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HomeMy Public PortalAboutExhibit MSD 60B Surrebuttal Testimony of Janice M ZimmermanBEFORE THE RATE COMMISSION OF THE METROPOLITAN ST. LOUIS SEWER DISTRICT AUGUST 19, 2011 SUBMITTAL OF SURREBUTTAL TESTIMONY OF THE METROPOLITAN ST. LOUIS SEWER DISTRICT ISSUE: WASTEWATER RATE CHANGE PROPOSAL WITNESS: JANICE M. ZIMMERMAN SPONSORING PARTY: METROPOLITAN ST. LOUIS SEWER DISTRICT DATE PREPARED: August 19, 2011 Metropolitan St. Louis Sewer District 2350 Market Street St. Louis, Missouri 63103   Exhibit MSD 60B Surrebuttal Testimony of Janice M. Zimmerman Exhibit MSD 60B 1 10 Impact of 1-Year Rate Freeze. Q1. Mrs. Zimmerman do the interveners currently recommend a one year rate 2 freeze vs the District’s proposed 4 year plan? 3 A. Yes. 4 Q2. Would the recommended 1-year rate freeze significantly impact the 5 District’s revenue? 6 A. Yes. As previously testified by Jeanne Vanda of Public Financial Management, Inc. 7 (PFM), the estimated $285 million in bond funding currently proposed in FY13 would 8 be reduced to $125 million. This reduction in the first year of the District’s bond 9 program would result in a $160 million funding shortfall in FY13. Q3. Do you support such a recommendation? 11 A. No. 12 13 15 16 19 Inflation Rate Q4. Were assumptions made in the May 10, 2011 Rate proposal regarding 14 future inflation rates for MSD’s operation and maintenance (O&M) expenses for fiscal years 2013, 2014, 2015, and 2016? A. Yes. 17 Q5. Have you reviewed the written rebuttal testimony submitted by MIEC 18 concerning O&M expense inflation rate assumptions? Q6. Yes. 20 - 1 - Surrebuttal Testimony of Janice M. Zimmerman Exhibit MSD 60B Q7. What reference material did MIEC cite as the basis for its inflation rate 1 assumption of 2.4%? 2 A. The MIEC cited the 5-year average Consumer Price Index for all urban consumers 3 (“CPI-U”) for the period 2013-2017 as published in the March 10, 2011 Blue Chip 4 Economic Indicators. 5 Q8. Do you consider this an appropriate basis for MIEC’s 2.4% assumption? 6 A. No. The CPI-U is not an appropriate basis for an inflation rate assumption 7 applicable to MSD. The CPI-U consists of a “market basket” of goods and services 8 not relevant to the goods and services provided by the District. The U.S. Bureau of 9 Labor Statistics defines CPI-U as an index based on the prices of food, clothing, shelter, transportation fares, charges for doctors’ and dentists’ services, drugs and the other goods and services that people buy for day-to-day living. Per the U.S. Bureau of Labor Statistics, prices of these types of items are collected, on a monthly basis, in 87 urban areas across the country from approximately 4,000 housing units and 25,000 retail establishments such as department stores, supermarkets, hospitals, gas stations, and other types of stores and service establishments. The CPI-U data is collected from urban populations consisting of individual wage earners and groups such as professional, managerial and technical workers, the self- employed, short-term workers, the unemployed, retirees and others not in the work force. The CPI-U is an appropriate inflation indicator for goods and services used by the general population. MSD’s O&M costs are not in the same categories as those used in the CPI-U. While the CPI-U may be used as an inflation indicator for some of the District’s O&M costs, the majority of its O&M expenses consist of a combination 10 11 12 13 14 15 16 17 18 19 20 21 22 23 - 2 - Surrebuttal Testimony of Janice M. Zimmerman Exhibit MSD 60B of expenses impacted by more specific inflation indices such as the energy and fuel 1 components of the CPI, the Producer Price Index (PPI) and construction and 2 operational supply cost indices published by the Engineering News-Record (ENR). 3 Other O&M expenses are primarily impacted by factors other than inflation like 4 investment market conditions, actuarial traits of the MSD work force, and short term 5 historical trends of MSD actual expenses The following table provides a comparison 6 of the inflation indices used by MIEC and MSD. 7 Rate Proposal Inflation Rate Variance Assumption Inflation (Rate Prop O&M Expenses 4-Yr Avg Basis (1) 4-Yr Avg Indices vs Indices)MSD Basis Wages, Salaries & Other Misc Personnel Costs 2.40% CPI-U 3.00% 2.40% 0.60% March 2011 Blue Chip Indicators CPI-U: 2.4% Short-term Historical Investment Market Conditions Pension Plan costs 2.40% CPI-U 7.90% 7.90% 0.00% Projected Staff Acturial Traits Employee Medical & Dental Insurance 2.40% CPI-U 9.00%9.00% 0.00% Projected Staff Acturial Traits Bond & Liability Insurance 2.40% CPI-U 5.00% 5.00% 0.00% Short-term Historical Investment Market Conditions Contractual Services 2.40% CPI-U 4.50% 4.50% 0.00% 2010 PPI: 4.5% Machinery & Equipment Parts 2.40% CPI-U 3.00% 3.30% -0.30% March 2011 ENR Material Cost Index: 3.3% Operational Construction and Building Supplies 2.40% CPI-U 3.00% 3.80% -0.80% March 2011 ENR Construction & Building Cost Index: 3.8% Chemical Supplies 2.40% CPI-U 3.00% 4.50% -1.50% 2010 PPI: 4.5% General Supplies 2.40% CPI-U 3.00% 2.40% 0.60% March 2011 Blue Chip Indicators CPI-U: 2.4% Energy Utilities 2.40% CPI-U 4.70% 7.10% -2.40% 2010 CPI Energy Index for St. Louis: 7.1% Real Property 2.40% CPI-U 3.00% 2.40% 0.60% March 2011 Blue Chip Indicators CPI-U: 2.4% Average Inflation Rate 2.40% 4.46% 4.75% CPI-U = Consumer Price Index All Urban Customers PPI = Producer Price Index ENR = Engineering News-Record (1) Based on the March 10, 2011 Blue Chip Indicators report Comparision of O&M Inflation Indicators Inflation Indices MIEC 8 9 10 11 12 13 14 15 16 This table indicates, MSD’s O&M expense inflation rates are based on a composite of inflation indices specific to the type of cost. The inflation assumptions used for contractual services, machinery and equipment parts, chemical supplies, operational construction and building costs and energy costs are based on indices more closely related to these expenses than the CPI-U used by MIEC. The actual inflation assumptions used by the District also take into account short term historical actual cost trends which reflect operational efficiencies and result in projections lower than the individual inflation indices. These variances represent a conservative projection of O&M - 3 - Surrebuttal Testimony of Janice M. Zimmerman Exhibit MSD 60B 1 2 3 4 5 6 7 8 9 10 12 14 15 16 17 18 19 20 21 22 expenses as these categories represent 46% of the District’s total O&M projected change. The District’s inflation assumption for wages and salaries is 0.60% over the CPI-U used by MIEC to reflect potential wage increases. All remaining O&M expenses are unrelated to inflation and are based on short-term historical trends for investment market conditions as advised by the District’s financial advisory firm, PFM and Staff actuarial projections provided by Milliman Inc. The above table also demonstrates MIEC’s use of the CPI-U index as the primary basis for its O&M expense inflation rate assumptions regardless of the specific nature of the District’s various types of O&M expenses. For this reason, MIEC’s O&M expense inflation assumption is unreasonable and understates the District’s O&M expenses over the 4 year Rate Proposal. Q9. Please indicate how Mr. Gorman’s assumption understates the O&M 11 expensed. Q10. MIEC’s projected O&M expenses are understated due to the inappropriate 13 application of the CPI-U inflation index to all MSD O&M expense types. The District’s O&M expenses are categorized into three groupings: 1) expense types tied to a specific inflation index; 2) expenses based on specific inflation indices but adjusted to incorporate operational cost efficiencies and short term historical trends of MSD actual costs, and 3) expenses best predicted by factors other than inflation indicators such as trends in investment market conditions, actuarial traits of the MSD workforce and trends based on short-term historical MSD actual expenses. MIEC’s application of the CPI-U to all MSD O&M expense categories understates projected O&M expenses as indicated in the table below. - 4 - Surrebuttal Testimony of Janice M. Zimmerman Exhibit MSD 60B Understatement of MIEC / MSD MIEC Projected Comparable O&M Expense Change Basis MIEC MSD O&M Change Dollar Basis Same Inflation Index utilized. CPI-U 5,958$ 8,384$ (2,426)$ 0.6% variance is rate assumption Composite of Inflation Indices but Unrelated inflation index utilized by limited control due to variability of WW flow 2,536 3,608 (1,072) MIEC. Considered an understatement Investment Market, Staff Actuarial and Use of an inflation index inapplicable. Historical Trends 9,339 11,344 (2,005) Considered an understatement Total Projected 4 Year Change in O&M Expenses 17,833$ 23,336$ (5,503)$ Average per Year change $$$4,458 5,834 (1,376) %-24% Restatement of MIEC Change in Projected O&M Expenses 1 2 3 4 5 6 7 8 This table below also provides a restatement of MIEC’s change in projected O&M expenses in order to accurately compare to the District’s O&M cost inflation assumptions. The table demonstrates that MIEC’s projected change in O&M expenses is understated by $5,503,000 or 24%, based the use of the CPI-U across all MSD O&M expense categories. MIEC’s understatement of the District’s projected O&M costs results in the proposed rates being insufficient to cover the District’s cost of operation. 9 11 13 14 15 16 17 18 19 Bad Debt Q11. Mrs. Zimmerman has the District provided assumptions for the bad debt 10 provision reflected in the Rate Proposal? A. Yes. MSD’s projected bad debt provision for each of the four years was provided on 12 Table 3-6, Line 2 of the District’s Rate Proposal, Exhibit MSD 1. The assumptions for this projection are explained on Page 3.10, Section 3.4.1: “The provision for bad debt is projected to be temporarily offset in 2012 and 2013 due to the expected recovery of prior years’ bad debt expense by greater use of contracted collection agencies efforts, law firms and computer automated payment reminders. However, after these enhanced collection efforts of the prior bad - 5 - Surrebuttal Testimony of Janice M. Zimmerman Exhibit MSD 60B 1 2 3 10 11 12 13 14 15 16 17 18 20 22 23 debt, the annual allowance for bad debt expense is projected to increase from normal levels in proportion to the proposed revenues increases.” Q12. Do the District’s assumptions factor in the impact of its more aggressive 4 collection efforts? 5 A. Yes. The District assumes the level of its bad debt provision will decrease in FY12 6 due to the initial impact of the more aggressive collection efforts implemented in 7 FY11. This initial steep decline, however, is not projected to continue over the 4 8 year period of the Rate Proposal. The enhanced collection efforts are designed to 9 initially target those account delinquencies unresponsive to the District’s prior less robust methods. These accounts represent the majority of MSD’s bad debt. It is assumed the collection impact will result in the disposal of these targeted delinquencies by the end of FY13. This rapid decline in the bad debt provision associated with the initial collection efforts is then projected to lessen over the remainder of the 4-year Rate Proposal time period. While the collection efforts are assumed to continue to reduce the bad debt provision through FY16, the diminishing return on the enhanced collection efforts is projected to be overtaken and masked by the impact of the proposed rate increases. Q13. What is the impact of the proposed rate increases on the District’s bad debt 19 provision? A. The District’s bad debt provision is primarily influenced by two key factors, the 21 success of collection efforts and rise of wastewater rates. As previously stated, the District assumes its enhanced collection efforts will result in the substantial recovery - 6 - Surrebuttal Testimony of Janice M. Zimmerman Exhibit MSD 60B of delinquent bills in FY12 continuing at a declining trend throughout FY13, 1 eventually transitioning to a flat annual pace expected to maintain bad debt at a 2 relatively constant level through FY16. As such, one of the two key factors 3 influencing the bad debt provision stays relatively constant resulting in the proposed 4 rise in wastewater rates remaining as the only factor significantly impacting the bad 5 debt provision. 6 Q14. How are the proposed rate increases projected to impact the District’s bad 7 debt provision? 8 A. The District’s Rate Proposal contains a 64% total increase in wastewater rates. 9 Therefore, the District reasonably assumed the bad debt provision would increase steadily over the 4-year Rate Proposal period as rate increases overtake the efficacy of the enhanced collection efforts. The District projects the growth in the bad debt provision will accelerate over the Rate Proposal time period as the pressure of rising sewer bills increases. Using Schedule MPG-3 of Mr. Gorman’s July 18, 2011 rebuttal testimony, the District’s bad debt provision is projected to increase from $8,998,500 in FY13 to $12,613,400 in FY16. This represents a $3,614,900 or 40.2% increase in the bad debt provision over the Rate Proposal’s 4 year time period. This change in the bad debt provision collates with the 40.1% increase in total sewer service charge revenue associated with the proposed rise in wastewater rates. 10 11 12 13 14 15 16 17 18 19 20 4-Yr FY13 FY14 FY15 FY16 % Chg Total Revenue (a)242,286,300$ 270,743,000$ 302,973,200$ 339,217,100$ 40.0% Bad Debt Provision (b)(8,998,500) (10,055,400) (11,262,000) (12,613,400) 40.2% (a) Rate Proposal Table 3-11, Line 8 (b) Rate Proposal Table 3-6, Line 2 Change in Bad Debt Provison vs Change in Total Sewer Service Charge Revenue 21 - 7 - Surrebuttal Testimony of Janice M. Zimmerman Exhibit MSD 60B 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 Mr. Gorman’s bad debt assumption is overly optimistic as it unrealistically does not take into consideration a correlation between bad debt and increasing rates. Mr. Gorman also does not take into account that the District’s enhanced collection efforts are designed to continue throughout the 4 years of the Rate Proposal and beyond. MIEC’s bad debt assumption is further flawed as it ignores the District’s lack of shut off ability which is considered the strongest collection tool to incent the payment of delinquent bills. The impact of the lack of shut off as a collection tool was supported by Mr. Stannard during his testimony at the August 8, 2011 Rate Commission Technical Conference, (Transcript Exhibit MSD 57, page 113, lines 19 – 25 and page 114, lines 1 – 12) when he stated: “In most cases in the country, the wastewater utilities are connected with the water utilities, and so a lack of payment of a wastewater bill means water is turned off. MSD is like a number of wastewater utilities that are pure stand alone and do their own billing, but there’s not very many of them. Our ability to encourage payment is much more restrictive than being able to turn off the water. So the bad debt level is high, and it has climbed with increase in rates as well as the downturn in the economy. The key thing here is that with perhaps the more aggressive and robust collection procedures and processes that MSD has implemented – implemented earlier this year, that we will see a decrease in bad debt, but it’s too early to tell. There’s a – the forecast does include somewhat of improvement as related to that – those enhanced procedures; but I think for the next four years, it’s a reasonable forecast.” Schedule MPG-3 of Mr. Gorman’s July 18, 2011 rebuttal testimony indicates an FY16 total bad debt provision of $10,042,323. This represents an understatement of $2,571,077 when compared to the District’s projection of $12,613,400. This understatement equates to a shortfall in the level of revenue required by the District - 8 - Surrebuttal Testimony of Janice M. Zimmerman Exhibit MSD 60B - 9 - 1 2 through the 4 year Rate Proposal timeframe to fund its operations and address requirements in the Consent Decree. Q15. Does this complete your testimony today? 3 A. Yes. 4