Alternative Regulation and the Cost of Service Framework
For Vermont EEU Regulated Utilities
Overview
This alternative regulation and cost of service policy document provides a
framework for the cost of service rate and compensation regulation process as it
is generally applied to Vermont regulated utilities and specifically how it may
apply to “for profit” and “not for profit” EEU’s operating under Orders of
Appointment issued by the Vermont Public Service Board. Traditional cost of
service principles shall be applied in determining the revenue requirement
associated with authorized EEU utility operations and shall be the initial basis for
adoption of alternative/incentive regulation.
For background and comparative information, the principles included here are
also used in Vermont for investor owned utilities, municipal utilities, and
cooperatives.
Cost of Service Rate and Compensation Regulation
Policies and Principles
Vermont EEU utilities are to be fully integrated and rate regulated by the Public
Service Board1. The revenues a Vermont regulated EEU utility may collect, the
recovery of costs and the earning of profits and incentive payments during any
rate year are to be determined based upon existing Vermont statutes,
established PSB policies and rate making principles and over 100 years of legal
precedent established in PSB orders.
These statutes, policies, principles and precedents can be summarized as
follows:
 EEU rate and compensation regulation is a substitute for competition that
is focused on the provisioning of “least cost” services. It is designed to
include and simulate normal business risk for the EEU and does not
guarantee cost recovery or earnings while requiring sound managerial
practices, normal internal controls and cost management to attain
earnings and cost recovery.
 EEU Alternative regulation is an extension of rate and compensation
regulation that provides additional motivation and incentives for
innovation, creativity and efficiency in the provisioning of “least cost”
services.
 EEU rates and compensation and the related revenue requirement shall
be just and reasonable.
 There shall be no undue discrimination.
o No service subsidization
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All Vermont utilities are fully integrated and rate regulated by the Vermont Public Service Board except
where preempted by Federal Law, such as rates for CATV service, rates for cellular service, rates for
wholesale electrical energy and capacity and rates for electric transmission service.
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o No service group intra or interservice subsidization
o Cost causer pays.
There shall be a separation of jurisdictional and regulated and nonregulated activity.
An EEU utility shall have the opportunity to recover known and
measurable, just and reasonable, used and useful and prudently incurred
expenses in the provisioning of service.
Most Vermont rate regulated utilities are capital intensive and have the
opportunity to earn a fair and reasonable return on and a return of rate
base2. The rate base includes plant in service, material and supplies
inventory, working capital, and deferred taxes. The rate base must consist
of known and measurable charges for plant in service, the cost must be
just and reasonable, prudently acquired and used and useful in the
provisioning of service.
o Vermont utilities that are not capital intensive including “For Profit”
and “Not for profit” utilities that have no or only a relatively small
level of plant investment committed to public service (rate base)
such as EEU’s, shall have the opportunity to earn a fair and
reasonable percentage return on revenues or expenses in lieu of
earning a return on rate base.
The EEU utility shall follow US Generally Accepted Accounting Principles
and PSB established accounting principles and shall maintain their books
of account using the PSB authorized Uniform System of Accounts.
Under alternative regulation, the EEU shall have the opportunity to earn
incentive revenues beyond the authorized revenue requirement when
performance exceeds predetermined performance metrics.
The EEU “rate year” revenue requirement shall be determined based on
an historical annual “test year” cost of service adjusted for known and
measurable changes3. The cost of service filing may include multiple
annual rate years and cover the time period specified in the alternative
regulation plan.
When an EEU files a cost of service with multiple annual rate years in
conjunction with an alternative regulation plan, the EEU utility shall file
“Not for profit” utilities, such as municipals and cooperatives, who are capital
intensive have the opportunity to earn net income at a level that (a) provides just
and reasonable interest coverage ratios (Debt Service Coverage Ratio and or
Times Interest Earned Ratio) and (b) is sufficient to attract needed capital, but
which does not exceed a fair and reasonable return on rate base.
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Known and measurable changes include (a) those changes that will occur
during the test year that are not applicable to the rate year(s), (b) changes
occurring between the test year and the rate year(s) and (c) changes occurring
during the rate year(s).
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annual base rate changes for each year covered under the plan. The
annual base rate filing shall be developed based on an historical annual
“test year” cost of service adjusted for known and measurable changes.
The EEU utility shall inform the PSB of all Affiliate Transactions in excess
of $25,000 and shall present for PSB approval their documented Transfer
Pricing policies and practices.
The EEU utility shall present for PSB approval their documented cost
allocation policies and practices.
The EEU utility shall provide an evaluation of competitive alternatives with
each cost of service filing.
State Regulatory Cost of Service Process
Preparation and Planning
The state regulatory cost of service process requires preparation and planning.
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Financial planning covering the time period covered under the alternative
regulation plan.
Ancillary studies that meet the documentation requirements for satisfying
the “known and measurable” standard.
Annual volume of services to be delivered that may include work load
forecasts and deliverables for the time period covered under the plan.
Key Performance Metrics and annual objectives that establish the basis
for incentive revenue payments.
Uniform System of Accounts that provides historical test year audited
financial information.
Functional or Activity Based Accounting (GAAP) including cost allocation
processes for determining service costs.
Cost of Service and Revenue Requirements
After the preparation and planning, the EEU shall prepare a cost of service for
the test year with known and measurable adjustments to arrive at a revenue
requirement for the rate year[s].
The revenue requirement may include:
 Proposed “pass-throughs” for the rate year[s]
Allocation of Costs
When EEU authorized services and carried out within an entity that conducts
other business activity, the EEU’s revenues and costs may need to be separated
into a more granular level of detail than what the Uniform System of Accounts
may provide. This creates the need for the development and documentation of
revenue and cost separations, assignment and allocation policies and
procedures.
An entity’s total cost of operations as reflected in its USOA may need to be
separated by regulatory jurisdiction when the entity or its parent operates in more
than one regulatory jurisdiction. Further, an entity’s state costs will need to be
further separated between regulated EEU activity and costs and other nonregulated operations when the entity operates in both the regulated and nonregulated arenas. The EEU regulated activity and related costs are then further
separated by service or service category and rate class when preparing the cost
of service and revenue requirement. This separation is in addition to the normal
revenue, expense, capital separation that is required for GAAP and regulatory
reporting.
The separation of these costs shall be accommodated to the greatest extent
practicable through the adoption of a PSB authorized EEU uniform system of
accounts (EEU-USOA). Where this separation cannot be accomplished through
the EEU-USOA, such as for the common costs associated with buildings, the
President’s salary for example, allocations of such costs must be made to
establish the proper categorization of costs for subsequent recovery from
appropriate cost causers.
Cost allocations may be required to determine:
Interjurisdictional allocations
(1) The level of total state jurisdictional operating costs for multi-state utilities;
a. Includes the allocation of common costs associated with a
corporate headquarters operation that is involved in multi-state
operations and in regulated and non-regulated business activity.
Regulated/Unregulated Allocations
(2) The level of the regulated component of total state costs;
(3) The level of the non-regulated component of state costs;
Jurisdictional and Service Cost Allocations
(4) The revenue requirement for each service or category of service including
rate classes.
Cost Assignments and Cost Allocations
(5) All cost assignments and costs allocations shall be based on cost
causation.
(6) Common costs are general business costs and do not lend themselves to
assignment or allocation on a cost causation basis.
Lacking any
objective basis, for cost assignment, all common costs shall be allocated
and assigned on the basis of revenues or such other basis as the Board
shall approve.
Allocations Factors
(7) .Allocation factors shall be based on embedded cost relationships and or
marginal cost relationships.