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Labor Costs and the Rate Case

Incentives, staffing, and benchmarking in a tight economy.

Fortnightly Magazine - March 2012

of compensation might offset decreases in another.

For example, a utility might increase employee cash salaries to offset the non-cash effect of shifting employees from a defined-benefit pension plan to a defined-contribution pension plan. The appropriate question for regulators to address is: How will changing the levels of total employee compensation affect rates? Regulators’ examination of one particular component without adequate emphasis on total costs might be misleading.

Regulators also must take a similarly holistic approach to evaluating incentive compensation. The objective of these programs should be to encourage individual and collective employee behavior that benefits ratepayers as well as the company. Incentive compensation programs will obviously vary across utilities, based on management objectives and company-specific circumstances. To be most effective, however, and to support the recovery of program costs, these programs should have clearly defined goals and objective measurement criteria. Program goals might include improved reliability, customer service, expense management, and financial performance. For their part, regulators need to be transparent about the extent to which they consider financial criteria—which benefit ratepayers as well as shareholders—acceptable program metrics for compensation expense to be recoverable.

Some utilities have seen increases in employee productivity over the past several years, and that’s a significant benefit for ratepayers. As employees work longer and harder, they reduce output-adjusted compensation costs, all else being equal. However, evaluations of productivity can be complicated when utilities are attempting to reduce output—for instance, developing energy efficiency and conservation-related resources, which is increasingly becoming the industry norm. Productivity is traditionally measured according to level of output—electricity sales, for instance—per unit of labor input; more output per unit of labor input would denote an increase in productivity. However, gains in energy efficiency might cause a decline in electricity sales per unit of labor input—and productivity, by this measure, will appear to be declining as well, even though employees are performing effectively. For this reason, standard labor productivity metrics might not capture the full scope of employee effort and achievement, thereby understating labor productivity.

Benchmarking can help regulators understand employee compensation cost levels and trends, and determine whether requested cost recovery is reasonable. Benchmarking also can assist regulators in evaluating more detailed questions, such as: How does the target utility compare to peers in terms of labor productivity, or in terms of cash compensation?

In particular, peer group benchmarking compares the business performance and practices of a company to those of comparable companies. This technique, which companies, market analysts, and regulators often rely on to evaluate operational and financial performance, can be used to assess indicators of overall company performance as well as the performance of specific activities relative to peers.

However, another benchmark is being introduced in rate cases with greater frequency: the comparison between measures of utility compensation and measures of local economic conditions, including wages and employment. Although regulators might find it useful to look at the local wages of workers who have skills similar to utility employees, general wage and employment rates aren’t appropriate benchmarks for evaluating employee compensation costs, for several reasons. As described above, the utility labor