
contracts
that a
or by engaging
at the time, and that the utility may
in other
receiving
demand-side
power
management
the goal is to ensure sufficient capacity to meet customers’
of weather and unplanned
companies
and
natural
22
questions
23
reserves to have on hand, respectively.
when making decisions
gas
outages, consideration
companies
related to network
also
face
design or the amount
is given to
analogous
of stored
Similarly, there are analytical models that have
-2l-
OCA-T-3
Docket No, R2000-1
1
been developed to aid in the decision making process in these industries.
2
Although
the situation
facing the Postal Service is somewhat
different, it would
3
be useful for the Postal Service to develop some form of more analytical
4
determining
5
weights to them.
6
VI.
7
the likely range of outcomes
LARGER CONTINGENCY
The contingency
PROVISIONS
so thick as to be overly comfortable.
9
break-even
it is presumed
10
practices
11
the cushion
12
economists
13
that the structure of incentives
14
The contingency
15
events.
16
in doing so.
to
some likelihood or probability
ARE NOT PREFERABLE
provision must provide a cushion, but the cushion should not be
8
results,
and assigning
approach
Given the Postal Service’s
that managers
Nevertheless,
may result
call moral hazard.
provision
will exercise
if the allowed contingency
in a tendency
toward
mandate to achieve
slackness.
diligent and efficient
provision is too large,
This is a form of what
This does not imply immoral behavior;
rather, it means
and rewards may not lead to cost minimizing
is a form of insurance against unforeseen
Let me provide two examples.
In the electric utility industry,
17
uncertainty
or risk is the price of fossil fuel (coal, oil, natural gas).
18
allow utilities to pass through to customers
19
of fuel cost adjustments.
20
its fuel costs, it might
21
regulators
22
bear some of the risk.
the changes
behavior.
and uncontrollable
a major source of
Regulators
often
in their cost of fuel in the form
If, however, the utility is allowed to pass along 100 percent of
not have sufficient
have introduced
provisions
Likewise,
incentive
to hold costs down,
so some
that require the utility and its shareholders
the use of deductibles
-22-
in insurance
to
policies tends to
OCA-T-3
Docket No. R2000-1
1
give policyholders
2
not be present if policyholders
3
had taken care to prevent them.
4
an incentive to minimize
If the contingency
goal
losses and claims.
Such incentive
were made whole for losses regardless
provision is too generous,
in the face of adverse
of whether
would
they
managers can still meet their break-
5
even
6
decisions.
7
Service
8
provision
9
that goal is not being met, the Postal Service is directed to look for ways to generate
Mr. Tayman
[to] generate
circumstances
without
having
stated that the Board of Governors’
a net income
equivalent
to make
tough
policy is for “the Postal
to the recovery
of prior year
loss
amount included in the most recent rate filing and rates that are in place.“23 If
10
additional
revenues
11
Service is to resort to tiling for increased
ratesz4
12
generous
management
13
economically
14
VII.
can
or reduce expenses.
relieve
Postal
Service
Once those items are exhausted,
A contingency
of the
the Postal
provision that is overly
pressure
to manage
and efficiently.
OTHER REASONS
NOT TO INCREASE
THE CONTINGENCY
15
16
A.
The Extra $1 Billion Needed to Increase the Contingency
Costless
17
The extra $1 billion required to fund the requested
increase
PROVISION
Provision
Is Not
in the contingency
18
provision
from one percent to 2.5 percent of total estimated costs will not come out of
19
thin air.
It will come out of the pockets of the customers
20
form of higher rates and fees they must pay.
23
24
Tr. 21557.
Id. at 557-8.
-23-
of the Postal Service in the
The additional
dollars paid to the Postal
Docket No. R2000-1
OCA-T-3
1
Service to increase the contingency
2
to other things such as consumption,
3
opportunity
4
costs into account.
5
provision are dollars that customers cannot allocate
investment,
and saving.
Customers
loss as a result, and there has been no analysis produced that takes these
The opportunity
cost that customers
bear
as a result
6
contingency
7
and it is most likely considerably
8
rates well above
9
loans, or other consumer
debt at higher rates; and businesses
10
investment
such
11
considerably
12
will suffer an
provision
of funding
a larger
is not less than the rate of interest on US. Treasury
Treasury
opportunities
higher than that, since businesses
rates; individuals
as equity
carry credit-card
securities
that
securities,
routinely borrow at
balances,
automobile
and individuals
have
expected
have
returns
higher than Treasury rates.
It maybe
argued
that a larger contingency
could give customers
an indirect
13
benefit since it could tend to lengthen the rate cycle, so that postal rates and fees may
14
stay stable a bit longer.
15
the purpose of the contingency
16
more frequent rate cases (as is discussed
17
contingency
18
and uncontrollable
19
B.
20
Postal Service rates are reset on a periodic basis as necessary
21
operations.
22
some
provision
However,
even if there were such an indirect benefit, it is not
provision.
Moreover,
if the Postal Service decides to file
in the testimony
of OCA witness Callow), the
could be lower in light of the shorter period for which unforeseen
events are being provided for.
Shortenina
the Rate Cvcle Can Allow for a Smaller Continaencv
A major reason for the existence of the contingency
protection
against
unforeseen,
unexpected,
- 24 -
and
Provision
for its continued
provision is to provide
uncontrollable
factors
that
OCA-T-3
Docket No. R2000-1
1
adversely
2
the effects of all reasonably
3
be some
4
revenues
5
attempt to see, the greater the likelihood
6
shifting from a rate cycle based on the presumption
7
three to four years - as was the case from 1981 through
8
contingency
9
predictable
10
affect revenues and/or expenses.
unforeseen
foreseeable
events
and/or expenses
The Postal Service forecasts
events on the horizon.
- some
positive
from their estimated
provision can be lowered,
and some
values.
that forecasts
Nevertheless,
negative
there will
- that change
The farther into the future we
or estimates
will err. Thus, by
that rates will remain in effect for
since the near-term
1998 - the size of the
future is likely to be more
than the longer term.
This is similar to the notion that the more often a business
11
inventory,
12
contingency
13
a buffer against uncertain fluctuations.
14
or estimates
the smaller
its inventories
plans to restock its
can be and the lower its carrying
provision may be likened to business
inventories
costs.
The
in that they both provide
The Docket Nos. R84-1 and R87-1 rates were each in effect for slightly less than
15
three
16
Assuming
17
No. R97-1 rates will have been in effect for slightly less than two years.
18
Deputy Postmaster
Nolan noted projections
that the Postal Service could file
19
for new rates in 2003, 2005, and 2007.25 A two-year
rate cycle can allow for a smaller
20
contingency
years,
and the RSO-1 and RS4-1 rates were
that the Docket No. R2000-1
General
in effect for about four years.
rates are effective January
1, 2001, the Docket
Moreover,
provision.
25
PostCorn Bulletin, May 5, 2000, p, 2, and Alliance for Nonprofit Mailers, Alliance Report, May 10,
2000, p. 2.
- 25 -
Docket No. R2000-1
1
OCA-T-3
The cost and time involved in requesting
must be considered.
new postal rates (or
2
restocking
3
them too often, but if the Postal Service initiates regular and more frequent
reviews it
4
could provide benefits to certain mailers by providing smaller, more predictable
changes
5
in their postage
6
contingency
7
are techniques
8
to household
9
inventories)
and implementing
It would not be wise to attempt to revise
costs, and the overall level of rates could be lower due to a smaller
provision,
At the same time, as discussed
by OCA witness
Callow, there
available that could permit the Postal Service to increase
users of the mail by changing
In addition,
more frequent
single-piece
reviews
Moving to a somewhat
could
rates every two rate cases.
allow
10
accurately
over time.
11
smoothing
the path of postal rates and lowering
12
relative size of the contingency
13
shorter rate cycle, they are likely to be small compared
14
flow to customers
15
16
C.
17
Compare
provision.
what happens
Provision
their average
Although
Should
costs
more
there are costs associated
the
with a
to the cost savings that would
provision.
The Equity
provision turns out to be too small
18
versus too large.
19
Service can take actions to increase revenue and/or cut costs, and it can file for another
20
rate increase.
21
effective.
22
borrow
23
advantageous
Admittedly,
However,
from
the
provision
level by reducing
Not Be Used to Restore
if the contingency
If the contingency
rates to match
shorter rate cycle would have the effect of
as a result of a smaller contingency
The Contingency
Account
convenience
turns out to be insufficient,
the Postal
rate cases take time to file and for new rates to become
even if it prefers not to do so, the Postal Service has the ability to
Federal
Financing
Bank.
terms, since no private borrower
- 26 -
Such
borrowing
is generally
can borrow on terms equivalent
on
to the
Docket No. R2000-1
OCA-T-3
1
U.S. Treasury’s
At September
30, 1999, the Postal
2
Service had received direct loans from the FFB of $6.279 billion.”
It is currently limited
3
to an annual increase
4
capital investments,
5
the Postal Service had a debt level of $6.9 billion.28
6
Suppose,
cost of money plus l/8 percent.
in debt of $1.0 billion for operating
purposes
with an overall debt ceiling of $15 billion.”
however,
that the Postal Service’s
turn out to be on target and that the 2.5 percent contingency
8
that happens,
9
million)29 and the contingency
the funds flowing
11
credited to equity, leaving nearly $1.568 billion in equity.3’
12
the equity account
13
so.
account.
Service’s
provision is approved.
The total amount
of $1.948
estimates
If
losses ($268.257
billion would then be
Although
nearly to its original level, this is not the intended
Indeed, with a contingency
Postal
projections
provision ($1.680 billion)M will flow to net income and be
credited
15
and expense
of prior years’
10
14
to the equity
from the recovery
At the end of FY 1999,
revenue
7
and $2.0 billion for
provision
are on target,
of one percent
$940.163
this would restore
method of doing
of estimated
costs, if the
million will flow into the equity
26
Federal Financing Bank: Financial Statements As of September 30, 1999 and 1998 Together With
Auditors’ Report (Arthur Anderson, LLP, January 4, 2000), p. 8. Acrobat PDF file downloaded from
http:llwww.treas.gov/~/financialsll999~statements/l999~statements.html
May 3, 2000.
27
39 U.S.C. 5 2005 and Tr. 2/112, 173.
28
Tr. 2i177.
29
USPS-T-B, Table 53, p. 48.
30
2.5 percent of the Total Cost figure shown in USPS Exhibit 9J.
,,
31
Adding the $1.948 billion net income to FY 2000 net equity of ($380.389 million) from USPS-T-B,
Table 59, p. 53.
-27-
OCA-T-3
Docket No. R2000-1
1
account, which will show a positive balance of approximately
2
the first positive balance since 1987.32
3
This could happen.
Indeed, the recent success achieved
4
in meeting or exceeding
5
because
the
6
However,
just as the recovery
7
substitute
for an adequate
8
be used as a substitute
9
proper
annual
restoration.
11
request
12
using a back-door
13
D.
14
In addition,
charge
for recovery
of prior years’
of prior years’ loss allowance
contingency
mechanism
a shorter
amortization
losses
has decreased.
should not be seen as a
provision, the contingency
provision should not
for recovery of prior years’ losses.
provision,
even implicitly,
period for recovery
It would not be
as a mechanism
of equity
its rate of equity recovery, it can
of prior years’
losses rather than
approach.
lncreasina the Continqencv
Provision Mav Be Counteroroductive
it may be counterproductive
rates by an additional
16
“increasingly
17
increase
18
the competitive
19
competitors.
for the Postal Service
$1 billion to fund a larger contingency
competitive
environment
in rates necessary
position
If competition
to support the enlarged contingency
of the Postal Service
is, indeed, increasing,
to increase
provision,
in which the Postal Service
given the
operates.“33
provision
relative to its existing
its
The
cannot help
and emerging
the Postal Service could exacerbate
One percent of Total Costs from USPS Exhibit 9J plus allowance for recovery of prior years’
losses.
33
by the Postal Service
goal has taken some pressure off rates and fees,
If the Postal Service wants to accelerate
15
32
its breakeven
to use the contingency
10
$560 million, which will be
USPS-T-g, p. 44
-20-
.
OCA-T-3
Docket No. R2000-1
1
the problem
by raising rates by more than is absolutely
2
envision
3
competitors,
4
further encouraging
5
VIII.
a “vicious
cycle”
in which
rising postal
which would result in lower revenues
necessary.
rates create
It is possible
to
headroom
for
more
and a call for further rate increases,
competitors.
CONCLUSION
The Postal Service has several layers that protect its viability, the contingency
6
7
provision
8
and expenses,
9
the contingency
First, the Postal Service uses pro forma estimates
being one.
so that anything that can be forecasted
provision
provides
factors
some protection
that adversely
can be adjusted
against
and uncontrollable
11
Postal
Service
12
costs.
Fourth, the Postal Service can borrow for operations
13
do so.
14
Finally, the Postal Service can file for new rates as necessary.
15
important
16
the historical
17
economic
18
continue the presently
19
costs.
20
total estimated
can take actions
and has a part to play in maintaining
experience
conditions
The increase
of the Postal
the Postal
in the contingency
costs is not necessary
unexpected,
revenues
and/or
Third,
reduce
necessary
losses from future
to
rates.
Each of these tools is
the health of the Postal Service.
and the relative
can continue
allowed contingency
Second,
expenses.
if it becomes
prior years’
Service
Service
and/or
to increase
Fifth, the Postal Service can recover
for.
unforeseen,
10
management
affect revenues
of revenues
stability
Given
of current
to meet its objectives
and
provision of one percent of total estimated
provision
at this time.
-29-
from one percent to 2.5 percent
of