Regulatory Matters

In accordance with accounting principles for rate-regulated enterprises, Registrant records 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, 2018, Registrant had approximately $59.6 million of regulatory liabilities, net of regulatory assets not accruing carrying costs. Of this amount, (i) $81.9 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) $15.8 million of regulatory liabilities are from flowed-through deferred income taxes, (iii) $33.5 million of regulatory assets relates to the underfunded position in Registrant's pension and other post-retirement obligations (not including the two-way pension balancing accounts), and (iv) $1.1 million of regulatory assets relates to a memorandum account authorized by the CPUC to track unrealized gains and losses on BVES's purchase power contracts over the term of the contracts.

Regulatory assets represent costs incurred by GSWC for which it has received or expects to receive rate recovery in the future. In determining the probability of costs being recognized in other periods, GSWC considers regulatory rules and decisions, past practices, and other facts and circumstances that would indicate if recovery is probable. If the CPUC determines that a portion of GSWC’s assets are not recoverable in customer rates, GSWC must determine if it has suffered an asset impairment requiring 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 12 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, 2018			December 31, 2017
GSWC
Water Revenue Adjustment Mechanism, net of Modified Cost Balancing Account	$	24,264		$	29,556
Costs deferred for future recovery on Aerojet case	9,809			10,656
Pensions and other post-retirement obligations (Note 8)	31,066			33,019
Derivative unrealized loss (Note 5)	1,143			2,941
Low income rate assistance balancing accounts	3,660			5,972
General rate case memorandum accounts	6,798			10,522
Other regulatory assets	15,506			14,875
Excess deferred income taxes (Note 7)	(81,912		)	(83,231		)
Flow-through taxes, net (Note 7)	(15,816		)	(17,716		)
Tax Cuts and Jobs Act ("Tax Act") memorandum accounts	(8,274		)	—
Various refunds to customers	(7,880		)	(4,552		)
Total	$	(21,636	)	$	2,042

Regulatory matters are discussed in detail in the consolidated financial statements and the notes thereto included in the Form 10-K for the year ended December 31, 2017 filed with the SEC. The discussion below focuses on significant matters and developments since December 31, 2017.

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 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.

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. GSWC has implemented surcharges to recover its WRAM/MCBA balances as of December 31, 2017. For the three months ended September 30, 2018 and 2017, surcharges (net of surcredits) of approximately $7.7 million and $11.4 million, respectively, were billed to customers to recover previously incurred under-collections in the WRAM/MCBA accounts. For the nine months ended September 30, 2018 and 2017, surcharges (net of surcredits) of approximately $17.5 million and $24.8 million, respectively, were billed to customers. During the nine months ended September 30, 2018, GSWC recorded additional net under-collections in the WRAM/MCBA accounts of $12.2 million mainly due to higher than adopted supply costs. As of September 30, 2018, GSWC had an aggregated regulatory asset of $24.3 million, which is comprised of a $3.4 million under-collection in the WRAM accounts and a $20.9 million under-collection in the MCBA accounts.

Other Regulatory Matters:

Tax Cuts and Jobs Act ("Tax Act"):

On December 22, 2017, the Tax Act was signed into federal law. The provisions of this major tax reform were generally effective January 1, 2018. The most significant provisions of the Tax Act impacting GSWC are the reduction of the federal corporate income tax rate from 35% to 21% and the elimination of bonus depreciation for regulated utilities. Pursuant to a CPUC directive, the 2018 impact of the Tax Act on the water segment’s adopted revenue requirement is being captured in a memorandum account effective January 1, 2018. For the three and nine months ended September 30, 2018, approximately $944,000 and $7.4 million, respectively, of reduced water-revenue requirements were tracked and recorded as a regulatory liability, which were largely offset by decreases in income tax expense. In March 2018, GSWC filed updated testimony revising the revenue requirements to reflect the impacts of the Tax Act in its pending water general rate case that will set new rates for the years 2019 - 2021. On July 1, 2018, new lower water rates, which incorporate the new federal income tax rate, were implemented for all water ratemaking areas.

The CPUC also ordered GSWC to update its pending electric general rate case filing, which will determine new electric rates for the years 2018 - 2021, to reflect the lower federal corporate income tax rate. As a result, for the three and nine months ended September 30, 2018, GSWC reduced electric revenues by approximately $125,000 and $848,000, respectively, and recorded a corresponding regulatory liability that will be satisfied as part of implementing overall new rates from the general rate case retroactive to January 1, 2018.

Reductions in the water and electric revenue requirements resulting from the impacts of the Tax Act are largely offset by decreases in GSWC's income tax expense, resulting in no material impact to earnings (see Note 7).

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 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%. The previously authorized return on equity for GSWC’s water segment was 9.43%, with a return on rate base of 8.34%. Including the effects of the Tax Act, the lower return on equity and rate base are expected to decrease GSWC’s annual adopted revenue requirement beginning in 2018 by approximately $3.6 million. In April 2018, GSWC implemented new water rates to incorporate the cost of capital decision. For the nine months ended September 30, 2018, GSWC recorded a regulatory liability with a corresponding decrease in water revenues of approximately $955,000 representing the revenue difference between the old and new cost of capital rates through April 2018.

Pending General Rate Case Filings:

In July 2017, GSWC filed a general rate case application with the CPUC for all of GSWC’s water regions and the general office. This general rate case will determine new water rates for the years 2019 - 2021. On August 15, 2018, GSWC and the CPUC’s Public Advocates Office ("CalPA"), formerly the Office of Ratepayer Advocates, filed a joint motion to adopt a settlement agreement between GSWC and CalPA in connection with this general rate case. If approved by the CPUC, this settlement agreement will resolve all of the issues in the general rate case. GSWC and CalPA informed the assigned Administrative Law Judge ("ALJ”) that hearings would not be needed in light of the settlement agreement. Subsequently, the ALJ issued a ruling requesting additional information on a number of items in the general rate case. GSWC has provided the additional information requested by the ALJ and believes it has satisfied all of the questions raised. Both the ALJ’s request and GSWC’s response are public information. At this time, GSWC is awaiting a proposed decision by the ALJ, which is expected during the fourth quarter of 2018, with a final decision by the CPUC expected by the first quarter of 2019. When approved, the new rates will become effective January 1, 2019.

In May 2017, GSWC filed its electric general rate case application with the CPUC to determine new electric rates for the years 2018 through 2021. GSWC and CalPA have reached a tentative settlement, which resolves all revenue requirement issues in this general rate case. A settlement conference with all parties in the rate case is scheduled for November 2018. Among other things, the tentative settlement incorporates a previous stipulation in the case, which authorizes a new return on equity for GSWC's electric segment of 9.60%. GSWC’s prior authorized return on equity for its electric segment was 9.95%. The stipulation also included a capital structure and debt cost similar to those approved by the CPUC in March 2018 in connection with GSWC's water segment cost of capital proceeding, as discussed above. Because of the delay in finalizing the electric general rate case, year-to-date 2018 billed electric revenues have been based on 2017 adopted rates, pending a final decision by the CPUC in this rate case application. When a final decision is approved, the new electric rates will be retroactive to January 1, 2018.