OCA-T-2
Docket No. R2OOO-1
DIRECT TESTIMONY
OF
ROBERT E. BURNS
ON BEHALF OF
THE OFFICE OF THE CONSUMER ADVOCATE
MAY 22,200O
TABLE OF CONTENTS
I.
STATEMENT
OF QUALIFICATIONS
.,.................,.....................,......................
II.
PURPOSE AND SCOPE OF TESTIMONY
Ill.
THE CONTINGENCY
MUST BE REASONABLY
RELATED
TO
FUTURE UNCONTROLLABLE
EVENTS . . .._..........,._._....................,.................
Page
1
. .. . . . .. . .. . .. . .. . . .. . .. . .. . .. . .. .. . .. . .. .. . .. . . .. . . .. . 2
3
IV.
THE POSTAL SERVICE HAS NOT ARTICULATED
A REASONABLE
BASIS FOR ITS SUBJECTIVE JUDGMENT . . .. . . .. . .. . .. . . .. . .. . .. . .. . .. . .. .. . .. .. . .. . . .. . .. . . . 8
V.
CONCLUSION
. .. . . .. . . ...___.__...............................................................................
12
UNITED STATES OF AMERICA
Before The
POSTAL RATE COMMISSION
WASHINGTON,
D.C. 20288-0001
Postal Rate and Fee Changes,
2000
Docket No. R2000-1
1
DIRECT TESTIMONY
OF
ROBERT E. BURNS
1
I.
STATEMENT
OF QUALIFICATIONS
My name is Robert E. Burns.
2
I am a Senior Research
at the National Regulatory
and one of two
3
attorneys
4
and public
5
Commissioners
6
NARUC and has been since 1971.
7
State University with the purpose of providing NARUC members,
8
with neutral and objective public policy research on matters such as ratemaking.
9
capacity,
members
10
agencies
to present evidence
11
Kappa graduate
12
College of Law. I have over twenty-one
13
experience,
14
reports,
15
am also the principal
service
organization
(NARUC).
Institute (NRRI), which is the research
for the National
The
Postal
Association
Rate Commission
in proceedings
retained
of Regulatory
is a federal
The NRRI was established
of NRRI are occasionally
Utility
member
of
by NARUC at the Ohio
both state and federal,
by NARUC-member
before those agencies.
In that
regulatory
I am a Phi Beta
of Marietta College, as well as a graduate of The Ohio State University
with the last twenty
including
Research
Specialist
years of public utility and public policy research
being at the NRRI.
studies dealing with average
I have written fifty major NRRI
and marginal cost of service issues.
author of the NRRI report on The Prudent
hestment
I
Test, a
OCA-T-2
Docket No. R2000-1
1
report, which,
2
economical
among
other things,
Public
Service
before the Federal
4
the Mississippi
5
Corporation
6
Proposed Agreement
7
Project. ACC Docket No. E-01345A-98-0245.
8
II.
Commission
for honest,
efficient,
and
PURPOSE
Commission,
Energy
Regulatory
and, most recently
as a staff witness,
Commission,
before
the Arizona
on July 16, 1998, In the Matter of the
Between the Arizona Public Service Company and the Salt River
AND SCOPE OF TESTIMONY
My testimony
9
with incentives
management.
I have previously ‘testified
3
deals
10
contingencies”
11
Postal Reorganization
12
judge
13
exceeds
14
contingency
15
contingency
16
serves in another
17
contingency
18
stemming
19
reserve
20
management
21
reasonableness.
22
reviewing
will
explore
the
purposes
of “a
reasonable
provision
being included as a statutory item in the revenue requirement
the amount
the contingency
that would
is reasonable,
reserve
proposed
be reasonable.
I will
explore
the
by the Postal
In order to examine
purpose
of the
industry
reserve
where
cannot
an assessment
is expected
be adjudged
to be reasonable
and systematic
to protect
discretion
it is used, the insurance
Postal
the Postal
to pick the
contingency
requests,
and examine
-2-
without
Service
rate reserve
I show that a
some justification
of the risks that the contingency
Service
against.
reserve
Relying
will
not
solely
guarantee
applied by the Postal Rate Commission
the adequacy
the
Service’s
analysis
contingency
I also review the standards
industry.
might
whether
reserve and will relate that to the purpose that a contingency
from
under the
Act, 39 U.S.C. §3621, so that the Postal Rate Commission
for itself whether
for
of the reasons
on
its
in
given for
OCA-T-2
Docket No. R2000-1
the 2.5 percent
5
6
contingency,
which amounts
Postal Service’s witness on this subject, William P. Tayman.
My colleague,
Rosenberg,
will suggest
analysis
Commission
can judge the reasonableness
Ill.
7
an assessment
THE CONTINGENCY
MUST
UNCONTROLLABLE
EVENTS
foreseen
nor prevented
9
management.
.”
through
10
contingency
is to cover expense
11
uncontrollable,
12
are unforeseen
13
honest,
14
control those costs that are foreseen
15
are captured
16
contingency
17
year relating to revenue and costs.”
allowance
Contingency
is
Stated
efficient,
and foreseeable.
way, the purpose
in their magnitude
of a
and are
or to cover expenses
Expected
of future
FUTURE
and economical
that
After all,
will make every reasonable
effort to
and foreseeable
costs
In particular,
“[t]he
Service’s
forecast
. designed
to offset the effects of misestimates
costs.
in the test
PRC Op. R77-1 at 29.
reserves are used by the insurance
19
that is, to offset the effects of misestimates
20
contingency
reserve is generally
21
Association
of Insurance
22
component
23
floods, wind, or storm damage,
of insurance
TO
and beyond the control of management.
management
the
which could be neither
another
are unexpected
by which
RELATED
of honest,
the control of management;
and economical
in the Postal
REASONABLY
at 52.
Dr. Edwin
reserve in this case,
is to cover “expenses
which
and unforeseeable
efficient,
systematic
of the contingency
the exercise
PRC Op. R76-1
that is, beyond
and
BE
The purpose of the contingency
8
18
to $1.68 billion in the test year, by the
industry for the same purpose,
relating to revenue
referred to as a catastrophe
Commissioners
premiums
(“NAIC”)
cover
catastrophic
and costs.
reserve.
recommends
hazards,
that
Here the
The National
a separate
including
unusual
and large fires, where the loss may exceed $1 million.
-3-
OCA-T-2
Docket No. R2000-1
1
The position of the Financial Accounting
2
reserve or catastrophic
3
obligation
4
connection
5
past transaction
6
improperly
7
words, for a contingency
8
to pay for events that have not occurred,
9
occurrence.
made between
attempting
to smooth
11
average of catastrophic
(represented
or volatility
in earnings.
Regulations,
to
In other
it must be tied to a duty
but for which there is a projected
losses
If there is no
by the reserve) and some
reserve to be proper and reasonable,
for catastrophic
in force.
insured for), the reserve is tantamount
out irregularities
Indeed, California Insurance
that any loading
unless related to a current
that is, insurance
the future sacrifice
or event (the risks actually
Board is that a contingency
is improper
or liability of the reporting company,
10
12
reserve for insurance
Standards
probability
Title 10, Section 2644.5,
must be based on a multi-year,
of
require
long-term
claims with the number of relevant years set by the regulator.
In other words, in the insurance
industry a contingency
will permit the insurance
13
industry to collect monies for those years that a greater number of losses occur than
14
are forecasted.
For example,
15
hurricanes
landfall
16
contingency
17
The
make
for a year when
or for a year
with
a greater
a Hurricane
number
Andrew.
than
expected
Otherwise,
a
reserve, if any is allowed, will be included in the profit allowance.
Postal
Rate
18
analytical
19
Commission
20
financial
21
variances,
22
arriving at a contingency
Commission
in endorsing
variance
analysis
as a sound
tool, does not rely solely on that tool to the exclusion of other factors.
will apply other pertinent
condition
factors
to the variance
analysis,
of the Postal Service, the state of the economy,
The
“such as the
the causes
of the
and such other relevant factors which may arise [that] must be considered
provision.”
PRC Op. R EO-1,10112
-4-
(citations omitted).
in
OCA-T-Z
Docket No. R2000-1
There has been for some time movement
away from contingency
are not based on the likelihood of a future event.
In the 1984 NAIC Study of Investment
Income, the NAIC Task Force stated, “Estimates
income are used by insurers
in combination
The implication
7
8
Commission
9
tied to the possibility
of losses, expenses,
is the contingency
has for the Postal
Service
and revenue
provision
.I”
and the Postal
provision should, to the maximum
that its expense
to determine
The addition of a contingency
the relative risk is not necessary.
that this
and investment
with overall profit objectives
the price at which its policy will be written.
to a target return based upon
reserves that
forecasts
Rate
extent possible,
contain
be
misestimates.
10
These “variances,
11
in assumptions
12
unforeseen
13
flOll0.
14
analysis supplemented
by other pertinent factors is a proper and feasible procedure
15
employ
a reasonable
16
And, the Commission
17
starting point in evaluating
between
underlying
events
and/or
projections
errors
and actual results ‘will occur as a result of errors
contained
in establishing
19
indicates
20
some
21
controllable
has found “appropriate
expenses.
uncontrollable
the utilization
proposed
events,
NAIC Study of Investment
Income. Supplement
-5-
variance
of variance analysis
request.”
contingency
as a
Id. at 33.
by the insurance
Standards,
to
PRC Op. R77-1 at 31.
it is merely
Under Financial Accounting
PRC Op. REO-1,
that “historical
provision.”
reserve taken
;198+
.“’
has concluded
the Postal Service’s contingency
to a contingency
to future,
techniques.
contingency
that, unless the Postal Service’s
fashion
in the rate filing estimates arising from
in forecasting
Indeed, the Postal Rate Commission
The approach
18
estimated
industry
also
reserve is related in
a device
to even
out
such a device would be
to the NAIC Proceedings,
vol. II, at 9 and 25
OCA-T-2
Docket No. R2000-1
1
considered
part of the profit allowance
2
Service
3
allowed.
4
request to future, uncontrollable
5
Other experiences
is required
to operate
This underscores
6
contingency
7
utility regulatory
8
purchased
9
future events,
in the insurance
on a break-even
the importance
industries
underscore
with fuel adjustment,
clauses.
events.
power, and purchased
11
clauses,
12
they pay is passed through to the ratepayers.
13
cushion
14
Indeed, public utility managers
15
tended
18
even
17
advantage
public utilities tend to be mediocre
the managers
power adjustment,
are sheltered
adjustment
and other
fuel, purchased
hedging
In the case of
adjustment
any price that
clauses thus
of failing to control controllable
of utilities with such automatic adjustment
not to hedge risks of purchased
futures
of price, because
The automatic
mechanisms
power,
exist,
and
from the effects of
gas subject to automatic
negotiators
from the consequences
of tying a
We can learn from the
purchased
Where managers
purchased
where
the importance
they make less effort to take actions to control costs.
fuel, purchased
not be
of the Postal Service relating its contingency
10
18
basis, so such a profit would
reserve to possible future, uncontrollable
gas adjustment
Of course, the Postal
events.
in regulated
experiences
industry.
costs.
clauses have
and purchased
because
there
gas,
is no
to be gained.
A larger
than
incentive.
necessary
Managers
contingency
cushioned
reserve
creates
19
managerial
20
will tend not to act as aggressively
21
could, and likely would, happen for Postal Service managers
if the contingency
22
were
for future,
raised to a level that exceeds
from the consequences
a similar
to cut costs and waste.
reasonable
-6-
provision
perverse
of controlling
They become
costs
lax.
This
reserve
uncontrollable
OCA-T-2
Docket No. R2000-1
1
events and thus acts to cushion
2
controllable
from the consequences
of failing to curb
risks.
These
3
managers
general
precepts
4
reviewing the Postal Service’s
5
has evaluated
6
the degree of economic
7
contingency
8
events, ‘I3 including
9
errors.4
are consistent
contingency
the contingency
to serve
request.
national economic
stability present. ’ The Commission
the dual role of providing
unfavorable
financial
contingency
10
evidence,
and Postal Service
11
reasonably
12
guide the final decision.’
13
the Postal Service’s contingency
14
Service’s
explanation
of subjective
15
potential
forecasting
errors;
16
national economic
17
three areas, the Postal Service’s
18
Edwin
articulated.5
PRC Op. R80-1, qOlO9.
/d.,nOllO.
PRC Op. R87-1, m 2072-73.
PRC Op. R80-1, m[Oll2,
0115.
unforeseeable
for forecasting
management
judgment;
suggest that evaluation
subjective
such
review of
as key
I will discuss the first of these
management
the review
factors
of
of the Postal
(2) an objective
of external
stability.
by substantial
of risks must be
request rests upon (1) careful evaluation
and economic
PRC Op. R76-1 at 56.
against
analysis serves as a tool to
prior decisions
and (3) consideration
will address
the
perception
In all cases, review of variance
indicators
has long considered
must be supported
subjective
The Commission’s
and
and compensating
request
managements
to
conditions
a “cushion
events,
approach
From the outset, the Commission
in light of prevailing
The Postal Service’s
Rosenberg,
with the Commission’s
of potential
judgment.
forecasting
My colleague,
errors
Dr.
through
OCA-T-2
Docket No. R2000-1
1
variance
2
will also present
3
recommended
IV.
analysis and the consideration
a specific
of external economic
recommendation
factors.
for the appropriate
Dr. Rosenberg
contingency
to be
in this case.
THE POSTAL SERVICE HAS NOT ARTICULATED
FOR ITS SUBJECTIVE JUDGMENT
It is clear from the history of Commission
cannot justify a contingency
A REASONABLE
proceedings
reserve as being reasonable
BASIS
that the Postal Service
simply because
management
8
deems it so. Yet that is what the Postal Service has done in this case.
The testimony
9
of Postal Service witness Tayman
on risks facing
makes various general observations
10
the Postal Service, all of which witness Tayman frankly characterizes
11
not based on specific evaluation
12
variance
13
errors,“*
14
Tayman’s
15
managements
16
evidence
17
a reasonable
18
Op. R87-1,12073.
analysis
“[i]n deference
but expressly disavows
evidence
factors.’
to the Commission’s
Witness
desire
any reliance on such an analysis9
must be judged
perception
is permitted,
of individual
as primarily
of unforeseeable
“managements
being
Tayman
presents
to evaluate
Therefore,
a subjective
and uncontrollable
perception
as subjective and
risk.
forecast
witness
articulation
While
of
such
of those risks must be articulated
degree in order to satisfy the substantial
evidence
requirement.”
a
to
PRC
Tr. 21385-86 (witness Tayman’s response to interrogatory OCA/USPS-T9-43), id. at 280
(response to interrogatory DMALJSPS-TS-15), and id. at 304 (response to interrogatory DMAAJSPS-TS47).
7
8
USPS-T-9 at 44.
9
“[Mlanagement
must be allowed to assume its responsibility
contingency most appropriate for achieving its goals.” Id. at 45.
-8-
to determine
the amount
of
OCA-T-2
Docket No. R2000-1
Review of witness
1
Tayman’s
2
not been sufficiently
3
reliance upon managements
4
pages-and
5
annual revenue
6
shows that the necessary
well-articulated
no supporting
Recent
7
discussion
to permit the Commission
subjective judgment.
information,
that the contingency
financial
shows that managements
substantial
to place
Mr. Tayman devoted
data, or studies-to
request
justify
dispositive
less than two
the $1.68
represents. I0 A review of Mr. Tayman’s
evidence
Mr.
performance.
“has not been as favorable
has
billion
points
is lacking.
Tayman
states
8
performance
9
plan, and that the Postal Service spent more than expected
that
recent
financial
as in the mid 1990’s,” that FY 99 fell short of
on Y2K remediation.”
But
10
the Postal Service finished FY 99 in the black, with net revenue of $363 million dollars.‘2
11
This was achieved
12
$267.0 million in FY 1999, and an estimated
13
is a very good example
14
known many years ago that .the transition
15
present remediation
16
Service did not have a track record of reliable
despite
spending
$88.6
million
on Y2K resolution
$42.6 million in FY 2000.”
of the sort of expense that a contingency
problems,
of computer
in FY 1998,
This latter point
can cope with.
systems to year 2000 would
but due to the unique nature of the problem,
forecasting.
10
See USPS-T-9 at 4344.
11
Id. at 43.
I?.
1999 Cost and Revenue Analysis, LR-I-275, tiled April 4, 2000.
13
Tr. 21278 (response of witness Tayman to interrogatory
-9-
It was
the Postal
Yet the Postal Service
DMAIUSPS-TS-13).
.