Before Wald, Sentelle and Rogers, Circuit Judges.
FOR THE DISTRICT OF COLUMBIA CIRCUIT
On Petition for Review of an Order of the Federal Energy Regulatory Commission
Opinion for the Court filed by Circuit Judge Wald.
This case involves the ratemaking treatment of post-retirement benefits other than pensions, which consist largely of retiree medical benefits ("PBOPs" or "retiree medical benefits"). Historically, PBOPs have been reported on a cash basis for both accounting and ratemaking purposes. In 1990, the Financial Accounting Standards Board ("FASB") instructed companies to switch to accrual accounting for PBOPs, requiring companies to account now for the post-retirement benefits they expect to pay in the future to their current employees. In its 1991 rate proposal to the Federal Energy Regulatory Commission ("FERC" or "Commission"), New England Power ("NEP") requested a raise in its rates based in part on the switch to accrual accounting of PBOPs. FERC granted the request, see 61 F.E.R.C. Para(s) 61,331 (1992), reh'g denied, 65 F.E.R.C. Para(s) 61,036 (1993), and the Town of Norwood ("Norwood") challenges the approval of accrual treatment of PBOPs for ratemaking purposes.
Under the pay-as-you-go approach to PBOPs, utilities incorporate into their accounts and rates only the actual payment of PBOPs to current retirees; they do not account for their future obligations to currently active employees. Under the accrual method, by contrast, the company incorporates into its current costs and rates an estimate of the future retiree medical benefits that it has promised to its present employees. In December, 1990, the FASB directed all companies subject to the FASB accounting standards with over 500 plan participants to switch to accrual accounting for post-retirement medical benefits. See Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions ("FAS 106"), reprinted in Joint Appendix ("J.A.") at 106-36.
FAS 106 proceeds from the "basic premise of generally accepted accounting principles that accrual accounting provides more relevant and useful information than does cash basis accounting." FAS 106 at 2, reprinted in J.A. at 108. In particular, the FASB concluded that the retirement benefits of current employees are best conceived of as deferred costs of their current employment-"[i]n exchange for the current services provided by the employee, the employer promises to provide, in addition to current wages and other benefits, health and other welfare benefits after the employee retires," id. at 1, reprinted in J.A. at 107-and thus properly identified as a cost of current employment. Such reporting, the FASB concluded, would "enhance the relevance and representational faithfulness" of financial statements. Id.
For the near future, the accrual method is likely to result in greater liability than the cash method because recent factors "such as spiraling medical costs, early retirements, an aging population, and the accumulation of benefits obligations" have raised the "potential future liability for PBOP costs ... dramatically." 61 F.E.R.C. Para(s) 61,331 at 62,207. In addition, when a company switches from pay-as-you-go to accrual accounting it incurs a large and sudden liability, the transition obligation. At the time of transition, the company will have already accumulated a significant future liability for the retirement medical benefits of existing employees that it has never accounted for in its books. Had the company been using accrual accounting all along, it would have accounted for these future costs to its employees as they accrued. When that same company switches to accrual accounting, it has to somehow provide for this deferred cost. FAS 106 authorizes companies to either place this liability on their books immediately or to amortize it over a 20-year period.
In this case, NEP filed a rate request incorporating a switch to accrual accounting. As part of this switch, NEP petitioned to collect the transition costs-that amount of liability already accrued-from ratepayers over the next 20 years. The Administrative Law Judge ("ALJ") denied the request on the grounds that future PBOPs were too difficult to estimate and that the transition obligation imposed excessive intergenerational subsidization. 60 F.E.R.C. Para(s) 63,006 (1992). The Commission reversed, 61 F.E.R.C. Para(s) 61,331 (1992), and denied a subsequent motion for rehearing, 65 F.E.R.C. Para(s) 61,036 (1993).
Although FAS 106 applies to regulated as well as unregulated industries for accounting purposes, *fn1 the accounting approach does not necessarily dictate the ratemaking approach, and the Commission did not hold itself to be bound by FAS 106 for ratemaking purposes. *fn2 Rather, it independently assessed the merits of accrual accounting and concluded that accrual accounting was preferable because "the customers receiving the benefits of the employees' work should pay the associated costs." 61 F.E.R.C. Para(s) 61,331 at 62,213. It granted NEP's petition on the conditions that (1) NEP place all funds collected to meet the accrued obligations in an irrevocable trust and (2) if "overfunding ever occurs, NEP [must] reserve any over-collection expressly for the benefit of customers, through reduced expense projections in subsequent filings." Id.
Norwood offers two main challenges to the use of accrual accounting in ratemaking for retiree medical benefits. First, it argues that estimation of these benefits is so uncertain and speculative that it cannot meet the statutory requirement that rates be "just and reasonable." 16 U.S.C. Section(s) 824d(a). Second, it challenges the imposition of the "transition obligation" on the coming generation of ratepayers as both (a) improper inter-generational subsidization and (b) ...