Regulatory Matters

9 Months Ended

Sep. 30, 2020

In accordance with accounting principles for rate-regulated enterprises, GSWC and BVESI record regulatory assets, which represent probable future recovery of costs from customers through the ratemaking process, and regulatory liabilities, which represent probable future refunds that are to be credited to customers through the ratemaking process. At September 30, 2020, GSWC and BVESI had approximately $44.9 million of regulatory liabilities, net of regulatory assets, not accruing carrying costs. Of this amount, (i) $78.8 million of regulatory liabilities are excess deferred income taxes arising from the lower federal income tax rate due to the Tax Cuts and Jobs Act ("Tax Act") enacted in December 2017 that are expected to be refunded to customers, (ii) $11.5 million of regulatory liabilities are from flowed-through deferred income taxes, (iii) $41.7 million of net regulatory assets relates to the underfunded position in GSWC's pension and other retirement obligations (not including the two-way pension balancing accounts), and (iv) a $2.5 million regulatory asset relates to a memorandum account authorized by the CPUC to track unrealized gains and losses on BVESI's purchase power contracts over the term of the contracts. The remainder of regulatory assets relates to other items that do not provide for or incur carrying costs.

Regulatory assets represent costs incurred by GSWC and BVESI for which either has received or expects to receive rate recovery in the future. In determining the probability of costs being recognized in other periods, GSWC and BVESI consider regulatory rules and decisions, past practices, and other facts or circumstances that would indicate if recovery is probable. If the CPUC determines that a portion of either GSWC’s or BVESI's assets are not recoverable in customer rates, the applicable entity must determine if it has suffered an asset impairment that requires it to write down the asset's value. Regulatory assets are offset against regulatory liabilities within each ratemaking area. Amounts expected to be collected or refunded in the next twelve months have been classified as current assets and current liabilities by ratemaking area. Regulatory assets, less regulatory liabilities, included in the consolidated balance sheets are as follows:


(dollars in thousands)	September 30, 2020		December 31, 2019
GSWC
Water Revenue Adjustment Mechanism and Modified Cost Balancing Account	$	24,904	$	22,535
Costs deferred for future recovery on Aerojet case	7,169		8,292
Pensions and other post-retirement obligations (Note 8)	40,606		40,693
Derivative unrealized loss (Note 5)	—		3,171
General rate case memorandum accounts	218		4,820
Excess deferred income taxes	(74,597)		(79,886)
Flow-through taxes, net	(10,809)		(12,439)
Other regulatory assets	12,227		18,842
Various refunds to customers	(3,620)		(8,478)
Total GSWC	$	(3,902)	$	(2,450)
BVESI
Derivative unrealized loss (Note 5)	2,518		—
Other regulatory assets	171		—
Total AWR	$	(1,213)	$	(2,450)

Regulatory matters are discussed in the consolidated financial statements and the notes thereto included in the Company's Form 10-K for the year ended December 31, 2019 filed with the SEC. The discussion below focuses on significant matters and developments since December 31, 2019.

Alternative-Revenue Programs:

GSWC records the difference between what it bills its water customers and that which is authorized by the CPUC using the Water Revenue Adjustment Mechanism ("WRAM") and the Modified Cost Balancing Account (“MCBA”) accounts approved by the CPUC. The over- or under-collection of the WRAM is aggregated with the MCBA over- or under-collection for the

corresponding ratemaking area and bears interest at the current 90-day commercial paper rate. On August 27, 2020, the CPUC issued a final decision in the first phase of the CPUC’s Order Instituting Rulemaking evaluating the low income ratepayer assistance and affordability objectives contained in the CPUC’s 2010 Water Action Plan, which also addressed other issues including matters associated with the continued use of the WRAM by California water utilities. The final decision also addressed the continued use of the MCBA, which is a full-cost balancing account used to track the difference between adopted and actual water supply costs (including the effects of changes in both rates and volume). Based on the final decision, any general rate case application filed by GSWC and the other California water utilities after the August 27, 2020 effective date of this decision, may not include a proposal to continue the use of the WRAM or MCBA, but may instead include a proposal to use a limited price adjustment mechanism (the Monterey-Style WRAM) and an incremental supply cost balancing account. On or prior to October 5, 2020, GSWC, other California water utilities, and the California Water Association filed separate applications for rehearing on this matter. At this time, management cannot predict the outcome of this matter.

As required by the accounting guidance for alternative revenue programs, GSWC is required to collect its WRAM balances, net of its MCBA, within 24 months following the year in which an under-collection is recorded in order to recognize such amounts as revenue. The recovery periods for the majority of GSWC's WRAM/MCBA balances are primarily within 12 to 24 months. In February 2020, GSWC filed with the CPUC for recovery of the 2019 WRAM/MCBA balances. Accordingly, GSWC implemented surcharges to recover all of its WRAM/MCBA balances as of December 31, 2019. For the three months ended September 30, 2020 and 2019, surcharges (net of surcredits) of approximately $4.4 million and $5.5 million, respectively, were billed to customers to recover previously incurred under-collections in the WRAM/MCBA accounts. For the nine months ended September 30, 2020 and 2019, surcharges (net of surcredits) of approximately $10.5 million and $9.1 million, respectively, were billed to customers to recover previously incurred under-collections in the WRAM/MCBA accounts. During the nine months ended September 30, 2020, GSWC recorded additional net under-collections in the WRAM/MCBA accounts of approximately $12.8 million due to lower-than-adopted water usage, as well as higher-than-adopted supply costs currently in billed customer rates. As of September 30, 2020, GSWC had an aggregated regulatory asset of $24.9 million, which is comprised of a $10.3 million under-collection in the WRAM accounts and a $14.6 million under-collection in the MCBA accounts.

Catastrophic Event Memorandum Account:

The CPUC has approved GSWC's and BVESI's requests to activate a Catastrophic Event Memorandum Account ("CEMA") for the impact of the COVID-19 pandemic. The Company's response to the pandemic has included suspending service disconnections for nonpayment. Costs incurred by GSWC and BVESI in response to the COVID-19 pandemic, including bad debt expense in excess of what is included in their respective revenue requirements, are being included in the CEMA accounts for future recovery. As of September 30, 2020, $1.4 million in COVID-19 related incremental costs have been recorded as regulatory assets as GSWC and BVESI believe their respective costs are probable of recovery.

Cost of Capital Proceeding:

In March 2018, the CPUC issued a final decision in the cost of capital proceeding for GSWC and three other water utilities serving California for the years 2018 – 2020. Among other things, the final decision adopted for GSWC's water segment a return on equity of 8.90%, with a return on rate base of 7.91%.

Investor-owned water utilities serving California are required to file their cost of capital applications on a triennial basis, with the next scheduled filing required to have taken place on May 1, 2020 and to be effective for the years 2021 – 2023. In January 2020, GSWC, along with the three other water utilities, requested an extension of the date by which each of them must file its 2020 cost of capital application. In March 2020, the CPUC approved the request, postponing the filing date by one year until May 1, 2021, with a corresponding effective date of January 1, 2022. GSWC’s current authorized rate of return on rate base of 7.91%, based on its weighted cost of capital, will continue in effect through December 31, 2021.