Prospectively Relevant Test Year
In a rising-cost industry with heavy capital investment requirements, the use of historic test years assures there will be no return on or recovery of capital that is invested during the test year and thereafter until the utility files another rate case. Any return on such investments could therefore be delayed for a number of years. This discourages necessary investment during these periods and skews construction and investment timing based on artificial test year issues rather than system needs and efficient construction planning processes. Due to regulatory lag, strictly historical test years can virtually ensure that the utility does not earn its allowed rate of return, thereby increasing risk and the cost of capital.
From a regulatory and public policy perspective, the touchstone for test years should be whether they produce rates that are prospectively relevant, that is, that the rates most accurately reflect the costs during the period the rates are most likely to be effective. A "best practice" in this area would provide the utility with the obligation to identify the most prospectively relevant test year and the choice to use that test year in a rate proceeding. The utility would have the choice of utilizing a historic, current or future test year and would have the burden of demonstrating the propriety of that choice in the rate proceeding. The use of future test years would have additional filing and proof requirements associated with them to assure that any projections are reasonable. Any party could of course challenge the utility's choice of test year.
This PDF is a 50-state survey on the test years utilized by public utilities commissions in setting rates.